Stock Fundamentals

Why you should accumulate Cognizant Technology stock

Hari Viswanath BL Research Bureau | Updated on August 01, 2021

Course correction provides an opportunity

Long-term investors can accumulate the stock of Nasdaq listed IT services company Cognizant Technology Solutions (Ticker: CTSH). Its business and operations are comparable with the Tier-1 Indian IT services companies (TCS, Infosys, Wipro and HCL Tech), driven and supported well by a solid offshore model based out of India. Cognizant’s lack of participation in the rally of IT service stocks and broader market, provides an opportunity for investors who are willing to be patient as the company fixes some of its past missteps that have impacted business performance in recent years.

On the basis of one-year forward PE (price to earnings) multiple of 17.2 times, Cognizant is trading inline with its historical average and at a good discount to Tier-1 peers (PE multiple range of 19 to 30 times).

The company is net cash positive (around 3 per cent of market cap) and the business is yielding strong cash flows (CY21 free cash flow yield expected at around 6 per cent) This, along with stability in earnings provides a decent margin of safety in the stock at current levels. Given that the turnaround visble from its recently reported Q2 results may take some time to yield results, investors can also accumulate the stock on dips, instead of buying in one go.

Business

The main driver of growth now is digital services, where Internet of Things (IoT), Artificial Intelligence (AI), experience driven software engineering and cloud are key areas of focus. At the end of June quarter, digital represented around 44 per cent of revenue and grew 15 per cent Y-o-Y.

The company has 4 business verticals – Financial Services (34 per cent of revenue), Healthcare (29 per cent), Communication and Technology (15 per cent), Products and Resources ( 22 per cent).

Cognizant gets three-fourths of its revenues from North America.Over the long-term US will likely remain the biggest spender on IT services.

Disruptions in recent years

. For the decade between CY 2006-16 (FY2007-17 for peers), it grew at a pace that far exceeded that of rivals – USD revenue CAGR of 25 per cent versus TCS at 19 per cent; Infosys at 16 per cent and Wipro at 13 per cent. However, since 2016, it has fallen a bit on the wayside. Its dollar revenue growth came at a CAGR of just 2 per cent between CY18-20 and operating margins contracted by almost 300 bps to 14 per cent in 2020.

While it is hard to pin point a single reason for its underperformance, it appears to be the cumulative effect of multiple distractions the company faced had to face since 2016. In 2016, it got embroiled in an alleged bribery investigation in India and thus violated US anti-corruption laws. This was followed by activist hedge fund Elliot Management taking a 4 per cent stake in the company in 2016 and pressurising the board and management to make changes to its business and financial strategies. Subsequently, company had to deal with an exodus of senior management. The company was hit by a ransomware attack in April 2020 just as Covid started impacting operations.

Turning around

The company has been gradually trying to find its feet back. In 2019 it appointed Brian Humphries, who was then the CEO of Vodafone Business and had wide experience in the tech industry, as its new CEO to drive its business with focus on digital segment.

In its recently concluded June quarter, the company surprised on the positive side with revenue of $4.6 billion and adjusted EPS of $0.99 that were about 3 per cent above consensus. It also increased its CY21 organic constant currency revenue growth guidance to 5.8 to 6.8 per cent versus growth of around 4 per cent guided at the end of March quarter. The results and guidance increase reflect strong demand for its digital solutions. Despite the high attrition which usually impact margins, the full year operating margin guidance was maintained, which can be viewed positively.

Published on July 31, 2021

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