Cognizant - Results: Industry growth upper bound maintained - Ambit

Analyst: Ankur Rudra, CFA, ankurrudra@ambitcapital.com, Tel: +91 22 3043 3211

Our view of the results: Cognizant reported 2QCY12 (June ending) revenues of US$1.8bn, up 4.9% QoQ in line with its guidance (4.7% growth). Full year 2012 revenue guidance was maintained — US$ 7.34bn, +20% YoY. Banking and Retail recovered strongly growing 6% and 7% QoQ respectively in a seasonally strong period. 3QCY12 revenue guidance came in at US$ 1.88bn, +4.4% QoQ, indicating substantially better confidence than Infosys and Wipro, and reassuring the growth outlook for the underlying market - particularly belief in the pace of peers such as TCS and HCLT. Crucially, management highlighted that spending growth has returned in Banking and this helped Cognizant maintain guidance despite negative cross currency pressures. Cognizant has now grown to become the second largest Indian IT firm, outgrowing Infosys in the quarter about a year within outgrowing Wipro.

Sector takeaways: In our July 10 note, Is offshoring passé? we highlighted that the rising diversity in performance within the large Indian IT offshoring firms was driven by a difference in focus areas and ability to negotiate inflexion points. Indeed, Cognizant's results continue to display the continuing diversity in performance within the largest Indian IT firms with Cognizant, HCL Tech and TCS outgrowing Infosys and Wipro. Although not explicitly focused on infrastructure management, Cognizant scores highly on our skill mapping index for key success factors in terms of its customer proximity and hunting skills that help it grow faster than erstwhile larger rivals. Cognizant reiterated its full year growth guidance that is reassuring to the extent that the business environment has not worsened over the last three months as some of its peers have been pointing to. Although the recovery in spending in Banking (up 6% QoQ), a positive growth, continues to be driven by non-discretionary services.

We had mentioned in February that Nasscom and Cognizant had set the growth bounds for the year with their annual guidance, respectively, 11%-14% and 23%. Weak results from Infosys and Cognizant in the March quarter had lowered the growth bounds from 8% (Infosys) to 20% Cognizant. In the June quarter even weaker tidings from Infosys have taken the low end of industry expectations to 5%. However, Cognizant's strong results, guidance and robust commentary keeps the upper growth bounds for the industry at 20%. We continue to expect overall industry growth to be modest while TCS and HCLT that enjoy a greater presence in Emerging Markets and Europe and a greater proportion of remote infrastructure management services (RIM) to outgrow peers comfortably. We continue to remain BUYers of TCS and HCLT and expect the shares to react strongly today. Whilst some of the optimism is likely to rub off on Wipro and Infosys we would be cautious of reading this as a turning point for these firms given deeper company specific problems here. We remain SELLers on both Wipro and Infosys.

Key takeaways from the earnings con call:

- Revenues: 2QCY12 revenues were US$1.795bn, +4.9% QoQ, stronger than 1Q and just ahead of the guidance. Although return of strong seasonal growth is a positive, the QoQ movement was on the back of weaker comps.

- Verticals: Banking returned to a healthy growth of 6% QoQ led by insurance, while Retail remained strong at 7% QoQ. Healthcare growth remained muted at 3.6% due to weak trends in pharma.

- Application maintenance and Application development: Application development grew at 5.3% QoQ while application management grew at 4.3% QoQ. Management reiterated that the 20% YoY US$ revenue guidance is underpinned by strength in non-discretionary service lines.

- Stable pricing: Management reiterated that pricing continues to be stable.

- Geographies: Europe was flat, hurt by cross-currencies while the US grew by 5.5% QoQ. Whilst Cognizant continues to struggle to find its rhythm in Europe, management highlighted optimism about the European pipeline for CY13. ROW grew by 16% QoQ on a small base.

- Debtor days and CFO: Debtor days increased marginally to 74 (+1 days QoQ), although they improved from last year (75). Cash conversion improved from 72% to 88% YoY while CFO was up 51% YoY and FCF, 36% YoY.

Source : Equity Bulls

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