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Cognizant
Overweight ; CTSH, CTSH US
10-K Review: Growth Driven by Existing Clients, Margins Sustainable
The overall message in CTSH’s Form 10-K was consistent with the recent earnings
call – strong growth across the board. The company is seeing strong ramp-up in its
existing customers – a primary driver of its premium growth rate. CTSH’s India-based
costs (and wages) increased this year, but we believe sensitivities are very manageable
and lower than peers’; we see enough levers in the business model to help offset such
margin pressure. We continue to like CTSH for its attractive long-term growth
potential and believe the stock is a core growth holding. CTSH remains our top ITS
pick despite its premium multiple of 27x our CY11 EPS estimate vs. peers at 20x.
• Broad-based growth. All service lines, verticals, and regions grew 5% or more
on a q/q basis in 4Q10. The Form 10-K also indicated that the company’s top five
account contribution increased 5% q/q, accounts 5-10 increased 6% q/q, and all
other clients increased 9% on a sequential basis. CTSH plans to continue investing
in its EMEA and Asian businesses and expects the two regions will drive its longterm growth. The company had 12,200 project managers and senior technical
personnel as of 4Q10, compared to 8,300 last year (a 47% increase).
• Growth acceleration in existing customers, while new accounts’ contribution
slightly declined. Revenue from CTSH’s existing customers (customer for more
than a year at the quarter end) increased 36% y/y in CY10, up from 13% in CY09.
New client contribution to y/y revenue growth interestingly remained steady at
300bps in both years. High growth in existing clients is consistent with our view
that CTSH’s premium growth stems from faster penetration in its existing client
accounts. New client contribution was particularly strong in the manufacturing/
retail and “Other” segments (56% of total new client revenue vs. 33% of revenue).
• Healthcare payors and BFS were strong. CTSH’s healthcare payors vertical
likely grew at a 50%+ y/y rate in CY10. The sub-segment contributed 65% of the
y/y growth in company’s healthcare and life sciences vertical, despite that it
represents ~50% of the vertical’s revenue. Revenue from banking and capital
market clients increased by $410M in CY10 vs. CY09, potentially increasing at a
~45% rate in CY10 – faster than the overall company growth rate.
• Rupee and wage inflation sensitivity increased. A 1% appreciation in Indian
rupee vs. the USD resulted in ~27-bp margin impact, higher than last year’s
sensitivity but in line with recent trends. Net of hedges, the impact of 1%
appreciation in the Indian rupee (vs. the USD) is 14bps. Indian wages represented
more than 20% of total costs in CY10 (vs. less than 20% last year and 23% in
C3Q10). We attribute the increased sensitivities to offshore based costs to annual
salary increases. However, the company mentioned price increases should help it
offset margin impact of wage inflation.
• Bonus accruals. The company’s compensation-related accruals (primarily stems
from bonus accruals in our est.) rose by $117M in 4Q10 (vs. an increase of $112M
in 3Q). As a percentage of revenue, compensation accruals represented 8.9% of
4Q10 revenue vs. 9.2% in 3Q10. We believe accruals could be a key margin lever
at management’s disposal to offset any unanticipated headwinds. We expect CTSH
to continue to report non-GAAP margins in the upper half of its 19-20% range.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Cognizant
Overweight ; CTSH, CTSH US
10-K Review: Growth Driven by Existing Clients, Margins Sustainable
The overall message in CTSH’s Form 10-K was consistent with the recent earnings
call – strong growth across the board. The company is seeing strong ramp-up in its
existing customers – a primary driver of its premium growth rate. CTSH’s India-based
costs (and wages) increased this year, but we believe sensitivities are very manageable
and lower than peers’; we see enough levers in the business model to help offset such
margin pressure. We continue to like CTSH for its attractive long-term growth
potential and believe the stock is a core growth holding. CTSH remains our top ITS
pick despite its premium multiple of 27x our CY11 EPS estimate vs. peers at 20x.
• Broad-based growth. All service lines, verticals, and regions grew 5% or more
on a q/q basis in 4Q10. The Form 10-K also indicated that the company’s top five
account contribution increased 5% q/q, accounts 5-10 increased 6% q/q, and all
other clients increased 9% on a sequential basis. CTSH plans to continue investing
in its EMEA and Asian businesses and expects the two regions will drive its longterm growth. The company had 12,200 project managers and senior technical
personnel as of 4Q10, compared to 8,300 last year (a 47% increase).
• Growth acceleration in existing customers, while new accounts’ contribution
slightly declined. Revenue from CTSH’s existing customers (customer for more
than a year at the quarter end) increased 36% y/y in CY10, up from 13% in CY09.
New client contribution to y/y revenue growth interestingly remained steady at
300bps in both years. High growth in existing clients is consistent with our view
that CTSH’s premium growth stems from faster penetration in its existing client
accounts. New client contribution was particularly strong in the manufacturing/
retail and “Other” segments (56% of total new client revenue vs. 33% of revenue).
• Healthcare payors and BFS were strong. CTSH’s healthcare payors vertical
likely grew at a 50%+ y/y rate in CY10. The sub-segment contributed 65% of the
y/y growth in company’s healthcare and life sciences vertical, despite that it
represents ~50% of the vertical’s revenue. Revenue from banking and capital
market clients increased by $410M in CY10 vs. CY09, potentially increasing at a
~45% rate in CY10 – faster than the overall company growth rate.
• Rupee and wage inflation sensitivity increased. A 1% appreciation in Indian
rupee vs. the USD resulted in ~27-bp margin impact, higher than last year’s
sensitivity but in line with recent trends. Net of hedges, the impact of 1%
appreciation in the Indian rupee (vs. the USD) is 14bps. Indian wages represented
more than 20% of total costs in CY10 (vs. less than 20% last year and 23% in
C3Q10). We attribute the increased sensitivities to offshore based costs to annual
salary increases. However, the company mentioned price increases should help it
offset margin impact of wage inflation.
• Bonus accruals. The company’s compensation-related accruals (primarily stems
from bonus accruals in our est.) rose by $117M in 4Q10 (vs. an increase of $112M
in 3Q). As a percentage of revenue, compensation accruals represented 8.9% of
4Q10 revenue vs. 9.2% in 3Q10. We believe accruals could be a key margin lever
at management’s disposal to offset any unanticipated headwinds. We expect CTSH
to continue to report non-GAAP margins in the upper half of its 19-20% range.
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