Please Share:: 
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Good is no longer enough
Revenue growth guidance fails
to excite; limited valuation
upside
Action: Valuations limit upside, wait for better entry point
Cognizant’s lower-than-anticipated revenue growth in 1QFY11 and its
FY11 revenue growth guidance do not provide enough triggers for an
increase in target price. While we like Cognizant for its growth
outperformance and relative margin stability, at the current valuation of
24x FY12F earnings, we see limited valuation upside and would wait for a
better entry point. Maintain NEUTRAL.
Catalyst: Outperformance of tier 1 peers in revenue growth
Return to material outperformance on revenue growth over tier 1 peers
would be an upside trigger for the stock.
Revenue concentration to limit outperformance of peers
We expect the revenue growth differential between Cognizant and Infosys
to narrow from 14% in FY10 to about 8% in FY11F largely on: 1) smaller
non-US presence in a diversifying demand scenario; and 2) smaller
contribution from faster-growing emerging service lines (BPO, IMS and
EAS).
Maintain NEUTRAL; estimates largely unchanged
Over FY10-12F, we expect Cognizant to grow revenue at a CAGR of 29%,
post an EBIT margin decline of 80bps to 18% and show an EPS CAGR of
20%. We retain our TP of US$83, based on 23x 1-yr rolling forward
earnings.
Third quarter without outperformance
Cognizant delivered 4.6% q-q revenue growth in 1QFY11 – which was slightly below our
expectation of 5.6%. For the last 3 quarters, the sequential revenue growth at Cognizant
has been comparable to that seen at tier 1 Indian IT peers. We believe this will lead to a
toning down of Street expectations as the company has historically (over the past 3
years) outperformed its peers in revenue growth by a wide margin. Continued
outperformance in our view is crucial for its premium valuations to sustain.
Guidance fails to excite
Cognizant increased its revenue growth guidance for FY11 to 29% (from 26% earlier).
With consensus growth expectations at 29% and the current stock price factoring in
much higher growth of around 35%, we see limited reasons for upgrades to consensus
estimates.
The other disappointment in the guidance was that despite a 2.8% increase in revenue
guidance for 2Q-4QFY11, corresponding EPS guidance was unchanged. The company’s
guidance for earnings over 2Q-4QFY11 is at US$2.05 (unchanged from earlier).
Revenue concentration to limit outperformance vs peers
We expect the revenue growth differential between Cognizant and Infosys to narrow
from 14% in FY10 to about 8% in FY11F largely on account of the following factors:
Smaller non-US presence
Cognizant derives 22% of revenues from non-US geographies (vs 35-45% at tier 1
Indian IT companies). Growth rates at Europe and Rest of the World are nearly double
that of the US across tier 1 Indian competitors over the last 3 quarters, and Cognizant’s
smaller scale in non-US geographies will limit above-normal growth rates, in our view.
Cognizant is seeing softness in demand in Europe – reflected in slower growth rates in
this region relative to peers, in 1QFY11. Revenues from Europe increased by only 1.5%
q-q in 1QFY11 – which was below the company’s growth rate. Ramp-down in M&Arelated
project work in the UK (which showed revenue decline of 3.5% q-q) was the
primary reason for the muted growth in Europe. according to management.
Smaller presence in growing service lines
Cognizant derives ~25% of revenues from service lines like BPO, IMS (infrastructure
management services) and EAS (enterprise application services) vs an average of 41%
for tier 1 Indian IT companies. As spending shifts towards discretionary-related work, we
think Cognizant could be at a disadvantage compared to peers like Infosys/HCL Tech,
which have a much larger and established enterprise application services portfolio.
Pricing unlikely to provide material upsides
Management commentary on pricing was not very optimistic – the pricing gain of 2% at
offshore and onsite in 1QFY11 reflects most of the gains for FY11. Peers like Infosys
and TCS gave more positive commentary about further pricing gains in the coming
quarters.
Wage hikes in-line with industry
Cognizant announced offshore wage hikes of 12-14% effective May 1, 2011 for the
majority of employees and July 1 for senior employees. Management remains confident
of absorbing the impact of wage hikes and maintaining margins at the upper end of 19-
20% for 2QFY11F. Utilization rates dropped by 300bps q-q in 1QFY11 (on the back of
strong net addition of 7,200 employees) would be the primary lever the company would
use to offset the margin impact from wage hikes
Other highlights
• Cash and investments totalled US$2.16bn at the end of 1Q.
• Days sales outstanding (DSO) was 74 in1Q, compared to 71 in 4Q;
• Strategic clients increased by 7 to 173, with each of top 10 clients contributing in
excess of US$100mn in revenues annually.
Change of estimates
We have slightly increased our FY11F revenue estimates on the back of the increase in
revenue guidance to 29%. Our FY12F and FY13F revenue estimates are largely
unchanged. We look for 32.2% revenue growth in FY11F and 25.2% in FY12F.
Our margin estimates have increased for FY11F on the back of better-than-expected
margin performance in 1QFY11. We retain our estimates for FY12F and FY13F.
Our tax rate assumptions are higher on the back of management guidance.
Over FY10-12F, we expect Cognizant to grow revenue at a CAGR of 29%, post an
EBIT margin decline of 80bps to 18% and show an EPS CAGR of 20%.
Maintain NEUTRAL; retain TP of US$83
We maintain our NEUTRAL rating on the stock, with a TP of US$83 based on 23x oneyear
rolling forward earnings.
Valuation Methodology and risks
Our PT of US$83 is based on 23x one-year rolling forward earnings (US$3.6). The 23x
target P/E multiple marks a 15% premium to Infosys to reflect our view of Cognizant’s
revenue growth outperformance and relative margin stability. Upside risks are higherthan-
anticipated volume growth and ability to maintain margins vs our expectation of
declines. Downside risks remain rupee appreciation, greater-than-anticipated supply-side
pressures, and demand deterioration in the US, a key market for Cognizant.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Good is no longer enough
Revenue growth guidance fails
to excite; limited valuation
upside
Action: Valuations limit upside, wait for better entry point
Cognizant’s lower-than-anticipated revenue growth in 1QFY11 and its
FY11 revenue growth guidance do not provide enough triggers for an
increase in target price. While we like Cognizant for its growth
outperformance and relative margin stability, at the current valuation of
24x FY12F earnings, we see limited valuation upside and would wait for a
better entry point. Maintain NEUTRAL.
Catalyst: Outperformance of tier 1 peers in revenue growth
Return to material outperformance on revenue growth over tier 1 peers
would be an upside trigger for the stock.
Revenue concentration to limit outperformance of peers
We expect the revenue growth differential between Cognizant and Infosys
to narrow from 14% in FY10 to about 8% in FY11F largely on: 1) smaller
non-US presence in a diversifying demand scenario; and 2) smaller
contribution from faster-growing emerging service lines (BPO, IMS and
EAS).
Maintain NEUTRAL; estimates largely unchanged
Over FY10-12F, we expect Cognizant to grow revenue at a CAGR of 29%,
post an EBIT margin decline of 80bps to 18% and show an EPS CAGR of
20%. We retain our TP of US$83, based on 23x 1-yr rolling forward
earnings.
Third quarter without outperformance
Cognizant delivered 4.6% q-q revenue growth in 1QFY11 – which was slightly below our
expectation of 5.6%. For the last 3 quarters, the sequential revenue growth at Cognizant
has been comparable to that seen at tier 1 Indian IT peers. We believe this will lead to a
toning down of Street expectations as the company has historically (over the past 3
years) outperformed its peers in revenue growth by a wide margin. Continued
outperformance in our view is crucial for its premium valuations to sustain.
Guidance fails to excite
Cognizant increased its revenue growth guidance for FY11 to 29% (from 26% earlier).
With consensus growth expectations at 29% and the current stock price factoring in
much higher growth of around 35%, we see limited reasons for upgrades to consensus
estimates.
The other disappointment in the guidance was that despite a 2.8% increase in revenue
guidance for 2Q-4QFY11, corresponding EPS guidance was unchanged. The company’s
guidance for earnings over 2Q-4QFY11 is at US$2.05 (unchanged from earlier).
Revenue concentration to limit outperformance vs peers
We expect the revenue growth differential between Cognizant and Infosys to narrow
from 14% in FY10 to about 8% in FY11F largely on account of the following factors:
Smaller non-US presence
Cognizant derives 22% of revenues from non-US geographies (vs 35-45% at tier 1
Indian IT companies). Growth rates at Europe and Rest of the World are nearly double
that of the US across tier 1 Indian competitors over the last 3 quarters, and Cognizant’s
smaller scale in non-US geographies will limit above-normal growth rates, in our view.
Cognizant is seeing softness in demand in Europe – reflected in slower growth rates in
this region relative to peers, in 1QFY11. Revenues from Europe increased by only 1.5%
q-q in 1QFY11 – which was below the company’s growth rate. Ramp-down in M&Arelated
project work in the UK (which showed revenue decline of 3.5% q-q) was the
primary reason for the muted growth in Europe. according to management.
Smaller presence in growing service lines
Cognizant derives ~25% of revenues from service lines like BPO, IMS (infrastructure
management services) and EAS (enterprise application services) vs an average of 41%
for tier 1 Indian IT companies. As spending shifts towards discretionary-related work, we
think Cognizant could be at a disadvantage compared to peers like Infosys/HCL Tech,
which have a much larger and established enterprise application services portfolio.
Pricing unlikely to provide material upsides
Management commentary on pricing was not very optimistic – the pricing gain of 2% at
offshore and onsite in 1QFY11 reflects most of the gains for FY11. Peers like Infosys
and TCS gave more positive commentary about further pricing gains in the coming
quarters.
Wage hikes in-line with industry
Cognizant announced offshore wage hikes of 12-14% effective May 1, 2011 for the
majority of employees and July 1 for senior employees. Management remains confident
of absorbing the impact of wage hikes and maintaining margins at the upper end of 19-
20% for 2QFY11F. Utilization rates dropped by 300bps q-q in 1QFY11 (on the back of
strong net addition of 7,200 employees) would be the primary lever the company would
use to offset the margin impact from wage hikes
Other highlights
• Cash and investments totalled US$2.16bn at the end of 1Q.
• Days sales outstanding (DSO) was 74 in1Q, compared to 71 in 4Q;
• Strategic clients increased by 7 to 173, with each of top 10 clients contributing in
excess of US$100mn in revenues annually.
Change of estimates
We have slightly increased our FY11F revenue estimates on the back of the increase in
revenue guidance to 29%. Our FY12F and FY13F revenue estimates are largely
unchanged. We look for 32.2% revenue growth in FY11F and 25.2% in FY12F.
Our margin estimates have increased for FY11F on the back of better-than-expected
margin performance in 1QFY11. We retain our estimates for FY12F and FY13F.
Our tax rate assumptions are higher on the back of management guidance.
Over FY10-12F, we expect Cognizant to grow revenue at a CAGR of 29%, post an
EBIT margin decline of 80bps to 18% and show an EPS CAGR of 20%.
Maintain NEUTRAL; retain TP of US$83
We maintain our NEUTRAL rating on the stock, with a TP of US$83 based on 23x oneyear
rolling forward earnings.
Valuation Methodology and risks
Our PT of US$83 is based on 23x one-year rolling forward earnings (US$3.6). The 23x
target P/E multiple marks a 15% premium to Infosys to reflect our view of Cognizant’s
revenue growth outperformance and relative margin stability. Upside risks are higherthan-
anticipated volume growth and ability to maintain margins vs our expectation of
declines. Downside risks remain rupee appreciation, greater-than-anticipated supply-side
pressures, and demand deterioration in the US, a key market for Cognizant.
No comments:
Post a Comment