J.P. Morgan - India IT Services

Uncovering interesting patterns in Cognizant's Q/Q growth - it's all about outperformance in the quarters that matter

Cognizant’s (Cognizant rated OW – covered by Tien-tsin Huang) sequential (Q/Q) growth characteristics display an interesting pattern relative to its Indian peers. On examination of growth data, we make the following observations and draw conclusions from these observations:

· One, Cognizant’s revenue growth drop/slide in the fourth quarter (4Q) of the calendar year (Oct – Dec quarter) is the steepest relative to peers. Here, we define “slide or drop” in 4Q as the difference in sequential Q/Q revenue growth between 3Q and 4Q (i.e. Q/Q revenue growth in 3Q – Q/Q revenue growth in 4Q). Cognizant does not seem to distinguish itself on 4Q growth (relative to peers) - it does so in the seasonally strong quarters of the year (which is the June and September quarters, i.e. Cognizant’s 2Q and 3Q). In fact, its own revenue beat in 4Q relative to guidance has been modest/negligible in the past 3 years – a bit unusual for a company that normally registers fairly decent revenue beat in 2Q and 3Q relative to its own revenue guidance.

· Two, Cognizant’s growth build-up in the second quarter (2Q) of the calendar year (Apr-Jun quarter) relative to 1Q (Jan – Mar) is the maximum relative to peers. Here, we define “build-up” in 2Q as the difference in sequential Q/Q revenue growth between 2Q and 1Q (i.e. Q/Q revenue growth in 2Q – Q/Q revenue growth in 1Q). The June quarter (Cognizant’s 2Q) is the first quarter of the year that sees the full force of discretionary spending.

We draw three conclusions from this:

(a) One, Cognizant’s outperformance relative to peers and its own guidance is maximum in the two strongest quarters of the year (Jun and Sep). These are the two quarters that witness the maximum force of discretionary spending.Clearly, Cognizant does a much better job than peers of catering to discretionary spends (its exposure to the US is even more pronounced than peers; the US, as a geography, sees more discretionary spending than Europe; the latter is opening up more for outsourcing). In addition, Cognizant’s performance in 1Q (Jan-Mar), which sees the initial phase of discretionary spending towards the end of the quarter, is generally ahead of peers and its own guidance though not to the same extent as in 2Q/3Q, which see the full force of discretionary spending. Good companies, such as Cognizant, take disproportionate share of discretionary spends.

(b) Two, not all discretionary spending comes wrapped as RFP/RFI (or as opportunities that the client identifies). The proportion of discretionary spending that arises from opportunities uncovered by the vendor from familiarity with the clients’ business, processes and systems and from taking an integrated client view is higher than in pure outsourcing - outsourcing tends to be relatively more RFP/RFI driven. Busy, proactive account and delivery managers are not just those who respond with alacrity and finesse to proposals floated by the client but also those who uncover opportunities themselves through insights gained by ongoing interaction with the client. The likes of Cognizant and TCS do a better job (relatively speaking) of driving this in the stronger quarters.

(c) Three, laggards such as Infosys/Wipro just have to make the stronger quarters count. There is little point in laggards pointing to near growth parity with growth leaders in the seasonally weaker quarters such as 4Q and 1Q of the calendar year (particularly, 4Q). This is little indication of whether the laggards are closing the revenue growth gap relative to leaders. Where the rubber meets the road is in performance in the stronger quarters, which is where growth leaders pull ahead.

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Figure 1: Cognizant’s Jun quarter (vs. Mar) revenue growth pick-up (Jun qtr. Q/Q growth – Mar qtr. Q/Q growth) is the steepest among peers, while growth deceleration/slide in December quarter (from September quarter) is also the maximum vis-à-vis peers

Source: Company reports, J.P. Morgan; Note: We have not included HCLT Jun-09 minus Mar-09 quarter revenue growth in the calculation of its average because of distortion caused by AXON acquisition impact

Figure 2: Cognizant’s revenue growth acceleration in the first seasonally strong quarter of the year (June quarter) is maximum compared to other large Indian IT players.....

Source: Company reports J.P. Morgan

Figure 3: ……while revenue growth deceleration in the Dec. quarter (vs. Sep. quarter) is also maximum compared to peers; the Q/Q revenue growth in Dec. quarter is in line with Indian peers, but Cognizant pulls ahead in the first three quarters of the calendar year (relatively/seasonally strong quarters)

Source: Company reports J.P. Morgan

Figure 4: In recent times, Cognizant's December quarter (Q4) Q/Q revenue growth is generally quite tightly in line with its Q4 revenue growth guidance; the company does not keep much headroom to beat the guidance for December quarter, but….

Source: Company reports J.P. Morgan

Figure 5: Cognizant keeps decent headroom to beat Q1 guidance; the company has consistently grown ahead of its Q1 guidance by a meaningful margin (the Mar quarter starts seeing some initial pick-up of discretionary spending towards the end of the quarter) – it just gets better in Q2 and Q3 of Cognizant’s fiscal

Source: Company reports J.P. Morgan

Table 1: Quarterly revenue growth trend for large 5 IT offshoring players; revenue growth pick-up is the steepest for Cognizant in June quarter (vs. March quarter), while the company sees the highest deceleration in revenue growth in Dec. quarter (from Sep. quarter); Cognizant registers meaningful outperforms (vs. peers) in Jun and Sep quarters (seasonally strong quarters)

	Q/Q revenue growth					Jun quarter revenue growth – (minus) Mar qtr growth	Dec quarter revenue growth – (minus) Sep. qtr growth
Cognizant	Mar quarter	Jun quarter	Sep. quarter	Dec. quarter
2009	-1.0%	4.1%	9.9%	5.8%		5.1%	-4.1%
2010	6.3%	15.2%	10.1%	7.7%		8.8%	-2.4%
2011	4.6%	8.3%	7.8%	3.9%		3.7%	-3.9%
2012	2.9%	4.9%	5.4%	3.0%		2.0%	-2.4%
2013	3.7%	7.0%	6.7%	2.2%		3.2%	-4.5%
Average	3.3%	7.9%	8.0%	4.5%		4.6%	-3.5%
Maximum	6.3%	15.2%	10.1%	7.7%		8.8%	-2.4%
Minimum	-1.0%	4.1%	5.4%	2.2%		2.0%	-4.5%
TCS	Mar quarter	Jun quarter	Sep. quarter	Dec. quarter
2009	-3.4%	3.3%	3.9%	6.3%		6.7%	2.4%
2010	3.1%	6.4%	11.7%	7.0%		3.3%	-4.7%
2011	4.7%	7.5%	4.7%	2.4%		2.8%	-2.3%
2012	2.4%	3.0%	4.6%	3.3%		0.6%	-1.3%
2013	3.1%	4.1%	5.5%	3.0%		1.0%	-2.4%
Average	2.0%	4.9%	6.1%	4.4%		2.9%	-1.7%
Maximum	4.7%	7.5%	11.7%	7.0%		6.7%	2.4%
Minimum	-3.4%	3.0%	3.9%	2.4%		0.6%	-4.7%
Infosys	Mar quarter	Jun quarter	Sep. quarter	Dec. quarter
2009	-4.3%	0.1%	2.9%	6.8%		4.4%	3.9%
2010	5.2%	4.8%	10.2%	5.9%		-0.4%	-4.2%
2011	1.1%	4.3%	4.5%	3.4%		3.2%	-1.1%
2012	-1.9%	-1.1%	2.6%	6.3%		0.9%	3.8%
2013	1.4%	2.7%	3.8%	1.6%		1.3%	-2.1%
Average	0.3%	2.2%	4.8%	4.8%		1.9%	0.1%
Maximum	5.2%	4.8%	10.2%	6.8%		4.4%	3.9%
Minimum	-4.3%	-1.1%	2.6%	1.6%		-0.4%	-4.2%
Wipro	Mar quarter	Jun quarter	Sep. quarter	Dec. quarter
2009	-4.9%	-1.3%	3.2%	5.8%		3.6%	2.6%
2010	3.5%	3.2%	5.7%	5.6%		-0.2%	-0.2%
2011	4.2%	0.5%	4.6%	2.2%		-3.7%	-2.4%
2012	2.0%	-1.4%	1.7%	2.4%		-3.4%	0.7%
2013	0.5%	0.2%	2.7%	2.9%		-0.3%	0.2%
Average	1.1%	0.3%	3.6%	3.8%		-0.8%	0.2%
Maximum	4.2%	3.2%	5.7%	5.8%		3.6%	2.6%
Minimum	-4.9%	-1.4%	1.7%	2.2%		-3.7%	-2.4%
HCLT	Mar quarter	Jun quarter	Sep. quarter	Dec. quarter
2009*	11.3%*	7.6%*	3.8%	3.4%			-0.3%
2010	5.1%	7.6%	9.0%	7.5%		2.5%	-1.5%
2011	5.8%	5.3%	4.1%	2.0%		-0.5%	-2.1%
2012	2.5%	3.0%	3.2%	3.6%		0.5%	0.5%
2013	3.2%	3.1%	3.5%	4.0%		-0.1%	0.5%
Average	4.5%	4.8%	4.7%	4.1%		0.6%	-0.6%
Maximum	5.8%	7.6%	9.0%	7.5%		2.5%	0.5%
Minimum	2.5%	3.0%	3.2%	2.0%		-0.5%	-2.1%

Source: Company reports, J.P. Morgan; Note: We have not included HCLT Mar-09 and Jun-09 quarter revenue growth in the calculation of average, minimum and maximum growth because of distortion caused by AXON acquisition impact

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