Cognizant Sails in Choppy Waters

Recent outlook for companies in the IT Services sector has not been positive, and the sentiment has been supported by datapoints through CY2009. However, companies like Cognizant Technology Solutions Corp. (CTSH, Hold), Infosys Technologies, Ltd. (INFY, Hold) and Wipro Ltd. (WIT, Hold) appear to be bucking the trend and the shares have recovered nicely in the past couple of weeks.

Is this a case of "rising tide lifting all boats," given the market's upswing over the last week or so, or the beginning of a largely fundamental bullish scenario?

A closer look at the datapoints does not support a bullish outlook. Current offshore outsourcing bookings activity level remains depressed and pricing pressure of 5%-15% has become commonplace. Demand in the U.K. has softened noticeably in the last few months and client IT budgets in 2009 may end up down close to 10%-15%, putting material pressure on discretionary IT project spending.

The Indian outsourcing vendors are calling for revenues from the banking vertical to stabilize in Q2:09 after a Q1:09 sequential decline, for industry pricing to be stable or down just modestly in 2009 and for overall client IT budgets in 2009 to be down perhaps 0%-5%.

Likewise, sell-side analysts are expecting sequential revenue growth rates to turn positive for Infosys and Cognizant in Q2:09 following a sequential decline of up to 10% for the top-tier vendors in Q1:09. It seems unlikely that these assumptions will come true. Instead, industry revenues may sequentially go down again in Q2:09 and in Q3:09 before finally stabilizing in Q4:09.

However, it appears plausible that the major Indian firms can hold their margins at least in H1:09, especially with the rupee depreciating by another 5%-6% against the dollar over the recent past. Overall, it seems likely that there may be one or two downward guidance revisions as the light bookings activity, the accelerating pricing pressure and the just-completed and worse-than-expected 2009 client IT budget results work their way into vendor expectations.

On the lighter side, CTSH expects to strengthen its business by taking market share and acquiring companies/talent, catering to demand for cost containment services and focusing on operating discipline. For instance, Cognizant recently acquired a 30-person outfit that specializes in implementation of Oracle-based Retail solutions.

In Q4:08, Cognizant also initiated a hedging program ($350 million @ INR 49.44) to shield a portion of its rupee-denominated expenses. Also, Cognizant expects no direct/adverse impact from the recently proposed TARP/H-1B legislation.

Clients are placing greater emphasis on certain vendor attributes -- i.e., a trusted partner with unswerving commitment; deep industry knowledge combined with service innovation; and the highest standards of corporate integrity and ethics. Cognizant may eventually gain from such attributes.

Read the full analyst report on CTSH

Read the full analyst report on INFY

Read the full analyst report on WIT