The coronavirus pandemic led macroeconomic downturn has led to a slowdown in IT spending, which has impacted adoption of consultation and transaction processing solutions. Consequently the outlook for the Zacks Computers – IT Services industry appears drab at the moment.
However, ongoing digitization and measures to diversify IT services has somewhat improved the prospects for the industry players. Infosys Limited (INFY - Free Report) , EPAM Systems (EPAM - Free Report) , CDW Corporation (CDW - Free Report) and Fair Isaac (FICO - Free Report) are few stocks benefiting from this trend. Moreover, solid demand for advanced IT-service infrastructure solutions for remote working and digital healthcare has been a boon for these IT Service providers.
The Zacks Computers – IT Services industry comprises companies that provide consultancy, communications, IT management & operations, cloud-based web development platform, customer relationship management, professional information solutions and outsourcing services.
The industry participants serve a wide array of end-markets, which include manufacturing, banking, insurance, healthcare, government agencies and public sector institutions.
What’s Shaping the Future of the Computers – IT Services Industry
Sluggish IT Spending Mars Prospects: Coronavirus crisis-induced sluggish spending across small and medium businesses (SMBs) owing to restricted economic activity globally has impacted adoption of IT-services, primarily consulting services applications, infrastructure management, and transaction processing platforms. The industry players are anticipated to bear the brunt of slowdown in IT spending, as predicted by IDC. Additionally, shift in consumer buying patterns amid coronavirus-led supply chain constraints are likely to dampen the industry’s prospects.
Moreover, COVID-19 pandemic led softness in the automotive, travel and hospitality end-markets, is concerning.
STEM Skills Crisis Remains a Woe: Increasing U.S. protectionism continues to hurt the industry’s prospects as traditional IT services providers are significantly exposed to H1-B visa issuance. Notably, lack of skilled workers, particularly from STEM (Science, Technology, Engineering and Mathematics) fields in the United States, has been a concern for quite some time. Notably, coronavirus-led economic downturn has triggered layoffs and pay cuts, which are likely to lead to termination of H1-B visas and remain an overhang for some time now.
Growing Digitization is a Tailwind: Most of the industry participants are in the process of modernizing their traditional legacy-oriented business processes in order to keep pace with evolving IT services. The aim is to integrate synergies of emerging technologies including cloud, IoT, AI and analytics. Moreover, increasing Internet penetration in the emerging markets, particularly across Asia-Pacific, is a tailwind. For instance, DXC Technology (DXC - Free Report) , one of the notable IT services providers, is focusing on cyber business, cloud computing market and Big Data business to bolster prospects.
Remote Work & Online Learning Trends Boost Prospects: The industry’s growth is expected to accelerate in the days ahead on increasing number of remote workers in the wake of the coronavirus crisis-induced work-from-home wave. In this era of digital transformation, enterprises are actively seeking a common ground between on-premise and cloud infrastructures that will enable them to provide flexible and easily adoptable hybrid solutions. Notably, coronavirus-triggered demand for remote working, digital healthcare and online learning solutions has accelerated the adoption of digital transformation offerings among enterprises, which bodes well for the industry. Markedly, ServiceNow (NOW - Free Report) , a prominent player in the industry, is gaining from rising adoption of its workflows by companies undergoing digital transformation.
Zacks Industry Rank Indicates Bleak Prospects
The Zacks Computers - IT Services is housed within the broader Zacks Computer And Technology Sector. It carries a Zacks Industry Rank #184, which places it in the bottom 27% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bearish near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic on this group’s earnings growth potential. While the industry’s earnings estimate for 2020 has moved down 10.7% since Mar 31, 2020, and the same for 2021 has slumped 7.3%.
Despite gloomy industry outlook, few stocks have the potential to outperform the market based on a strong earnings outlook. But before we present the top industry picks, it is worth taking a look at the industry’s shareholder returns and current valuation first.
Industry Outperforms S&P 500, Lags Sector
The Zacks Computers - IT Services Industry has outperformed the Zacks S&P 500 composite sector in the past year. However, the industry has underperformed the broader Zacks Computer and Technology in same timeframe.
The industry has returned 31.4% over this period compared with the S&P 500’s gain of 15.3%. Notably, the broader sector has rallied 32.7% in same timeframe.
One-Year Price Performance
Industry’s Current Valuation
Increasing spend on acquiring skilled talent, and restructuring initiatives involving modernizing the traditional IT-service infrastructure are leading to higher debt levels.
It therefore makes sense to value the industry on the basis of EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio because this valuation metric takes into account the level of debt.
On the basis of the trailing 12-month EV/EBITDA ratio, the industry is currently trading at 35.29X, higher than the S&P 500’s 12.59X and the sector’s 12.87X.
Over the past five years, the industry has traded as high as 35.29X and as low as 19.85X, with the median being at 27.45X, as the charts below show.
EV/EBITDA Ratio (TTM)
EV/EBITDA Ratio (TTM)
4 Lucrative IT Services Stocks
We will discuss here four stocks that carry either a Zacks Rank #1 (Strong Buy) or 2 (Buy), which investors can take a look at. These stocks are well positioned to grow in the near term. You can see the complete list of today’s Zacks #1 Rank stocks here.
CDW Corporation: CDW Corporation is well poised to benefit from increased demand for integrated IT solutions that enable remote working and operations continuity plan. This is also mitigating the adverse impact of soft IT spending. Moreover, the buyout of Scalar Decisions is expected to boost growth in Canada.
Although the shares of the company have declined 0.5% in the past year, this Zacks Rank #1 company’s core strength of providing best-in-class services and easy-to-acquire technologies bolsters its growth prospects. Progress in network management, storage management and operating system software is a tailwind.
For this Lincolnshire, IL-based company, the Zacks Consensus Estimate for 2020 earnings has been revised upward by 4.7% over the last 30 days to $5.77 per share.
Price and Consensus: CDW
Infosys Limited: The India-based consulting, technology, outsourcing, and next-generation digital services provider, is benefiting from large deal wins. Its sustained focus on Agile Digital and AI-driven Core services is a tailwind.
Moreover, strong demand for its services in cloud, IoT, cyber security, data and analytics is a key catalyst. Higher investments by clients in digital transformation, AI and automation are positives.
These factors are expected to aid this Zacks Rank #2 company navigate through an unfavorable political climate in the United States and an increasing anti-outsourcing sentiment in certain countries.
The Zacks Consensus Estimate for Infosys’ fiscal 2021 earnings has been revised 1.9% upward over the last 30 days to 55 cents per share. It has a trailing four-quarter earnings surprise of 2.08%, on average. The stock has gained 23.4% on a year-to-date basis.
Price and Consensus: INFY
EPAM Systems: EPAM Systems is well known for its software engineering and IT consulting services.
This Zacks Rank #2 company is gaining from broad-based growth across its industry verticals and geographies triggered by ongoing digital transformation, focus on customer engagement and product development.
Strong performance of the Financial Services segment, driven by rising demand for asset management and payment-processing offerings, is also a major positive. Further, acquisitions have been a key catalyst, which enabled this Newtown, PA-based company to penetrate new markets, and diversify and broaden its product portfolio.
The Zacks Consensus Estimate for 2020 earnings has been revised upward by almost 6% over the last 30 days to $5.86 per share. Shares of the company have returned 76.4% in the past one year.
Price and Consensus: EPAM
Fair Isaac Corporation: Fair Isaac provides analytical solutions, and data management products, and credit account management services to financial institutions, retailers, healthcare organizations, and public agencies. This also offers credit scoring, credit reporting agencies, credit card processing agencies, and insurers.
This Zacks Rank #2 company is benefiting from its Scores business and strength in credit analytics domain, which witnessed strong growth for the past several years. Special pricing initiative for the Scores business is a positive for 2020. Moreover, growth in its software business is a tailwind.
The growing clout of the company’s solutions that aid businesses to automate and enhance business workloads and make data-driven decisions, amid easing COVID-19 restrictions, augur well.
For this San Jose, CA-based company, the Zacks Consensus Estimate for fiscal 2020 earnings has been revised upward by 7.6% over the last 60 days to $8.60 per share. The stock has gained 26.8% in the past one year.
Price and Consensus: FICO