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Event update: IT Services - Cognizant Q3CY18 Results; Strong Commentary for BFSI, positive read through for large cap Indian IT

CY18 guidance cut due to client ramp down and currency

Cognizant’s (CTSH) Q3CY18 performance (USD 4.07 bn; 1.8% QoQ growth) was ahead of guidance, but lower than consensus expectation (Bloomberg; USD 4.08 bn). CTSH has cut CY18 revenue growth guidance to ~8.6-8.9% at USD 16.09-16.13 bn (earlier: ~8-10% at USD 16.05-16.30 bn) largely due to cross-currency headwinds and client ramp-down. After adjusting for acquisitions, c/c revenues grew 7.3% on organic basis. CTSH has guided for 0.3-1.3% revenue growth for the fourth quarter, which translates into US$4.09-4.13 bn in revenues. The guidance implies flattish growth for Q4 at bottom end of guidance and 1.4% growth at top end of guidance. The new guidance includes 70bps contribution from the Bolder acquisition and  cross-currency tailwind of 30bps, down from 60 bps earlier.

Commentary on Financial services indicates pickup in North America geography

All verticals grew at robust rate sequentially and on yoy basis except financial services. CTSH reported muted performance in Q3 (-0.3% QoQ) in Financial Services (below company’s average: 1.8%).Communications, media and tech once again led growth with impressive 17.1% yoy revenue growth. Management indicated that revenue growth from large North America has started recovering. European clients continue to see some softness as they transition through shift in technology, but are expected to follow the same trend as their North American peers. We believe the strong commentary on BFSI especially in North America will anticipate well for Indian IT companies. Consulting & Technology Services accounted for 58% of revenue and grew 6.6% YoY, outsourcing services (42% of revenue) grew by 10.7% YoY. The increase in outsourcing was driven by the acquisition of Bolder Healthcare and a large client win (TMG healthcare).

Strong Growth in Digital Vertical

CTSH Digital revenue accounted for 30% of revenue, up strong ~20% YoY, ahead of company’s average growth. Management reported good traction for digital services, especially in the US. Insurance spends were healthy among mid-tier banks. Management highlighted Digital offerings continue to generate higher margin than the company’s average. Management mentioned that key areas of growth in Digital are in Cloud migration, RPA, Machine Learning. According to the management, clients continue to optimize legacy to invest in Digital and Digital solutions, which is pressuring legacy offerings. BFSI commentary suggests IT spends specifically by North American banks are witnessing a comeback with focus on Digital and growth is likely to return in large clients.

Strong improvement in EBITDA margins

EBITDA margins performance was strong this quarter up by 160 bps QoQ due to (i) 74 bps tailwind from rupee depreciation, (ii) 75-80 bps tailwind from revenue recognition, (iii) 80 bps from operational efficiencies such as improved utilization and (iv) tailwinds from SG&A cost reduction, offset by 100 bps headwind from wage increases and promotions. CTSH have mentioned that they will reinvest any margin in excess of 21% in CY2018

Read-through for Indian IT

While CTSH guidance is disappointing but the commentary for BFSI is encouraging. We continue to remain positive on the demand environment as we can see improved deal wins and strong recovery in North America geography & financial services. Large deals wins were strong across players with digital growing faster than the rest of the businesses. We stay selective and prefer large-caps, maintain Outperformer on Infosys, TCS and TechM.