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Event update: IT Services - Read from Cognizant 10-K filing; Mixed BFSI/Retail outlook

Key takeaways from Cognizant (Unrated) 10-K filing

Cognizant published its 10-K filing in SEC and the filing indicated that 1) Banking and Retail verticals were a drag on growth, 2) Outlook for these two verticals hasn’t changed materially, which is a divergence from the commentary of Infosys ( indicating improvement in BFSI) and TCS ( calling a bottoming out of Retail), 3) Europe (ex-UK) market share gain continues and 4) CTSH is looking to scale Digital practice areas and is looking at acquisitions to scale them and shifting headcount towards onshore markets. Overall CTSH’s performance is similar to what we have seen from Indian IT players (Infosys/TCS) and we believe that BFSI and Retail verticals are facing cyclical headwinds, and thus recovery in discretionary spending might be customer specific in CY18 (explains the divergence in vertical commentary), with a more secular pick up only in CY19. Maintain our positive stance on Indian IT.

Aligning digital into 3 practice areas

CTSH has aligned its Digital service offering into 3 practice areas 1) Digital Business, 2) Digital Operations, 3) Digital Systems and Technology. These three practice areas will be aligned across four industry oriented business segments of Cognizant. CTSH is undergoing reskilling, expansion of local workforce and acquisitions to scale these Digital practice areas. Most of the acquisitions (spent $233m in CY17) in 2017 were towards building these capabilities.

Commentary on BFSI and Retail outlook mixed

CTSH indicated that healthcare segment demand is likely to be affected by regulatory uncertainty in the US ( low exposure for Infosys/TCS). However Banking customers are still focussing on cost optimisation and discretionary spending among retail customers remains affected by weakness in the sector. This commentary is slightly divergent from Infosys and TCS which are either calling bottoming out and/or signs of improvement. We think this could possibly be explained by customer specific spending or better performance in sub segments (example Insurance doing better within BFSI). In any case, CY18 is not a big spending recovery year in our estimates.

CY17 – Revenue addition in Banking and Retail weak

We had highlighted in our IC note that Banking and retail segments for large cap Indian IT had been a drag verticals. We saw a similar trend for CTSH through CY17. Within financial services for CTSH, banking clients added only $79mn in revenues YoY in CY17 vs. $161m in CY16. Similar retail, CPG and Travel was weak as revenue addition for CY17 stood at $54m in revenues vs. $130m in CY16. However, Manufacturing and healthcare were outperformers with revenue addition of $326m and $279m. These two contributed 25% and 21% of revenue addition for CTSH in CY17 respectively

Rest of Europe key outperformer through 2017

Market share gain in Europe (ex- UK) remains a fairly secular trend for Indian IT and CTSH through the year saw company leading growth with $ revenue growth of 29%. UK remains a drag on overall Europe performance for CTSH with as revenues in the geography declined 2% YoY. This is second consecutive year of weak growth in UK and the management indicated that UK banking customers are withholding spends.

Drop in India employee headcount with US$53mn employee separation charge

India employee headcount for CTSH dropped 4% YoY to 180,000 as the company moves towards localisation of workforce and adjusts delivery (through automation). Workforce localisation is visible with headcount in both North America and Europe up by 6% and 20% respectively. Share of non-India headcount has gone up from 28% in CY16 to 31% in CY17. In fact, CTSH took a business realignment charge of $72mn (0.5% of revenues) of which $53m was related to employee separation costs.