EUR 850.00 For Business Accounts Only

Morningstar | Cognizant Results Mostly In Line; Financial Services Slightly Underwhelms; Shares Near Fair Value

Cognizant’s second-quarter results were mostly in line with our expectations, with revenue inside management’s guidance range, although the firm’s EPS performance was above our forecast. Cognizant’s focus on digital transformation products and services via its business, operations, and systems and technology lines continues to fuel its top-line growth and prop up its bottom line. In the quarter, management noted that the company’s digital revenue grew in the low 20% range and is now close to 30% of total company revenue. We expect the digital business to continue to grow in the low 20s over the near term as clients look to modernize their operations. Cognizant’s stock price pulled back after the results as the firm’s financial-services performance was underwhelming. Given the importance of the financial-services division (38% of fiscal 2017 revenue), with the company noting weakness in some large “money-center” banking clients, we think investors were spooked by the commentary. In addition, peers have been reporting better-than-expected financial-services numbers during this earnings cycle. Still, we think the firm’s financial-services result is isolated to a few large clients and isn’t emblematic of Cognizant’s wider, well-regarded standing in the industry. We reiterate our $80 fair value estimate and narrow economic moat rating. Shares are now slightly below our fair value but remain in 3-star territory.

For the quarter, revenue rose 9.2% year over year to $4.01 billion, including a 100-basis-point foreign exchange tailwind. The communications, media, and technology division performed the best, growing 15.8% year over year to $541 million as media and technology clients continue to look for IT-led innovation. At the other end of the spectrum, the financial-services division was the growth laggard, up 4.5% to $1.47 billion as specific large clients looked to lower their "run-the-bank" spending (outsourcing-led, cost saving services).

The firm’s non-GAAP operating margin expanded 200 basis points year over year to 22%. A greater proportion of higher-value digital services helped the result in addition to good utilization, workforce restructuring, and a simplified overhead structure. We expect a full-year margin around 21%, though, as the firm looks to increase its internal investments in the back half of the year.