Cognizant Technology Offers Tepid Outlook For 2023 (NASDAQ:CTSH)

A Quick Take On Cognizant Technology Solutions

Cognizant Technology Solutions (NASDAQ:CTSH) reported its Q4 2022 financial results on February 2, 2023, beating revenue and missing EPS estimates.

The firm provides a range of IT consulting to middle market and large enterprises to assist them in their digital transformation efforts.

I’m cautious as we move further into 2023, so I’m on Hold for CTSH until we see results under new leadership and macroeconomic conditions.

Cognizant Overview

Teaneck, New Jersey-based Cognizant was founded in 1994 and provides a wide variety of consulting and technology outsourcing solutions to companies worldwide.

The firm is headed by Chief Executive Officer Mr. Ravi Kumar, who was appointed to his position in January 2023 and was previously Chairman of Infosys BPM.

The company’s primary industry focus areas include:

• Financial Services

• Healthcare

• Products and Resources

• Communications, Media and Technology

CTSH acquires customers via its direct sales, marketing and business development efforts and via partner referrals.

Cognizant’s Market & Competition

According to a 2021 market research report by 360 Market Updates, the global market for digital transformation strategy consulting was estimated at $58.2 billion in 2019 and is forecast to reach $143 billion by 2025.

This represents a forecast CAGR of 16.2% from 2020 to 2025.

The main drivers for this expected growth are a large transition from on-premises, legacy systems to cloud-based environments with complex architectures.

Also, the COVID-19 pandemic has likely pulled forward significant demand to modernize enterprise systems resulting in increased growth prospects for digital transformation consultancies.

Major competitive or other industry participants include:

• Globant

• EPAM

• Slalom

• Accenture

• Deloitte Digital

• McKinsey

• Thoughtworks

• BCG

• Ideo

• Capgemini

• Company in-house development efforts

The company is active in other industry verticals.

Cognizant’s Recent Financial Performance

• Total revenue by quarter has continued to rise per the following chart:

• Gross profit margin by quarter has trended lower in recent quarters, as the chart shows here:

• Selling, G&A expenses as a percentage of total revenue by quarter have trended lower in recent quarters:

• Operating income by quarter has trended higher with the recent exception of Q4 2022:

• Earnings per share (Diluted) have followed a similar trajectory to that of operating income:

(All data in the above charts is GAAP)

In the past 12 months, CTSH’s stock price has fallen 24.3% vs. that of Capgemini’s drop of 5.9%, as the chart indicates below:

Valuation And Other Metrics For Cognizant

Below is a table of relevant capitalization and valuation figures for the company:

Measure [TTM]	Amount
Enterprise Value / Sales	1.7
Enterprise Value / EBITDA	9.3
Price / Sales	1.8
Revenue Growth Rate	5.0%
Net Income Margin	11.8%
GAAP EBITDA %	18.2%
Market Capitalization	$33,960,480,800
Enterprise Value	$32,993,480,700
Operating Cash Flow	$2,568,000,000
Earnings Per Share (Fully Diluted)	$4.42

Click to enlarge

(Source – Seeking Alpha)

As a reference, a relevant partial public comparable would be Capgemini (OTCPK:CGEMY); shown below is a comparison of their primary valuation metrics:

Metric [TTM]	Capgemini	Cognizant Technology Solutions Corporation	Variance
Enterprise Value / Sales	1.9	1.7	-10.5%
Enterprise Value / EBITDA	14.4	9.3	-35.1%
Revenue Growth Rate	18.6%	5.0%	-73.2%
Net Income Margin	6.9%	11.8%	71.9%
Operating Cash Flow	$2,500,000,000	$2,568,000,000	2.7%

Click to enlarge

(Source – Seeking Alpha)

Commentary On Cognizant

In its last earnings call (Source – Seeking Alpha), covering Q4 2022’s results, management highlighted that large deals are a priority for the company’s growth efforts and that the firm has ‘become better equipped to solution and manage large deals.’

The newly appointed CEO, Ravi Kumar, expects to focus additional resources in this regard.

The company also announced the signing of a 10-year $1 billion renewal contract with CoreLogic.

Notably, management also sees ‘a strong push now to bring AI into the business landscape with the expectation that AI will reengineer enterprises as completes as enterprise software did three decades ago.’

As to its financial results, revenue rose 1.3% year-over-year, or 4.1% on a constant currency basis, so the company has been negatively affected by the strong US dollar.

However, outside the aforementioned large renewal, bookings momentum is ‘muted’ going into the new year.

GAAP operating margin was 14.2%, a drop of 1.1% due in large part to a noncash impairment of capitalized costs from a volume-based contract with a Health Sciences client.

For the balance sheet, the firm finished the quarter with $2.5 billion in cash, equivalents and short-term investments and $646 million in total debt.

Over the trailing twelve months, free cash flow was $2.24 billion, of which capital expenditures accounted for $332 million. The company paid no stock-based compensation in the last four quarters.

Looking ahead, management only provided guidance for Q1 2023, which it expects to be $4.73 billion at the midpoint of the range.

The firm expects full-year 2023 performance to be below its previous goal due to an uncertain economic environment.

Regarding valuation, the market is valuing CTSH at lower multiples than competitor Capgemini, likely due in part to its significantly lower revenue growth rate.

The primary risk to the company’s outlook is the prospect of a material macroeconomic slowdown in 2023, which would slow project implementation and new customer wins.

A potential upside catalyst to the stock could include a ‘short and shallow’ downturn and a return to growth after.

CTSH’s stock price has risen in recent weeks along with the general rise in technology stocks as the cost of capital outlook has improved.

In the short-term, technology-oriented stocks appear to be highly dependent on a benign interest rate environment, so investors should proceed accordingly.

As for me, I’m cautious as we move further into 2023, so I’m on Hold for CTSH until we see results under new leadership and macroeconomic conditions.