The last time I wrote on here was just before Cognizant Technology's (CTSH) earnings for FY12 and Q4:12. The shares were trading right around here and saw a small pop post-earnings but came shy of my $85/share price target post earnings. The Indian IT and quasi-Indian IT (CTSH, due to the fact that its a US-based company with the majority of its work force based in India, is thus quasi-Indian) sector has received a lot of ho hum articles on Seeking Alpha and also received a few downgrades by sellside analysts. They are wrong! Here's a few reasons that they seem to have missed:
The majority of pricing cut seems to now be in the past. Take for instance Infosys (INFY); EBITDA margins declined by 530 basis points in the last year as productivity also dropped by 5% over the same period. It would seem that the discounts the company had to provide in order to continue its business traction is almost over with. If there is still going to be any adverse impact to margins, it will be minimal.
Current utilization rates at the Indian and quasi-Indian IT companies are at record lows and as volume momentum returns in 2013 and beyond, utilization rates should go up by about 5-7% for the sector.
All these companies are continuing with their hiring activity at a frenetic pace, hiring at the rate of several thousand new employees per month, month in and month out. A sure sign that management teams expect better revenue momentum going forward.
After the challenges these companies have been through since the financial crises, there have been tremendous improvement made in internal operating performance which will help offset the still slightly sluggish external operating environment as clients are still holding on to their purse strings fairly tightly. In addition, clients are still having difficulty on clarity beyond a quarter or two, but the improvements made to the internal operating improvement should be enough to offset those issues.
All the Indian and quasi-Indian IT companies are making a strong push into continental Europe which is where there is tremendous scope for growth going forward. European companies need to bring down costs significantly and outsourcing of IT is one sure fire way to do it and management teams know that. Look for more work coming to IT companies as continental European company management teams start to focus on improving operating efficiencies.
The US SEC is set to start the bidding process on its $4 billion Consolidated Audit Trail National Market System (CAT NMS) project sometime this month and I expect the two companies mentioned in this article to win different parts of this massive $4 billion pie, thanks to their expertise in the BFSI (banking, financial services and insurance) verticals. This is a high profile deal and will be a feather in their caps when the winners are announced and could be good for 3-5% gains in the shares on announcement of the winners alone. Chatter is that the expression of interest deadline was March 5, 2013, and the bidding process will begin April 25, 2013.
Cognizant is expected to report earnings of $0.93/share on revenues of $2.01 billion for its Q1 ended March 31, 2013. For FY13, current estimates are for earnings of $3.98/share on revenues of $8.62 billion.
Infosys is expected to report earnings of $0.74/share on revenues of $1.99 billion for its Q4 ended March 31, 2013. For FY:14, the Street is expecting earnings of $3.15/share on revenues of $8.25 billion.
In my opinion, estimates are muted for both companies at the moment and should be going up as we move through the year.
In summation, filter out the noise and chatter, and focus on these names over the short-to-medium term where returns could be anywhere from 10% to 20% depending on one's time frame.
Until the next time, safe investing.
Additional disclosure: Long INFY in India, CTSH and INFY calls