The commercial services sector was down strongly last week in sympathy with the market fall, and based on fears of a global recession and its impact on corporate spending, and on the margins and profits of companies that provide various kinds of IT, outsourcing and other commercial services to corporations. This article covers our analysis of the big news and price moves in the commercial services sector last week, evaluating them for buy and sell ideas.
Infosys Ltd (INFY), Cognizant Tech (CTSH) and Wipro Ltd (WIT): All three Indian providers of outsourcing services to global corporations, based mainly in North America and Europe, fell strongly last week on fears that a global recession would severely hurt demand for their services. CTSH, a provider of custom IT consulting, technology and outsourcing services, fell the hardest, and was down 14.9% last week after Goldman Sachs removed it from their buy list on Monday morning before the market opened, falling even more sharply during the market downturn on Thursday and Friday. Peer INFY, a provider of software re-engineering, systems integration, infrastructure management and other IT services, fell 11.6%; and another peer WIT, a provider of consulting, IT, outsourced R&D, and infrastructure and BPO outsourcing services, fell 10.1% during the week. All three generally move in tandem, and have turned down since peaking in late 2010 to early 2011. Of the three, CTSH is down the least, falling 34% since peaking in April, and it is also the one with the strongest growth, with revenue and earnings up 34% and 22% respectively in the June quarter, and projected revenue growth of 23% going forward for FY 2012 over 2011. Comparable growth rates for WIT are at 23% revenue and 0% earnings growth for the June quarter, and forward growth of 15%. INFY grew revenue and earnings at 26% and 21% in the June quarter, and projects forward revenue growth of 18%. All three, however, trade at a comparable forward P/E of 16 for CTSH and WIT, and 14 for INFY. Thus, from a valuation standpoint, CTSH is the most attractive of the three as it trades at the lowest P/E adjusted for growth. Furthermore, based on our review of the holdings of over 60 high alpha hedge and mutual funds (from managers such as Soros, Icahn, and Mario Gabelli), we determined that of these three, guru funds are most bullish about CTSH, holding $593 million after adding a net $38 million in the June quarter, whereas they hold only $1 million of INFY and none of WIT. International Business Machines (IBM), Accenture Plc (ACN), and Computer Sciences Corp. (CSC): All three are among the largest providers of consulting, IT and BPO services to businesses and government agencies, and they fell strongly last week on no company-specific news, but mimicking the broad sell-off in the markets and due to the possible impact of a deeper recession on consulting and outsourcing revenues. Of the three, ACN dropped the hardest last week, down 13.1%, CSC fell 7.9%, and IBM fell 6.3%. CSC trades the cheapest at a forward 5-6 P/E while revenue growth is in the low single digits at 2%-3% and earnings have been flat to down. IBM in contrast trades at forward 10-11 P/E while earnings growth is in the mid to high teens, and ACN trades at a forward 12-13 P/E while long-term earnings growth has averaged in the low teens.
Thus, from a valuation perspective, IBM is the most attractive based on its low P/E and high relative and consistent growth, and CSC is also somewhat attractive from a deep value standpoint in terms of its extremely low 5-6 P/E even though operating fundamentals are rather poor. Furthermore, of the 60 plus high alpha or guru funds that we track, as a group they are most bullish on IBM, adding a net $278 million during the June quarter to their $709 million prior quarter position in the company. Furthermore, guru funds are bullish on CSC, adding a net $46 million to their $56 million prior quarter position, and they are bearish on ACN, cutting a net $69 million from their $355 million prior quarter position.
Buy Hewlett-Packard Co. (HPQ): HPQ is currently a provider of IT and outsourcing services, PCs and peripherals, printers and scanners, and servers and storage devices. However, with the announcement late last week of the $10 billion acquisition of European data analytics company Autonomy, and the intent to spin-off its PC division and shut-down its tablet and smartphone business, it is fast morphing into an IBM-kind of software and services model. The street initially rewarded the company with the stock up almost 8% in morning trading Thursday, but panic took over as the market collapsed late Thursday, and the stock ended down almost 8%. Friday, the stock collapsed down over 20% for the day after reporting disappointing forward guidance of $32.1-$32.5 billion in revenue and $1.12-$1.16 in earnings for the October 2011 quarter versus consensus estimates of $33.9 billion and $1.31.
At Friday’s close of $23.60, HPQ looks like a deep value buy, trading at a very reasonable forward 4.4 P/E as earnings are still projected to increase in the mid to high-single digits going forward. However, it is most likely that these forward earnings estimates will be pulled down in the coming weeks as analysts factor in the exit from the PC business into their forward earnings estimates. Even then, we believe that the stock has overreacted to the downside, probably precipitated by weakness in the markets and economy, as well as panic selling by investors who may have been severely disappointed over HP’s plans to exit its core PC business. Furthermore, the stock is approaching a major technical support area in the $21-$23 range that should hold. Looking forward, with HPQ’s transition into an IBM model, it is making a similar transition to what IBM did six years ago in 2005, and a look at IBM’s long-term chart reveals that its stock has more than doubled since it made that transition in 2005. It is conceivable that HPQ may pull together a similar transition, and current shareholders in that case would be handsomely rewarded. Either way, we would be buyers here in the low-$20s as the downside is currently limited based on its attractive valuation, whereas the long-term upside could be huge if the transition is executed well.
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Please note that the cumulative price change referred to in the last column of the Table above is used here as a measure of volatility to determine big movers in the group. It equals the sum of the absolute value of the change in daily prices. So, for example, if a security had price moves of 2%, -3%, 4%, -6% and 1% during the five days of the week, the cumulative price change during the week would be the sum of the absolute values of the daily price changes, which in this case would be 16%.
Credit: Historical fundamentals including operating metrics and stock ownership information were derived using SEC filings data, I-Metrix® by Edgar Online®, Zacks Investment Research, Thomson Reuters and Briefing.com. The information and data is believed to be accurate, but no guarantees or representations are made.
I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Disclaimer: Material presented here is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion. Further, these are our ‘opinions’ and we may be wrong. We may have positions in securities mentioned in this article. You should take this into consideration before acting on any advice given in this article. If this makes you uncomfortable, then do not listen to our thoughts and opinions. The contents of this article do not take into consideration your individual investment objectives so consult with your own financial adviser before making an investment decision. Investing includes certain risks including loss of principal.