Investors Should Follow Cognizant Technology Solutions in Closely Monitoring Its Employee Attrition Rate

Includes: CTSH, INFY, WIT
by: William Trent, CFA

Cognizant’s (NASDAQ:CTSH) earnings beat the consensus target as usual, but the stock reaction was fairly muted. In part this is likely due to the fact that strong earnings reports out of Indian outsourcing peers Infosys (NASDAQ:INFY) and Wipro (NYSE:WIT) had already clued investors to expect a strong outcome. However, it also points to signs that the supply of cheap coders in the subcontinent may be reaching some limitations. According to the Earnings Call Transcript from SeekingAlpha [emphases our own]:

In building the foundation for future growth, we aggressively invested in building our employee base, increasing our headcount by over 15% sequentially and adding about 4,700 employees around the world. We were very pleased with our ability to attract the best talent in the industry, a testament to Cognizant’s reputation as an employer of choice in our industry. During Q3, we saw a reversal of the positive attrition trends from earlier this year. For the first six months of 2006, our annualized attrition of 13.2% was running about two percentage points below our annualized attrition of 15.3% for the first half of 2005. Yet attrition in Q3 increased to about 20%, four percentage points higher than in Q3 2005.It is important to note that our YTD annualized attrition is approximately 15.5%, roughly equal to our attrition rate for the same period during 2005 and that attrition is an issue that our entire industry is facing. Historically we have experienced an increase in attrition in Q3, as those employees returning to graduate school leave the company. However, the recent increase was certainly higher than we expected or desired. Based on our extensive exit interview process, higher education ranks highly but no single factor accounts for the recent increase…

Fundamentally, we are committed to returning attrition to its normalized levels and ensuring that our employees have world class opportunities to develop their talents and careers within Cognizant.

Our October numbers show lower attrition rates than Q3 and we will continue to closely monitor the trend.

When we first profiled Cognizant in May, we highlighted employee growth as their most significant issue:

If we had to point to one specific risk factor as being Cognizant’s greatest, it would be managing all of that growth. We don’t think it will happen this year, but it could. Or, just as likely, they could continue to coast for several more years. And in the meantime, it is a nice problem to have.

Judging from management’s comments, it is getting a little less nice. But one analyst was quick to put it in context:

Q - Adam Frisch – UBS
Quick housekeeping, Gordon the 60% revenue growth, was that YoY or sequential?

A - Gordon Coburn
Hang on… that was…

Q - Adam Frisch – UBS
I’m just kidding, I’m trying to make a point. On attrition, obviously that’s the one negative data point, but it’s just in one quarter.

Indeed. It isn’t quite "run for the exits" time, but the attrition rate is enough to suggest that investors should join management and “closely monitor the trend.”

CTSH 1-yr chart:

CTSH 1-yr chart