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Elevator Pitch
I rate Cognizant Technology Solutions Corporation (NASDAQ:CTSH) stock as a Buy. My earlier January 20, 2024 initiation article highlighted Cognizant's 2023 share price outperformance and the company's financial outlook for the current year.
The focus of the latest write-up is CTSH's revenue growth prospects for the short term and intermediate-to-long term. I have decided to upgrade my rating for Cognizant from a Hold to a Buy. In the near term, Cognizant could possibly deliver a Q2 2024 revenue beat, considering its latest management commentary and the results of a recent industry survey. For the mid-to-long term, CTSH has the potential to register faster-than-expected top-line growth by executing well on its inorganic growth strategy.
Recent Acquisition Is A Good Illustration Of CTSH's Inorganic Growth Opportunities
In early-June, Cognizant published a press release disclosing a proposed acquisition of "Belcan, LLC, a portfolio company of AE Industrial Partners and a leading global supplier of Engineering Research & Development (ER&D) services."
Details Of CTSH's Planned Acquisition Of Belcan
Cognizant's June 10, 2024 Investor Presentation
At its prior Q1 2024 analyst call on May 1, CTSH stressed that "we continue to evaluate assets for the right capabilities to support our strategic priorities (my emphasis)", and indicated that its previous acquisitions have allowed it to "cross-sell (my emphasis) within our existing client base."
My view of Cognizant's latest M&A deal involving Belcan is positive because this transaction is aligned with the company's "strategic priorities" and will likely offer meaningful cross-selling opportunities.
With respect to the cross-selling potential, Cognizant is targeting to achieve more than $100 million of "revenue synergies" on a yearly basis in the following three years with the Belcan transaction, according to its June 10, 2024 investor presentation slides. At its investor call for the M&A deal, CTSH noted that the marketing of "Cognizant's IT services to Belcan customers" and the selling of "Belcan's engineering services to Cognizant's automotive and industrial clients" will be the main "revenue synergies" for this transaction.
Separately, one of Cognizant's key "strategic priorities" is "accelerating revenue growth" as indicated in its annual report. In terms of top-line expansion, the Belcan deal puts CTSH in a better position to capitalize on the growth of the ER&D market. This is on top of cross-selling synergies highlighted above.
Cognizant's actual FY 2015-2023 revenue CAGR was +5.7% and its trailing twelve months' revenue was $19.3 billion according to S&P Capital IQ data. As a comparison, the ER&D services market's TAM (Total Addressable Market) is forecasted to increase at a three-year CAGR in excess of +10% to $255 billion in 2026 based on research firm Zinnov's projections cited in CTSH's June 10 presentation. In other words, the ER&D services market is more than 10 times the size of Cognizant's revenue base and growing at a much faster rate than what the company did in the past.
The market currently has a pretty conservative view of CTSH's near-term top-line growth prospects. In specific terms, the Wall Street analysts project that Cognizant's revenue will increase by +0.2% and +4.6% for FY 2024 and FY 2025, respectively.
If Cognizant can continue to execute on value-accretive M&A transactions going forward, the company's actual revenue for the coming years could surprise on the upside. At the JPMorgan (JPM) 52nd Annual Global Technology, Media and Communications Conference on May 21 this year, CTSH emphasized that "M&A is an important lever" for the company. As per the chart presented below, Cognizant has identified four key business areas where it has the potential to grow meaningfully, and this could be done via inorganic means.
Cognizant's Four Key Areas Of Growth Potential
Cognizant's June 10, 2024 Investor Presentation Slides
Second Quarter Financial Performance Might Surpass Expectations
CTSH will likely announce the company's Q2 2024 financial results in late-July, and there is a good chance that Cognizant's actual second quarter performance could be a positive surprise.
At the company's June 10, 2024 investor call relating to the Belcan deal, Cognizant mentioned that "we now expect Q2 revenue will be in the upper half of the guidance (my emphasis)" based on "the trends we have seen." CTSH's top line guidance indicates that the company's Q2 2024 revenue will be in the $4.75-4.82 billion range, which implies a sales contraction (in local currency terms) of between -2.5% YoY and -1.0% YoY.
A key factor supporting a potential Q2 2024 results beat for CTSH is market share gains. The company revealed at the TD Cowen 52nd Annual Technology, Media & Telecom Conference on May 30, 2024 that it is "winning a little more than our fair share (my emphasis) on large deals" at a time where the deal mix has changed with "more large deals in offering."
The other factor is that actual IT spending might be better than what the market anticipates. According to the results of technology research firm Nash Squared's latest survey of "322 digital leaders" cited in Computer Weekly's June 18, 2024 article, only a mere 12% of respondents anticipated a decline in their respective IT budgets in the coming one year.
Variant View
Cognizant's shares might perform poorly under some scenarios.
One scenario is that CTSH executes on a fewer-than-expected number of accretive M&A deals in the future, which means that the company's actual inorganic growth turns out to be weak.
Another scenario is that Cognizant's Q2 2024 financial results are a big miss due to a substantial cut in IT budgets or market share loss.
Closing Thoughts
CTSH's valuations might re-rate to a higher level in line with the stock's historical averages, assuming that the company achieves a better-than-expected top-line performance in the future. As per S&P Capital IQ data, the market currently values Cognizant at a consensus next twelve months' normalized P/E of 14.7 times, which is much lower than its historical 15-year average P/E ratio of 18.4 times.
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