Cognizant Earnings: Large Deals Help Discretionary Blows; Shares Significantly Undervalued

Cognizant’s CTSH results were right in line with our top- and bottom-line expectations in the third quarter. Our expectations, however, were baking in significant discretionary weakness from cut customer budgets—and such softness was realized though large deal activity softened the blow. We think the market is allowing near-term discretionary weakness to factor into longer-term discretionary spending expectations, which we think is too conservative in the wake of hefty demand for digital transformation projects which we see as rebounding after this time of macroeconomic weakness. While the firm narrowed the range for full-year revenue and EPS within their past ranges, we think this is a reasonable adjustment as the firm has one more quarter under its belt. All considered, we are maintaining our fair value estimate for narrow-moat Cognizant at $94 per share. Shares have remained flat upon results, leaving Cognizant significantly undervalued, in our view. Altogether, we continue to view the stock as a top pick under our technology coverage as we are encouraged by their reversal of course compared with historical bumps in the road. We think this inflection is reflected in its net promoter score at all-time levels.

Cognizant’s total revenue increased by 1% year over year, as reported, to $4.9 billion in the third quarter. Shorter-duration engagements, which are more discretionary in nature, saw significant weakness, but Cognizant is not alone, as the whole IT services industry is weathering this headwind. Large deal activity, on the other hand, looks solid as it represented 30% of third-quarter bookings. Cognizant notes that they are seeing an uptick in interest in bundling services, which we like (despite this sometimes coming at a cost to margins) because we think it strengthens Cognizant’s switching cost moat.