Analyst Note| Julie Bhusal Sharma |
Cognizant posted solid results for the first quarter of the year, surpassing our former expectations, similar to other IT services firms, as overall demand recovered to a greater degree than projected. Although demand is shaping up nicely, increased automation of services could not come fast enough, as Cognizant highlighted the challenges in finding talent to meet its recovering demand--which could worsen as India’s COVID-19 crisis continues. Since the start of COVID-19, Cognizant has brought on a greater mix of contractors, which we believe is undesirable in the long term given the costs of training and knowledge lost with the shorter tenure of contractors. As the IT services industry is recovering, attrition is balancing the seesaw, worsening due to a boost in talent demand. The costs of attracting and retaining talent have caused us to moderate our projected margin expansion for Cognizant over the next five years, as we bake in only 220 basis points of expansion compared with 300 basis points. Despite this change, we’ve increased revenue expectations over our explicit forecast as digital transformation becomes increasingly important for Cognizant’s clients--and is ultimately the root of the talent shortage. Altogether, we are maintaining our fair value estimate of $70 per share. Shares are down 5% upon results, leaving the stock fairly valued in our view.