Category Investments

Cognizant on cloud nine

09 November 2016 William Ball, Sanlam Private Wealth
William Ball, Senior Equity Analyst at Sanlam Private Wealth.

William Ball, Senior Equity Analyst at Sanlam Private Wealth.

With ‘the cloud’ playing an increasingly important role in information technology, companies at the forefront of this trend are making for very attractive investments. One such stock, Cognizant, listed on the Nasdaq, is a particular favourite of ours. Here’s why …

Fast facts

• Cognizant is headquartered in Teaneck, New Jersey.
• It’s a leading provider and innovator of IT, consulting, IT infrastructure and business process outsourcing services.
• As at 30 June 2016, it has 244 300 employees.
• More than 80% of its workforce lives in India.
• Around 80% of its revenue is derived from North America.
• It has over 50 delivery centres worldwide.
• It’s a member of the Nasdaq 100, S&P 500, Forbes Global 2000 and Fortune 500.
• And best news for investors: Forbes ranks it among the top-performing and fastest-growing companies in the world.

Four reasons we like it

1. The future is up in the cloud

Cognizant is a ‘pure-play’ global IT service name with an attractive growth proposition driven by the shift to digital technologies. We see the business as being well positioned over the longer term to capitalise on market trends, given its focus on ‘higher value’ and industry-specialised services.

The adoption of cloud-based digital services and solutions are compelling growth opportunities for the company. In our opinion this is increasingly looking structural with a potentially long runway for growth in light, relatively modest penetration rates. We expect the company to profit from constant innovation and the needs of clients to invest in digital projects.

This is supported by IT research firm Gartner, which has predicted growth in public cloud service spending will compound in the mid-teens through to 2020.

2. Two-in-a-box

Underlying growth is reinforced by strong client relationships, which are delivered through its ‘two-in-a-box’ model. This is where a senior leader manages the client relationship and another oversees service delivery from Asia. The proposition is designed to ‘quickly reduce IT budgets, overhaul IT operations and redeploy freed-up assets to more strategic initiatives that generate business value’.

Cognizant’s clients are looking for more efficient core applications, outsourcing and IT infrastructure, fuelling demand for their digitally focused services. The company is well positioned to meet clients’ requirements for specialised tools and processes to optimise their businesses.

Robust utilisation rates enable the company to increase capacity, while offsetting wage inflation. Given its conviction for a strong demand environment and ability to achieve industry-leading growth, Cognizant continues to expand.

3. Strong financials

The acquisitions made in healthcare have strengthened Cognizant’s position, which we see as an exciting opportunity, enabling it to take advantage of the technological evolution within the global healthcare arena. Moreover, it’s well positioned to capture growth from the structural developments within financial services as companies develop their digital services.

Looking at the financials, we like the company’s strong cash flow dynamics, limited capital expenditure requirements and management’s ability to generate high returns on capital. Attractive cash returns on invested capital, which we expect to continue for the foreseeable future, are also an appealing trait.

Source: Bloomberg, SPW analysis

4. Attractive valuation

We use a blend of discounted cash flow method and enterprise value to EBITDA multiple approach to arrive at an intrinsic valuation of US$67. The shares are attractively valued, trading at -1 standard deviation from its long-term average on 16 times 2016 earnings.

Source: Bloomberg, SPW analysis

More about Cognizant and its market

Cognizant’s core competencies include technology strategy consulting, complex systems development, enterprise software package implementation and maintenance, data warehousing and business intelligence. It has a rapidly expanding footprint that extends from India and China to Europe, North and South America, and the Middle East.

The company operates in four main segments: financial services, healthcare, manufacturing, and retail and logistics. Financial services (±40% of total sales) and healthcare (±29% of total sales) represent the bulk of its revenue streams. Outside this core, the company has been diversifying more into manufacturing, retail and logistics, which looks set to become the third leg of its business.

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