Cognizant Poised To Outpace The Market In 2015

Summary

Management recently revised guidance for FY15 upward on the expectation of strong revenue growth.
Recent company acquisitions have totaled $3.5B in contractual value.
Key acquisitions include Health Net and TriZetto.
Cognizant Technology Solutions (NASDAQ:CTSH)

Cognizant, based in Teaneck, New Jersey, provides a broad range of IT services to Global 1000 companies. The company leverages its onsite/offshore model to provide clients with faster, cheaper and better development and deployment of applications across multiple technology platforms and vertical areas. Cognizant employs 145,000 professionals at its facilities in India, Europe and the United States.

The company's recent five-year volume to performance can be seen below. The sharp drop in March of 2014 represents a 2:1 stock split.

Recent Fundamental Highlights

The company raised its FY14 revenue guidance from 14% growth y/y (implies at least $10.08B) to 14.5-14.9% y/y ($10.13B-$10.16B) and EPS guidance from $2.54 to $2.57.

Furthermore, the company has announced that the recent acquisition of TriZetto is now complete. This acquisition is well positioned to succeed in the healthcare industry as it is a leading provider of software and solutions to healthcare payers. The acquisition cost the company $2.8B or 3.8x revenue and will likely continue to pay off in the years to come.

The positive company outlook could be further revised upward in the coming months as company acquisitions begin to come online and with changes in expected cash flows.

Outlook

Cognizant has the potential to return better-than-industry growth rates in 2015 as it has historically grown on average 9% faster than the upper end of the industry in recent years. The discrepancy between CTSH total annual revenue growth and the industry has slowed in recent years due to a higher base effect and the push out of large deals in 2014. Analyst estimates show that CTSH could outpace the market with a growth rate of 15%.

Additionally, the recent acquisition of TriZetto (healthcare software and solutions) closed on the 20th of November 2014. This acquisition is expected to contribute positively to the long-term growth and margin profile of the company. But aside from this, the company also has closed three transformational deals in 2014 totaling $3.5B in contractual value. These deals are expected to add $200M in incremental revenues in 2015, including the acquisition of Health Net, which is expected to provide $2.7B in incremental cash flows in the next 7 years. Shown below is the company's ability to create returns on invested capital. Management's ability to create strong returns in recent years should be an indicator of the potential of its recent acquisitions.

Outsourcing revenues have slowed from 16.1% y/y growth in 1Q14 to 5.8% growth in 3Q14. However, with the acquisition of Health Net, a large financial services contract, and another contract beginning to ramp up in FY15, outsourcing revenues are expected to benefit.

Economic Moat Trend

CTSH has a competitive advantage in healthcare (25% of revenue). The company's model is unique - investing everything over a margin level to drive growth. This advantage is only likely to grow with recent acquisitions and contribute positively to margins.

The addition of TriZetto should help open new relationships at 80-90 clients with the ability for CTSH to cross-sell IT services into TriZetto's client base as well as selling TriZetto software to existing clientele. It should also help expand its service offerings while capturing the shift in health insurance toward exchanges and consumer-driven healthcare.

Employee headcount grew 6.6% q/q and 20% y/y in 3Q14 and this positive movement could indicate future growth as the company hires talent in an effort to gear up for future projects, especially in the short term given majority of 3Q hiring was lateral.

The company's ten-year net profit margins can be seen below. The number has ranged from 18% to 13% in the past few years. However, recent acquisitions are poised to continue to increase these margins.

Major Risks

Reduction in global IT spending from macro events. Often when companies are forced to cut costs during times of economic uncertainty, IT upgrade spending is among the first items cut. Any slowed global growth could negatively impact the company.
CTSH competes in a very crowded market with some large players (Oracle (NYSE:ORCL), Microsoft (NASDAQ:MSFT), SAP (NYSE:SAP)). A new innovation or fundamental change in any of these companies could lead to a negative impact on company earnings.
Some of the company's employees are sourced from out of the country and any limitation on H-1B visa holders could stifle company growth.
Investment Rationale

CTSH should be on investors' watch lists as revenue growth drives multiple expansions and the company has an excellent record of execution. There are catalysts in place to drive results over the long term, including customer cost savings and regulatory work in healthcare and financial services.

Cognizant currently trades at $56.10 (closing price as of Jan. 26th) and looks attractive with strong upside potential in the near to medium term.