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Is Cognizant Technology Solutions Stock a Buy?

By Dave Kovaleski – Feb 17, 2020 at 10:31AM

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The IT consultant is undergoing a major restructuring.

Cognizant Technology Solutions (CTSH -1.59%) got a boost from a solid fourth-quarter earnings report, which it hopes to build on through a major restructuring plan.

The company, which provides information technology consulting to businesses around the world, saw its stock price jump nearly 10% last Thursday after its Feb. 5 earnings release and conference call. Cognizant stock is up over 11% year to date, a stark improvement over 2019, when it underperformed the S&P 500 index, returning negative 2.3%.

So, what has driven the bounce back, and is the stock a buy?

An image of a computer chip in the shape of a cloud over a circuit board

Cognizant Technology seeks growth in its digital and cloud consulting businesses. Image source: Getty Images.

Fit for growth

Cognizant beat earnings estimates in the fourth quarter with adjusted earnings of $1.07 per share, ahead of estimates of $1.04. The company saw revenue increase in the fourth quarter, up 3.8% year over year to $4.2 billion. Net income was $395 million, down from $648 million in the fourth quarter of 2018.

Cognizant's business is split into four groups: financial services, healthcare, products and resources, and communications, media, and technology. Financial services represent the biggest slice, accounting for 34.3% of revenue. The segment saw sales increase 1.2% year over year. Healthcare saw a 1.6% jump in revenue, but the biggest gainers were products and resources and communications, media, and technology, which saw revenue rise about 8% each in the quarter. These segments were both buoyed by higher demand for system upgrades and modernization to cloud and digital services. From a geographic standpoint, revenue was up 3.1% in North America and 1.5% internationally for the quarter.

The positive momentum may stem from Cognizant's "Fit for Growth" plan, a restructuring initiative announced last year that will cut costs and free up money for investment in "four key digital battlegrounds," as CEO Brian Humphries called them on the fourth-quarter earnings call: data, digital engineering, cloud computing, and Internet of Things (IoT).

"We are investing aggressively and are determined to win in these four digital battlegrounds. And as we do so, we expect to accelerate our revenue growth," Humphries said.

The cost reductions will primarily be achieved through layoffs, facility consolidation, and exiting the content moderation business. These changes are estimated to result in the reduction of some 10,000 to 12,000 jobs, primarily in India, with an estimated annual cost savings of $450 million in 2020 and $500 million to $550 million in 2021.

Buying spree

Mergers and acquisitions (M&A) are a big part of the growth strategy, as the company recently purchased two companies to bolster its cloud capabilities. One is Code Zero, a firm it bought on Feb. 3 that helps companies migrate to cloud-based systems. The other is EI-Technologies, a Paris-based digital technology consulting firm it acquired on Feb. 5. In Q4, Cognizant bought Contino, a U.K.-based consultancy that specializes in advanced data platforms.

"Both acquisitions we made this week are firmly behind the cloud ambition that we have, and you'll see more of the same on a go-forward basis behind each and every one of those digital battlegrounds. To be very clear, I view M&A as a means to an end to achieve the strategy," Humphries said. 

For 2020, Cognizant expects revenue to grow 2% to 4% year over year, which includes lost revenues from exiting the content moderation business. First-quarter revenue is anticipated to expand 2.5% to 3.5% year over year. Operating margin -- which is the margin of profit a company reaches after all operating costs are subtracted -- is expected to be 16% to 17% for the full year, similar to 2019. Earnings per share are expected to fall in the range of $3.97 to $4.13 for the year, up slightly from the current $3.99.

The company also announced a 10% increase to its quarterly cash dividend to $0.22, so that's good news for investors.

Muted outlook

While Cognizant got a nice bounce from the earnings report and is heading in the right direction with its Fit for Growth plan, investors probably won't see the fruits of the strategy for another year as the cost reductions won't be fully realized until 2021 and 2022. Also, the company's outlook for its two biggest client segments -- financial services and healthcare -- is muted for 2020. 

Cognizant's share price has come down to a nice entry point at $64 and it's trading at a pretty low 16 times earnings. The technology specialist is trending in the right direction, but it'd be wise to wait to see if it can sustain growth for a few more quarters through this transformation plan before buying.

Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Cognizant Technology Solutions. The Motley Fool has a disclosure policy.

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