Cognizant Technology Solutions Corp.’s weak guidance for the second half of 2016 just confirms what the results of the other top-tier information technology (IT) firms indicated earlier. Demand for IT services has ebbed considerably this year.
Cognizant had ended 2015 with a revenue growth of around 15% after adjusting for the contribution of the Trizetto acquisition. Based on its current guidance, the company is likely to end 2016 with growth of only 9%.
For all the bad news this quarter’s results season has ushered in, IT stocks have done particularly well. Despite a string of earnings downgrades, the Nifty IT index has been flat since the beginning of the earnings season. In other words, valuations are rising at a time when prospects are looking weaker; this is clearly a recipe for disaster.
The sharp cut in Cognizant’s revenue guidance highlights the extent of the trouble. At the mid-point of its guidance range, revenue is expected to rise by $1.12 billion this year, compared with 2015. The earlier guidance had assumed an incremental revenue of $1.41 billion at the mid-point of the range. Of this $290 million reduction in expected revenue, only $40 million is on account of the recent sharp depreciation in the British pound. The rest, worryingly, is because of a further weakening of the macroeconomic environment and a softening in clients’ discretionary spending pattern.
The company said in a call with analysts that the single largest impact has been on its banking and financial services (BFS) segment, followed by the healthcare segment. The former has been hit by the prolonged low interest rate environment, it said. The Brexit vote has made matters worse. Macroeconomic uncertainty has increased and so has the possibility of interest rates staying low for much longer.
Economists at the Federal Reserve Board said in a paper earlier this year, “Persistently low interest rates may erode the profitability of banks as low rates are typically associated with lower net interest margins."
In the healthcare space, the delays in regulatory approval for some mergers and acquisitions are resulting in lower IT spending by these companies. Until there is clarity on this front, growth of the segment will remain muted. These two segments account for 70% of Cognizant’s total revenue.
Of course, the other top-tier IT services companies are far more diversified; but there are hardly any bright spots out there. Barring Infosys Ltd, most top-tier companies are expected to end up with single-digit revenue growth in the current fiscal.
Meanwhile, shares of Infosys and Tata Consultancy Services Ltd trade at 17-20 times estimated fiscal 2017 earnings. It can be argued that these are reasonable valuations, when compared with the various bubbles in the other sections of the market. But that would be akin to clutching at straws.