Despite the weakness, we retain a ‘neutral’ rating given CTSH is trading at an undemanding valuation of ~15x FY20F EPS.
The growth outlook does not enthuse, though valuations are undemanding. While 3Q surprised positively on revenues, the outlook for 4Q and FY20 appears weak given drags from three of the top five BFS clients and CTSH continuing to suffer from low diversification in BFS, cost pressures in healthcare, especially in the US, and overall curtailment or no pick-up in integration spends at clients that concluded M&A, and deceleration in y-y growth even in performing verticals such as retail (base effect from Softvision) and communication (exiting the digital operations contract).
We do not see signs of a turnaround yet and expect growth in FY20F to be only slightly better than in FY19 on an organic basis (FY19 guidance implies organic growth of ~3%). This is largely because of a favourable base and the impact of exiting the digital contract will be offset by incremental contribution from Zenith and Contino acquisitions. CTSH lowered its EBIT margin guidance for FY19 to 16.5-17% and for FY20 to 16-17% from 17% earlier despite cost realignment efforts (expects $500-550 million annual savings in FY21). This is due to investments in sales, digital, automation & tooling (~150bp impact in FY20) and higher wage hikes (~120bp) to curb rising attrition. We estimate for USD revenue/EPS CAGR of ~5% (4% organic)/7% over FY19-22F.
Despite the weakness, we retain a ‘neutral’ rating given CTSH is trading at an undemanding valuation of ~15x FY20F EPS, we like its end-to-end capabilities and strong positioning in Healthcare where CTSH could benefit when spends return post-M&A, its lower legacy exposure in Retail and Communication and the support from EPS accretive buybacks.
We trim our revenue estimates by 2-3% for FY20/21F led by plans to exit the digital operations contract and a weaker outlook due to macro.