Cost Issues A Big Hurdle For Cognizant Growth Story, Say Analysts

Despite its move to optimise the employee pyramid for bringing back growth, analysts are of the opinion that Cognizant is not out of the woods yet.

While cost control can be one of the possible options for sustaining margin and pushing growth, Cognizant’s challenges seem to be multifold.

Underperformance of its two key verticals – financial services and health care – contributing more than 60 percent of its total revenues, is one of the major reasons behind the Nasdaq-listed firm’s current woes. Even client-specific issues and pricing pressure on the legacy side of the business are other challenges the company has to overcome in order to return to its heydays.

“Despite beating estimates in its September (2019) quarter revenue, we think that Cognizant has some fundamental issues, especially in its financial services and health care segments. These will take time as the company struggles with a host of internal and external issues, such as client specific challenges, baggage from the previous leadership and structural challenges revolving around the pricing issue in the legacy side of the business,” said Peter Bendor-Samuel, founder and chief executive officer (CEO) of global IT outsourcing consultancy firm Everest Group.

In the quarter ended September 30, the Teaneck-headquartered firm reported 5.1 percent rise (year-on-year basis) in its constant currency revenue at $4.25 billion. In comparison, larger peer TCS reported 8.4 percent revenue growth on constant currency term (YoY basis) and for Infosys the growth was 11.4 percent. Also, Cognizant’s July-September organic growth in constant currency terms was 5.8 percent. This is lower than the average growth of its peer group such as TCS, Infosys, Wipro and HCL Technologies.

Analysts see weakness in the health care vertical as the major drag on Cognizant’s growth prospects as of now. “It’s good to see overall growth returning though Cognizant is still not out of the water as it needs to salvage its health care segment which has been the company’s largest hurdle,” said Hansa Iyengar, senior analyst at London-based Ovum Research.

In Q3 of 2019, the IT services firm reported a 1.9 percent YoY growth in its financial services segment that accounts for more than 35 percent of its revenues.

But growth in the health care vertical with a revenue contribution of around 26 percent declined 0.9 percent.

Against this backdrop, Cognizant’s new CEO Brian Humphries’ decision to change the employee mix by reducing the number of mid to senior level employees and hiring more fresh graduates is seen as step in the right direction. “What we are trying to do is to get back to the employee pyramid which has been eroded in the recent past. So, we are getting that right with less middle and senior management,” Humphries told Business Standard last week.

The new CEO had said in an earlier analyst call that the bloated cost structure had also led to losing contracts to rival TCS and Infosys in some instances. “Job cut (of around 13,000) was anticipated, and it is clear that to sustain margins, costs need to be brought under control,” Iyengar said. In the September quarter, operating margin of Cognizant stood at 15.7 percent, 270 basis points lower than what it was in the year-ago period.

Though reducing headcount will help control cost, the CEO has to overcome the cultural issues associated with the layoffs. “India is not losing its importance as the key delivery centre for Cognizant. But reducing headcount will have its own cultural challenges which the new management has to handle,” said an IT outsourcing advisor.

Before US-based hedge fund Elliott forced the company to bring the focus to margin from revenue growth, Cognizant was the poster boy of the global IT services industry.

During 2004-08, the Indian-origin firm had posted a compound annual growth rate (CAGR) of 48 percent, while between 2009 and 2013, it came down to 28 percent. Even in 2014 and 2015, revenue growth rates for the company stood at 16 and 21 percent, respectively. It was in 2016 when its growth faltered for the first time. “Accompanied by the new CEO’s approach of ‘growth over margins’, these are a set of the much-needed actions which the current management is taking to undo Elliott-induced strategic shortcomings,” said Bendor-Samuel. “Cognizant now seems to be sailing in the right direction, but its performance assessment calls for patience on part of all stakeholders,” he added.―Business Standard