What IT investors should read into Cognizant's September quarter results

The company slightly trimmed upper end of its CY16 revenue growth guidance largely to factor in nearly $18 million impact of weakening pound against US dollar

Global software services giant Cognizant on Monday reported lower-than-expected 11.8 per cent year-on-year rise in net profit in the September quarter but cut its annual revenue forecast for the third straight time this year. Allaying investors’ fears, the company though said that it does not anticipate any negative business impact on account of ongoing investigations for improper payments made in India. 

To recall, Cognizant is accused of violating the US Foreign Corrupt Practices Act amid allegations that the IT major may have made improper payments to obtain permits and building licences in India. 

On Monday, reacting to its Q3 quarterly earnings, the shares of the company rose over 5 per cent on the Nasdaq. 

The Teaneck, New Jersey-based IT firm follows a January-December financial year. 

Below are key takeaways from Cognizant’s Q3 earnings:

1) Guidance cut in line with rivals

The company slightly trimmed upper end of its CY16 revenue growth guidance by 50 bps to 8.5‐9.0 per cent from 8.5‐9.5 per cent, largely to factor in nearly $18 million impact of weakening pound against US dollar.  Rivals TCS, Infosys and Wipro also slashed their revenue guidance for FY16 and disappointed Street with tepid performance in September quarter on account of weakness in sectors like banking and financial services. 

The IT spends on financial services has seen a dip lately due to clients cancelling or downsizing the contracts owing to uncertainty over Britain's decision in June to exit the European. UK is the second biggest market for large domestic IT firms, accounting for 25 per cent of their market.

2) Improper payments in India

The IT services provider disclosed that it has identified "potentially improper payments" worth $5 million that it made for company-owned facilities in India. “If the payments are limited to $5 million, this would probably be well below investors' worst case, said Cowen and Co analysts in a research note as reported by Reuters. 

The company also said that some top-level managers may have participated in or failed to take action to prevent the fraud. However, people possibly involved with the payments are no longer with the company or in a senior management position, it added. 

3) Optimistic commentary positive for domestic IT players

Brokerage Edelweiss Securities believes cognizant’s guidance implies flat to 1.5 per cent growth in the December quarter in spite of seasonal weakness - a positive takeaway for domestic IT companies like Infosys, TCS, HCL Tech and Tech Mahindra. December quarter for IT firms remains traditionally weaker for IT firms as business is impacted by low volume growth amid Christmas and New Year holidays.

4) Cloud technology

Although domestic IT players lack the relevant exposure to cloud technology, brokerage Edelweiss Securities deduced that Cognizant maintaining guidance for Q4CY16 in spite of weak environment clearly reflects the industry’s inherent strength and limited impact of cloudification on large peers. 

“We believe, delayed decision has been the primary culprit behind revenue growth challenges for Indian IT players and cloudification does not have any role in it,” said Edelweiss report.

Infosys, Tech Mahindra and HCL Tech are brokerage's preferred picks.