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First Infosys, Now Cognizant. Bad News Piles Up For IT Sector

IT stocks have underperformed the broader markets and are likely to come under further pressure following Cognizant's June quarter earnings announcement on Friday.
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Cognizant lowered its annual revenue guidance for second straight quarter on Friday
Cognizant lowered its annual revenue guidance for second straight quarter on Friday

Highlights

  1. Cognizant lowered its 2016 sales guidance for the second time in a row
  2. Cognizant is expected to post slowest growth in 10 years
  3. Last month, Infosys had cut its annual sales guidance

IT stocks have underperformed the broader markets and are likely to come under further pressure following Cognizant's June quarter earnings announcement on Friday.

New Jersey-based Cognizant, which employs a majority of its employees in India, lowered its 2016 sales guidance for the second time in a row, citing cautious demand from clients.

Cognizant now expects its 2016 revenue to grow between 8.5 per cent and 9.5 per cent.



"This will be the first time in 10 years, and possibly in its history, that Cognizant is expected to deliver single-digit revenue growth," said Nirmal Bang Securities.

Cognizant's guidance cut comes days after Infosys lowered its fiscal year 2016-17 guidance (constant currency) from an industry-leading 11.5-13.5 per cent to 10.5-12 per cent, triggering a sharp correction in IT stocks.

Cognizant cited weaker-than-expected discretionary spending by clients in the second half of 2016 and Brexit-related worries for lowering its annual revenue guidance.

Cognizant's subdued commentary has important ramifications for domestic IT companies, which not only compete with the US-headquartered IT major, but also operate in similar geographies.

Both Cognizant and Infosys get around 33 per cent of their revenues from the key banking, financial services and insurance (BFSI) space. Cognizant gets 16 per cent of its total revenue from Europe, while Infosys received 23 per cent of its revenue from Europe in the June quarter.

Religare Securities noted that Cognizant's earnings have grown faster than domestic IT companies and its guidance downgrade points to demand pressures and a difficult environment.

"We maintain that the growth risk for Indian IT remains high and this could translate into margins in absence of material rupee depreciation against the US dollar," the brokerage said.

Nirmal Bang Securities predicted that a second guidance cut from Infosys may be on its way, though it still expects the company to post industry-leading growth.

"It is not just Cognizant which pointed out this weakness, but almost all tier-1 Indian players have indicated such a situation in respect of BFSI clients. We believe banks are rationalizing IT spending by vendor consolidation, insourcing and higher level of industrialization," said the brokerage.

Nirmal Bang Securities has a "sell" on the IT sector, while Religare advised investors to stay "cautious" about the IT space.



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