The business of writing software in India has been booming. But some of the biggest providers — Accenture (NYSE:ACN), Cognizant (NASDAQ:CTSH), and Computer Sciences Corp. (NYSE:CSC) — are getting nervous. Is this is a sign of trouble in these stocks or is there an opportunity to buy?
For decades, big organizations have decided that their computer systems are important but they simply can’t afford to put top programmers on their staff. As a result, they hire outside companies to build systems to solve problems like keeping track of inventory or selling products online.
This industry is big and growing. According to Canadian researcher XMG Global, the global outsourcing industry is forecast to end 2011 at $464 billion — 9.2% larger than in 2010, which was 13.9% up from 2009. And the reason it’s growing is simple — companies need new computer systems, and while they have the budgets to build them, they can’t get the job done quickly and cheaply with their in-house staff.
But XMG believes growth in the industry goes up in proportion to global economic growth. And now a feared slowdown in global expansion is scaring some of the biggest outsources. For example, the top 20 IT companies in India account for more than 60% of engineering job offers to students there, according to The Times of India.
And those big employers have made plenty of offers. So far in 2011, Indian outsourcer TCS hired 40,000 students, Infosys 30,000, Cognizant 28,000, Wipro 20,000 and HCL 8,000. They hired that many people based on two factors — the number of big deals in their sales pipeline and the rate at which they expect programmers to quit or get fired.
But the attrition rate is falling as the number of job opportunities for experienced programmers dries up, and the size of new deals also is declining. For example, in the past couple of quarters, the attrition rate has dropped from 25% to 15% and companies no longer are able to close deals bigger than $100 million.
As a result, in India, students who are about to graduate regularly receive general offer letters that do not specify when they should report to their employer. They later receive so-called appointment letters that tell them when to start. The Times of India reports that there are many who graduated in June but are nervously awaiting a letter — perhaps in October or November — signifying they finally are able to work.
These delayed start dates are like the canary in the coal mine for earnings prospects for the industry. But do they mean that you should avoid all of the stocks in the industry? Consider Cognizant and Accenture — but steer clear of CSC. Here’s why:
- Cognizant: Booming, profitable, fairly priced stock. Cognizant revenues soared 40% to $5.3 billion in the past year, and the company’s net income of $826 billion was up 37.1% — yielding a fat 15.6% profit margin. Although it has a slim profit margin, the stock is fairly priced based on a price/earnings-to-growth ratio of 1.13 (where 1.0 is considered fairly valued). Cognizant’s P/E is 24.5 on earnings forecast to grow 21.7% to $3.40 in fiscal 2012. Cognizant’s second-quarter earnings rose 20.8% from the same quarter in 2010, while revenue was up 34.4% to $1.49 billion.
- Accenture: Profitable, growing, moderately expensive stock. Accenture revenues are up 18.4% to $27.4 billion in the past year, during which ACN posted a $2.3 billion profit, up 27.9%. The stock is fairly expensive based on a PEG ratio of 1.47. Accenture’s P/E is 16 on earnings forecast to grow 10.9% to $4.25 in fiscal 2013. In its fiscal fourth quarter, reported Wednesday, Accenture announced a 37% jump in earnings and a 23% revenue increase. If Accenture can continue this growth pace, its valuation looks low.
- CSC: Barely profitable, fairly priced stock. CSC revenues barely budged, up 0.8% to $16.2 billion in the last year, and its net income was $750 million, down 13.2% — and it had a slim 5% profit margin. The stock is fairly priced based on a PEG ratio of 0.95. CSC’s P/E is 5.8 on earnings forecast to grow 6.1% to $4.66 in fiscal 2013.
Cognizant looks like the winner in this bunch because of its explosive growth and reasonable valuation. Accenture also is a strong player, but it’s not growing as fast (understandably given its size). CSC, despite its fair valuation, continues to be an also-ran. The concern for the first two is that those delayed appointment letters signal slower growth ahead.
As of this writing, Peter Cohan did not own any of the aforementioned stocks.