Where One Key Analyst Sees the IT Sector Going From Here

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Although the March quarter is not considered strong for the IT services industry, one analyst believes that a few companies came through and made a great case for themselves. Typically this is the second weakest quarter for the industry, with the weakest being the December quarter. Accordingly, funding for incremental work/projects are released at this time, as well as guidance. Wedbush took a look at these factors and thought about where IT stocks could run from here.

Among its tier 1 offshore peers, Wedbush believes that Cognizant Technology Solutions Corp. (NASDAQ: CTSH) offers the best risk/reward, and the firm issued an Outperform rating for the stock. Wedbush also has Outperform ratings for Accenture PLC (NYSE: ACN) and Epam Systems Inc. (NYSE: EPAM). The firm also mentioned Virtusa Corp. (NASDAQ: VRTU) as a favorite turnaround story and likely to provide conservative 2018 guidance.

Accordingly, Wedbush also believes that fluid, preemptive plans (expanding offshoring, onsite recruiting) to address a hostile administration to the various visa programs may also result in muted tone and conservative guidance for the sector as a whole.

Historically, March quarterly results are considered the second weakest in the space (second to the December quarter). The quarter takes place while the budget cycle is worked out and budgets are finalized. Funding for incremental work/projects go through the system (are released) during the last month of the quarter.

Wedbush also believes that annual guidance, may be impacted by multiple moving parts, including:

  • Recent appreciation in the INR vs. The USD, GBP, and EUR, which took place towards the end of the quarter and could impact both revenue growth and margin guidance.
  • Conservative guidance as in most cases, as finalized IT budget is yet to translate into actual funding/awards.
  • Muted tone as most management teams are in the process of operationally preempting more onerous visa regulations.

The firm also commented:

While the sector continues to face secular headwinds as the delivery of asset/labor intensive legacy services shift to asset/labor light models (Cloud, SaaS, Automation), resulting in a deflationary impact on top line growth, our survey work suggests a cyclical IT spending uptick in CY17, with the FS vertical experiencing its first spending uptick in 3 years. In this group, we point to a host of well-positioned IT Services vendors, including Accenture (40%+ of revenues from digital) and a host of digital/SMAC pure plays, including EPAM, Globant and Luxoft.

Shares of Cognizant closed Monday at $58.98, with a consensus analyst price target of $65.13 and a 52-week trading range of $45.44 to $63.23.

Accenture closed at $116.63, in a 52-week range of $108.66 to $126.53. The consensus analyst target is $130.68.

Epam shares were last seen at $75.12, with a consensus price target of $81.11 and a 52-week range of $54.53 to $78.40.

Virtusa closed Monday at $27.48 a share, with a consensus price target of $35.13 and a 52-week range of $18.03 to $38.31.