Tech Services: Powering Up Again?
By Stephanie Crane
Are corporate CIOs loosening their purse strings? Not quite, but the worst may be over for some segments of the information technology sector. After a period of softness in outlays for IT, we at Standard & Poor's Equity Research Services see some signs that spending is firming. And that has led us to revise our outlook on the IT Consulting & Other Services subindustry -- companies that provide services like applications development, strategy consulting, and Web page creation -- to neutral, from negative.
However, while we have seen signs of some stability, we would caution that corporations remain hesitant to openly spend their discretionary funds beyond three key segments: security, disaster recovery, and Sarbanes-Oxley compliance. We would also caution that as India-based Infosys (INFY ; recent price, $57) enters the global IT consulting arena, we could begin to see pricing pressures. Meanwhile, Unisys (UIS ; $10) has noted that the contract deferrals it witnessed last quarter are being realized now, although with less revenue than expected.
Share prices of group members have suffered thus far in 2004. Year to date through Sept. 10, the S&P IT Consulting & Services Index dropped 10%, vs. a 1.4% rise for the S&P 1500 index (the combined S&P 500, S&P MidCap 400, and S&P SmallCap 600 indexes). We attribute this in large part to weak demand in key segments of the consulting market. During the second quarter, Unisys, the only S&P 500 company in this subindustry, saw deferred contracts in its enterprise-server business and experienced issues closing several of its IT infrastructure services contracts.
Another industry member, Hewitt Associates (HEW ; $27) recently noted that consulting aimed at retirement benefits was considered discretionary by its customers and adjusted its growth expectations from this business segment to a percentage range in the low single digits.
To deal with the lackluster near-term prospects that we see, we believe that some IT service outfits have been supplementing their growth via acquisitions and partnerships. Another strategy that we think is gaining momentum involves focusing on smaller and shorter-duration IT service contracts, which often involve reduced upfront costs and have a shorter payback time.
We anticipate that consulting and systems-integration projects should begin to show modest improvement in 2005. In the government marketplace, we view increased spending on defense and Homeland Security initiatives as positive: Many IT services companies have expertise in this field.
Computer-services concerns will likely continue to benefit from the effects of an increasingly global economy, deregulation, an IT labor shortage, e-business opportunities, and the constant need by corporations and government entities to use services and systems that should enable them to boost productivity and help cut costs.
Our top selection among IT consultants is Computer Sciences (CSC ; $48), which we upgraded to 5 STARS (buy) from 4 STARS (accumulate) on Sept. 14. We raised our opinion based on a positive outlook for the company's fundamentals and the stock's valuation, which we regard as attractive. Infosys is also among our favorites, with a 4-STARS ranking.
We're not as bullish on the shares of two major industry players: EDS (EDS ; $20) and Accenture (ACN ; $27) each carry a 3-STARS (hold) ranking. As for the other companies mentioned in this report, we have a 3-STARS opinion on Hewitt, while Unisys is ranked 2 STARS (avoid).
As of June 30, 2004, SPIAS U.S. research analysts have recommended 35.9% of issuers with buy ratings, 52.7% with hold ratings and 11.4% with sell ratings.
5-STARS (Buy): Total return is expected to outperform the total return of the S&P 500 Index by a wide margin, with shares rising in price on an absolute basis. 4-STARS (Accumulate): Total return is expected to outperform the total return of the S&P 500 Index, with shares rising in price on an absolute basis. 3-STARS (Hold): Total return is expected to closely approximate the total return of the S&P 500 Index, with shares generally rising in price on an absolute basis. 2-STARS (Avoid): Total return is expected to underperform the total return of the S&P 500 Index and share price is not anticipated to show a gain. 1-STARS (Sell): Total return is expected to underperform the total return of the S&P 500 Index by a wide margin, with shares falling in price on an absolute basis.
All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.
This research report was prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"). The research and analytical services performed by SPIAS are conducted separately from any other analytical activity of Standard & Poor's. No research analyst that prepares a research report on a subject company has a financial interest in or is associated with that subject company. SPIAS is affiliated with other entities, which may receive compensation for performing services for companies covered by Standard & Poor's Equity Research Services.
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Analyst Crane follows stocks of IT consulting companies for Standard & Poor's Equity Research Services