EPAM Initiation and Earnings: Discretionary Softness Sees Stabilization; Shares Moaty and Fairly Valued

We have initiated coverage on EPAM Systems EPAM with a $222 fair value estimate and a narrow moat rating. The IT services firm sets itself apart from companies like Accenture or Tata Consultancy Services with its deep concentration in engineering services – which pertains to the creation of custom enterprise software or code. The demand for engineering services has accelerated since the COVID-19 pandemic, which shed light on the need for an agile and flexible IT landscape – enabled by custom software. Yet, we think demand for such services is here to stay, as digital transformation projects require hefty software engineering to lift systems to the cloud and finetuning thereafter is inevitable. Altogether, EPAM’s bread and butter of engineering services is a more discretionary type of IT enterprise spend, which means its mix has proved extremely favorable in good macroeconomic times but compounded vulnerability in weaker macroeconomic times. Nonetheless, we think their long-term trajectory is solid and we are pleased to see a focus on increasing consulting revenues which can further drive demand in EPAM’s engineering services.

Today, EPAM reported third-quarter earnings which beat market expectations on both the top and bottom line as near-term discretionary weakness has reached some stability (especially within North America). EPAM’s total third-quarter revenue decreased by 6% year over year to $1.2 billion. Unlike most major IT services firms, where financial services makes up the largest portion of revenue mix, EPAM’s greatest vertical exposure is in travel and consumer, whose revenue was down 6% year over year in the quarter (compared to financial services revenue down 3% year over year).

Non-GAAP earnings per share of $2.73 in the quarter were down 12% year over year due to overall pricing pressure and lower utilization weighing on profitability. Nonetheless, this was somewhat offset by variable compensation expense.