Investing in India: Part II

By Ian Wyatt, Big Idea Investor | ACS | May 09, 2006 | comment

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Investing in India: Part II 

The Game's Not Over Yet: Investing in Outsourcing to India 

By Nancy Zambell, Staff Writer, Big Idea Investor 

In the first article in our series on investing in India, we discussed the tremendous opportunities in that country as a result of U.S. businesses exporting a variety of service and information related tasks to the region.  

Outsourcing has been found to reduce and control operating costs, free up internal resources for other purposes, provide a project focus not always obtainable in a multi-tasking environment, and to acquire resources not available internally. The ultimate payoff is cost savings, which leads to increased profitability for the companies that decide outsourcing is the right business decision.  

Corporate America's emphasis on the bottom line will continue to fuel the expansion of outsourcing as businesses fight for survival in extremely competitive industries, and at the same time answer the call for increasingly aggressive earnings growth from their shareholders and Wall Street.  

In addition to the call centers that most of us are familiar with, thousands of additional tasks are being performed around the globe, including: 

• Information Technology, including software development, network support, R&D and engineering services

• Human Resources functions such as payroll processing, 401(k) administration, worker's compensation and recruiting

• Administration duties, including accounting, marketing and advertising and purchasing

As a result, legions of outsourcers have sprung up in India, all of them ready to accommodate companies large and small that require their services. With so many outsourcing companies popping up, investors would do well to don their skeptical hats prior to running out and investing their hard-earned dollars in just any India outsourcing company. 

Although the need for Business Process Outsourcing (BPO) and Information Technology (IT) industry outsourcing continues to rapidly expand due to a variety of favorable factors, new challenges including competition from other emerging economies are mounting. 

The result is that investors can no longer simply throw a dart at companies doing business in India, and instead need to pick and choose carefully when deciding where they place their investment dollars. 

Instead, we recommend that investors first adhere to tried-and-true investment principles which will separate the weak from the strong, and leave you with fundamentally sound businesses that are trading at less than their intrinsic values, demonstrate healthy cash flows from operations, and have little or no debt. 

If your potential investments meet those criteria, it's time to focus on particular requirements for investing in this industry. The companies in which you invest should also have strategies in place for ongoing cost reduction, improving efficiencies, investing in the latest technology (including VolP, automation, and workforce optimization), identifying growth opportunities in competitive markets, and offering an expanding array of services. 

We have reviewed a couple dozen outsourcing companies and have identified the following three for your consideration as potential opportunities for investing in this sector. 

Affiliated Computer Services (NYSE: ACS) 

ACS supports client operations in nearly 100 countries, including India. The company's commercial segment offers BPO services, including administration, human resources and related consulting, finance and accounting, customer care, and payment services. Additionally, ACS offers IT services including mainframe, midrange, desktop, network, consulting, Web-hosting solutions, and systems integration services.  

The company's government segment includes child support payment processing services, Medicaid operations, child and pharmacy benefit management programs, electronic toll collection, motor vehicle services, commercial vehicle operations and transportation enforcement programs, loan servicing, debt collection and unclaimed property collection services. 

ACS' shares present an opportunity to climb aboard as they recently took a hit due to a blip in third quarter earnings, which we consider a short-lived circumstance. I believe shares of ACS could trade at $64 in the coming months based on the company's current P/E of 18 catching up with the sector's average of 32, as well as expected earnings growth to $3.33 per share for this fiscal year. 

Sapient (Nasdaq: SAPE) 

Sapient provides IT solutions to its clients, including business processes, data warehouses, business intelligence solutions, e-business, Web-based solutions, enterprise architecture and integration, and also manages client's technology applications.  

Customers include businesses in the automotive, aerospace, defense, heavy equipment manufacturing, health care, education, financial services, technology, communication, retail, direct marketing, consumer products, travel and hospitality industries, as well as various government agencies. 

Sapient's shares are also ready to buy as a result of a pullback due to the company's warning that first quarter numbers would be less than its previous guidance due to deferred revenue and acquisition charges - another temporary situation. The company is currently trading at a P/E of 32, in-line with the sector average. Yet, its sales and earnings growth rates are handily beating those of the industry, which should result in a higher value for its stock. I believe shares of Sapient could trade at $8.50 in the coming months based on continued healthy bottom line growth.  

Syntel (Nasdaq: SYNT) 

Syntel provides worldwide IT outsourcing in applications outsourcing, e-business, BPO and teamsourcing. The company's customers operate in the financial, manufacturing, health care, transportation, retail and information/communication industries. 

Syntel's first quarter profit rose 34% and revenues were up 25%, compelling the company to raise its full year earnings forecasts. And although the company's shares are near their 52-week high, escalating earnings will continue to accelerate their appreciation. The industry is currently trading at a P/E of 32, while Syntel's P/E is 27, considerably less than is warranted, since the company's earnings growth is outpacing that of its sector almost 2-to-1. I believe shares of Syntel could trade at $27 in the coming months based on the company's growth in sales and earnings leading to a higher P/E, and therefore an elevated share price. 

The shares in each of these companies tend to be volatile and somewhat speculative, so we recommend that if they meet your personal investing parameters you should consider placing stop-losses at prices 30% less than you pay for the shares. 

In our next segment on investing in India, we will discuss opportunities for buying shares in Indian companies and mutual funds. 

Until then'happy investing!


Let the Sun Shine In: Slicing Up the Solar Spectrum of Photovoltaic Stocks

by Peter D. Henig, Market Columnist, Growth Report

It's definitely a new and classy problem to have - among publicly traded solar companies, which are the best and potentially most reliable stocks to own?  A year ago we couldn't have even asked the question - a year ago there wasn't that much of a choice.  Now, with at least three to four major pure-play solar companies public, several larger energy companies playing in the space, and even a few small and micro cap alternative energy stocks dancing around the margins, investors have a smorgasbord of solar to invest in; yet, sometimes the choices of which will make the best long term investments are no longer clear. 

As the euphoria among publicly traded alternative energy stocks settles back into a muffled roar, it's important for investors to start paying closer attention to company financials rather than counting on soaring valuations as a result of the hedge against the rising price of oil.  Moreover, as more solar companies enter the public markets and Wall Street analysts start to pick and choose their more reliable favorites, invests should also be wary of the fallout from high-flyers not making their numbers or one-time market stars suddenly hit with downgrades.

SunPower has clearly had a hot hand in the market ever since its Q4 2005 blockbuster IPO, and a share price that now gives the company a $2.4 billion market cap.  Shares of SunPower have nearly doubled over the last four months and the company recently released earnings that showed it swinging to a first quarter profit just shy of a penny a share on net income of $300,000, significantly ahead of its $7.2 million loss in the year ago quarter.  The company also increased its 2006 revenue guidance to $220 million from $210 million, though also noted that gross margins came in 2 percent shy of expectations.   

In a sign of quickly maturing times for solar companies - even market darlings such as SunPower - investors took SunPower's stock down several points on worries that the minor softness in margins could be the result of tightness in the silicon supply feedstock; tightness which is driving up the cost of silicon and constraining production capacity for solar cell manufacturers. (SunPower has sinced announced a new long term silicon supply contract with M. Setek Co., Ltd.) Though investors could equally have been taking profits on SunPower's shares, Wall Street analysts are beginning to field more neutral positions on the stock and the sector as earnings numbers reveal just which players are the most profitable -- and which are becoming a bit too rich even for this growing market. 

For this reason, a company such as Suntech has attracted a unique amount of attention given its selling point as the low-cost manufacturer in the market with its base in China and its ability to generate margins far ahead of its competitors.  According to recent earnings reports, Suntech's gross margins of 28 percent in Q4 2005 significantly outpaced those of SunPower at 20 percent and Evergreen Solar at 14 percent for the same quarter, as it secured its position as the most profitable player among the three -- and one with the greatest ability to withstand increased cost pressures.  Toss in its near tripling of production capacity and its ready access to the growing Chinese market and some argue that Suntech could be the 'best buy' among the top publicly traded solar firms.

Yet, here's where investors have to make their own judgment call given that nearly all alternative energy stocks are trading at multiples most rational observers would hardly deem a 'best buy.' 

Though Suntech trades at roughly 31 times forward earnings - seemingly a steep price to pay given all of our previous lessons in the post-tech shakeout - SunPower trades at an even richer 57 times earnings, and Evergreen at an Internet-like 700 times December 2007 earnings.  Though many of these companies are literally doubling sales year over year, any further shocks to the solar industry in the form of higher silicon feedstock prices or possibly unforeseen declines in oil prices, could severely threaten such inflated P/E multiples. 

As a result, investors tracking and trading this sector would be wise to start rotating out of the more highly speculative (some might say crazy) names such as Evergreen or Spire Corp (Nasdaq: SPIR) or Daystar Technologies Inc. (Nasdaq: DSTI), and stick with the likes of SunPower or Suntech or even some of the larger energy companies such as British Petroleum (NYSE: BP), that at least have some depth, certainty and predictability in terms of future earnings.  Not that the overall outlook for the sector doesn't call for more sunny days ahead, indeed it does; yet it might be wise for sophisticated alternative energy investors to prepare for shifting weather patterns once much of the market euphoria begins to cool off.

Peter D. Henig is the market columnist at Growth Report, the newsletter advisory that has returned average annual gains of 18.4% since 2001.  Can your portfolio use gains like that? Join Growth Report for a complimentary trial subscription today.



Chipotle Sizzles 

By Big Idea Investor Staff 

In spite of higher menu prices, Chipotle's (NYSE: CMG) first quarter results indicate that customers keep coming back for more of the chain's burritos, tacos, and salads. 

After the close of the market on Monday the recently public company reported earnings of $8 million or 26 cents a share versus $2.6 million or 10 cents a share in the year-ago quarter, handily beating consensus analyst estimates of 12 cents a share.  Revenue increased 42% to $187 million, also coming in far ahead of analyst estimates that called for revenue of $172 million. 

Founder, Chairman, and CEO Steve Ells credited Chipotle's blowout performance to "improving restaurant level execution, IPO-related publicity and mild weather." The company's operating margins increased to 20.2% from 17.1% in the year ago period due in part to increased menu prices in some markets because of the addition of naturally raised beef or chicken. 

The company has added more than 70 new stores in the past year, including 15 in Q1 2006, and has plans to add between 80 and 90 additional stores in 2006.  And though new store openings should help drive growth in the near-term, much of the company's outperformance can be attributed to growing existing store sales, which continue to build loyal customer bases.   

The company reported that same stores sales increased 19.7% in the first quarter. However, the company does note that they expect full year comparable sales results to clock in at the "high single digits" level.   

Longer term, management says they are comfortable projecting a longer term growth rate of 25% annually. 

Shares of Chipotle jumped 13% from Monday's close of $59 to close Tuesday's trading session at $67.  During Tuesday's trading session, 2.5 million shares changed hands, a seven-fold increase from average daily share volume of 354,000 shares.   

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