|Sep. 07 - Sep. 20, 1998|
Kothari Pioneer Mutual Fund
`IT sector will outperform the market'
In conversation with R Sukumar, fund manager, Kothari Pioneer Mutual Fund, on the future of computer software stocks
Two of Kothari Pioneer Mutual Fund (KPMF)'s existing growth schemes -- Kothari Pioneer Bluechip Fund and Kothari Pioneer Prima Plus -- outperformed the markets in recent years, thanks to their substantial exposure to infotech stocks. Buoyed by this stellar performance, KPMF recently launched a growth scheme dedicated to the infotech sector. Kothari Pioneer Infotech Fund (KPIF), the sector-specific fund, is the outcome of extensive research of the infotech sector which has a bullish outlook.
Having mopped up Rs 8 cr from the market from nearly 4000 retail investors through an initial issue last month, KPIF has already invested the funds in infotech stocks. In fact, enthused by an encouraging response from retail investors, it has decided to advance the commencement of the open-ended scheme by a week to 7 Sep.'98 from 14 Sep.'98.
Capital Market's Sameer Purohit spoke to KPIF's fund manager, R Sukumar, on the future investment strategy, reasons for optimism on the infotech sector and how value can be found in infotech stocks. Excerpts :
We plan to invest a substantial portion of the portfolio in large companies which have a robust business model, sound track record, ability to manage growth, transparency and integrity. I expect a steady appreciation in prices of these scrips. A portion of the portfolio will be invested in smaller companies which have a good chance of emerging as blue chips. Though riskier, these companies can be potentially very rewarding.
Software stocks have performed dramatically in the last three years, driven by a combination of high growth rates and better investor awareness of the sector's fundamental strengths. I expect the sector to outperform the market as it continues on its high growth path, though at more moderate levels compared to earlier years.
Number one is the projected high growth rates. Global demand for computer services is growing at a fast pace. Due to vast requirements and difficulty in managing operations, an increasing number of corporations are outsourcing their IT requirements. Indian companies are catering to this huge growing market. NASSCOM expects Indian software exports to touch Rs 36,000 cr by 2002 from Rs 6,000 cr in 1997.
================================================================== Bouncing back KPMF's performance report for end-Aug.'98 ================================================================== Last Last Last Last Since 1 month 3 months 1 year 3 years Inception =================================================================== Bluechip Fund NAV* -2.56 -9.68 27.01 6.08 26.06 Prima Plus NAV+ -2.71 -10.3 16.80 1.92 -1.17 BSE Sensex -8.64 -19.46 -25.61 -4.11 -2.29 Crisil 500 -5.17 -18.57 -19.94 -6.27 -11.68 * Started in Dec.'93 with an objective of investing in large cap stocks, the scheme has consistently outperformed the 30-share BSE Sensitive Index. + Started in Sep.'94, the growth scheme had a severe setback due to a substantial exposure in IPOs. The subsequent restructuring of portfolio has, however, enabled it to outperform Crisil-500, the broad-based index. ==================================================================
Second, India has the unique advantage of having a vast pool of English-speaking IT professionals at lower pay levels. Unlike the other sectors, the leading Indian software exporters have a track record of high quality. Indian companies have built relationships with a number of Fortune 500 corporations, which will allow them to expand their businesses.
Third, the high return on capital. The margins of software companies are high and capital requirements relatively modest, thereby enabling a high return on capital. Because of this, software companies are able to achieve high rates of growth from internally generated resources, thus reducing the need for equity dilutions.
Valuations of IT companies have expanded in the last two years. But the Lynch ratio (earnings per share growth/price earnings ratio) of the Indian IT sector is favourable compared to the BSE-30 and similar companies listed in the US. Also, in the US, the price earnings (PE) ratios of IT stocks are much higher than the market because of higher growth anticipated for this sector. I expect the current valuations of Indian IT stocks to hold in the medium term, though they may contract during periods of pessimism and expand during periods of optimism. If the current valuations hold, then the stocks will perform in tune with earnings growth which is very high. In the long term, when PE ratios shrink, high earnings should compensate for this and the stocks will appreciate substantially.
===================================== Bullish on IT Top holdings of 2 KPMF schemes ===================================== Company % of assets Bluechip prima fund plus ===================================== Infosys 8.06 11.37 Satyam Com. 8.20 6.81 Tata Infotech 7.36 6.11 TVS Suzuki 5.75 2.43 Digital Equip. 5.62 1.93 BPCL 5.00 3.90 MTNL 4.93 3.01 HDFC 4.93 2.12 Baja Auto 4.72 - Pfizer 4.52 2.67 VSNL 4.04 2.28 P & G 3.91 - HPCL 2.75 4.20 Smith. Pharma. 2.74 - SBI 2.70 - Wipro - 4.79 NIIt - 3.07 Britannia - 2.86 Mastek - 2.67 Cochin Ref. - 2.45 As on 31 Aug.'98 =====================================
We plan to invest in good quality companies which have already moved up the value chain and are moving up further every year. These companies stand to benefit from their established clientele and systems. The only country in the above list which can be a major threat in the long term is China. But Indian companies have a head start and the good ones should maintain this. Also, demand for IT services is growing and there is enough room for all.
Operating profit per employee (OPE) is a good measure of value addition. Infosys has been able to increase its OPE steadily by increasing the share of fixed bid contracts and branded services. Wipro, too, has been adopting a similar strategy. It also offers services in systems software for technology companies. Competition in this area is limited. Satyam has reorganised its operations so that specific groups can develop domain expertise in areas like banking and manufacturing.
The package, when fully implemented, will help in a number of ways. For one, Indian software companies need to become global. They need to employ people in various countries. So stock options are required to attract and retain talent.
Software companies use satellite links for data communication and it is a major cost. Reduction in rates for dedicated links will give a big boost to the sector.
It will help because a higher dollar rupee exchange rate or a costlier dollar will go straight to the bottom line.
The most important risk factor is the ability to manage growth. The sector is growing fast and organisations are becoming big. Managements should have the ability to institute systems to manage this growth. Some company managements are probably not equipped to handle this.
Another important risk factor is the relationship with G-7 countries. Indian software exports are mainly to G-7 countries. Hence, any major negative development in relationships with these countries can have an adverse impact.
Moreover, competition for low-value services can come from countries like China. Companies which do not move up the value chain may be affected.
It has to be understood that the IT sector by itself is a multi- faceted versatile industry with many segments that have their own growth rates, dynamics and sets of markets. By exploring and investing in different aspects of the IT industry, we should be able to achieve a level of diversification within this sector itself and thereby manage the risks.
Our research is focused on a number of qualitative issues like business model, competitive strengths, strategy, personnel, system, risks, etc. A lay investor may not have the inclination, time and competence to gather information on these companies. Whereas, we have been tracking this industry for quite some time. We do a lot of ground work as no published report can give an edge in researching these companies. I have at times spent days meeting different people of the same company, which gives a much better overall perspective.
Since it is a sector-specific fund and does not provide the desired levels of diversification, it can serve as a supplement or a booster to an already diversified portfolio.