Photographer: Dhiraj Singh/Bloomberg

Unloved India Software Stocks a Buy for This Insurer

  • Technology stocks in ‘buy zone’ after recent correction: CIO
  • Risk-reward for large-caps better versus mid-caps, Reddy says

The recent underperformance of Indian software stocks, once considered a bellwether of the overall market, is a glaring buy signal for Bajaj Allianz Life Insurance Co.

The S&P BSE Information Technology Index is the second-worst performer among 13 industry gauges compiled by BSE Ltd., weighed down by losses in names including Infosys Ltd. and Tech Mahindra Ltd. In contrast, India’s benchmark index has surged to a record.

“We prefer software stocks among defensive sectors such as pharmaceuticals and IT, as they have entered a ‘buy zone’ in terms of valuations after the recent correction,” said Sampath Reddy, chief investment officer at Bajaj Allianz, which manages 500 billion rupees ($7.7 billion) of assets. The Bajaj Allianz ULIP Equity Growth Fund, the largest managed by Reddy, has returned 19 percent so far in 2017.

Shares of Indian technology companies have been hurt by uncertainty about U.S. visas amid rising protectionist rhetoric that has forced some clients to delay decisions on outsourcing contracts. Investors have also been concerned about recent reports that founders at two of the top four providers were looking to sell their stakes. Some market participants advise waiting for a clearer trend to emerge in the sector.

“Investors must wait six-nine months for a decision on software exporters,” said Prasanth Prabhakaran, chief executive officer at Mumbai-based Yes Securities (India) Ltd. Companies able to adapt more quickly to changes in the operating environment will be “good buys.”

The BSE IT Index has climbed 3.9 percent so far this week, set for the steepest gain in that period in more than seven months. The gauge has fallen 16 percent from its peak in March 2015. Infosys and Tata Consultancy Services Ltd., the top exporters, kick off the earnings season for the April-June period this week.

‘Potential Intact’

Bajaj Allianz’s Reddy recommends investing in the sector now, and sees profitability being maintained amid continued sales expansion. “Return on capital employed on core business for these companies is still healthy and upwards of 25 percent, and even though the growth has slowed the potential for 5-10 percent growth is intact,” he said in an interview Monday.

The software gauge is valued at 15.6 times forward earnings, representing a 20 percent discount to the Sensex, the cheapest in eight years, data compiled by Bloomberg show.

Above-average valuations for the broader Indian market isn’t deterring Bajaj Allianz’s Reddy from adding to his holdings. “If earnings start growing at 15 to 20 percent, we can see these valuations sustaining and investors would continue to make money even from current levels,” he said.

Reddy forecasts earnings at NSE Nifty 50 companies to rise as much as 18 percent in the year ending March 2018. The Pune-based fund manager believes his estimates will be achieved, saying that problems that hurt profits in the past three years such as bad bank loans and a downturn in the commodity cycle have peaked.

In addition to software, Reddy is bullish on private banks, other financial services and metal companies. Large-cap stocks offer better “risk-reward” versus mid-sized peers, whose rich valuations are “a challenge,” he said. The S&P BSE MidCap Index trades at 19.5 times its estimated 12-month earnings, a two-year high.

“We are sticking to good, quality companies and we don’t mind paying little higher valuation than the normal range for them,” he said.

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