The Most Undervalued Stock in India

A couple of weeks ago, I wrote an article about India’s vast potential for both economic development and profit for investors. [“Read why I think India’s a better long-term investment than China”] In that article, I mentioned a few of the standard, well-known Indian stocks, but some of these tend to be expensive, so I wanted to delve deeper into lesser-known Indian stocks that might have greater potential down the road.

My search led me to a common space for well-known Indian stocks (outsourcing), but yet this company that has flown under the radar. Even better, its stock is undervalued and is set to potentially double within a couple years.

It’s little secret that India’s primary growth industry is outsourcing. This is where, to save time and cost, companies shift workloads to a third party instead of doing it themselves. Usually this consists of more mundane, basic tasks, but can also consist of more important functions, such as running important information technology (IT) transactions.

The leading firms in the IT space are well known and consist of Wipro (NYSE: WIT), Infosys (Nasdaq: INFY), and certain divisions of conglomerate the Tata Group Companies. The investment tradeoff of being well known is that the stocks are not cheap. Wipro’s American Depositary Receipts (ADRs) trade at nearly 30 times forward earnings. Infosys trades for more than 25 times forward earnings.

Outsourcing is an important driver in other industries, too, but for some reason doesn’t receive as much as attention in the marketplace. It should, because the advantages that India possesses in the IT sector also carry over to outsourcing in general. Telecom outsourcing is a close relative to IT in general and subject to similar drivers.

This brings us to WNS Holdings (NYSE: WNS). WNS began in 1996 as an in-house division of European airline giant British Airways. It is focused specifically on business process outsourcing, or BPO, for short. Specifically, WNS is involved in BPO activities that span from handling customer calls, providing billing support such as the handling of client sales and payments, as well as taking care of other accounting functions, and all the records that have to be maintained to run the financial supply chain. 

The company first started focusing on business outsourcing for third party clients in 2003, and in 2004, private equity investor Warburg Pincus took a controlling stake in the company, forming the foundations for an initial public offering in 2006.

WNS sits in a compelling component of the outsourcing market. In its financial filings, WNS cited industry data placing the global BPO market at $112 billion, stating that it should grow to almost $150 billion, or more than +7% annually, in the next few years. More than half of that market is in India.

WNS counts itself as one of the two largest BPO firms in India. The company provides the BPO activities mentioned above for a few specific industries, including banking, financial services and insurance. Travel and leisure is also a specialization, as is industrial and infrastructure as well as emerging businesses. Despite this focus, WNS still boasts over 225 clients across the globe, so while it is focused on select industries, it also has a certain amount of customer and geographic diversification that ensures a single client can’t hurt the company should it choose to go elsewhere.  

In the past two full years (the company’s fiscal year-end is in March), sales grew at a compounded rate of +15.3% annually, rising from just under $448 million to $583 million. Growth stemmed from organic, or internal means, given the industry is expanding at an impressive clip.  Acquisitions also play a big part of the corporate strategy. Since 2003, the firm has steadily bought out smaller rivals, including those that specialize in financial accounting, offshore analytics and companies that provide software to carry out BPO activities  WNS’ expansion rate is very impressive, given took place during one of the most severe economic downturns in modern times.

Profitability trends have been more uneven but are coming on strong. This isn’t clear by looking at net income, which has averaged only about $0.17 a share in the past three years. However, cash flow trends have been much more visible. Last year, WNS generated just over $41 million in free cash flow, or about $0.88 a share.
Action to Take —> Current expectations call for WNS to earn close to $1 for its current fiscal year. At a stock price of just over $10, that’s a very reasonable forward P/E of about 10. The trailing free cash flow multiple in the low double digits is also quite reasonable.

WNS should log close to $370 million in sales this year. Based on this small overall level of sales and a market capitalization below $500 million, the stock qualifies as a small cap. Being smaller can be risky, but it also means the company can grow rapidly from a smaller sales base.

This combined with a leading industry position, compelling industry growth outlook, and an extremely low valuation mean the stock could easily double from current levels in just a couple of years. As such, it is the most undervalued Indian stock I have come across in some time and would make a good candidate for international growth investors seeking a specific, but reasonably priced, play on India’s outsourcing.