In the October 2014 issue of the award-winning Investor Advisory Service, our team took a look at Syntel (SYNT). Here's an update on the stock.
At this time last year, healthcare and utility stocks were the best-performing sectors of 2014. While utilities have underperformed as the third worst-performing sector in 2015, healthcare has remained the top performer. However, the long anticipated biotech correction has pushed the sector into the red for the year, down 3%, putting it neck and neck with consumer goods at the time of this writing. Biotech, especially in the small-cap space, has looked frothy for a long time, but the speed and magnitude of the correction this September has been rather jarring. The trigger came when Hillary Clinton “tweeted” a link to a New York Times article detailing excessive price increases by some small specialty drug companies, and promised to lay out a plan to attack this price “gouging.” In the six days following her tweet, the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB) is down a whopping 20%, putting the healthcare sector into correction territory for the month, down 11%.
In market turmoil like this, it is important to remember a key investment motto of legendary value investor Benjamin Graham: This too shall pass. Biotech, especially small-cap biotech, is a high-risk, high-reward sector that is frequently volatile. In fact, this is the fifth time since 2009 that small-cap biotech has entered a bear market. However, each time it has recovered and marched higher. It is also important to distinguish between individual companies. The market has punished any and everything healthcare related, providing potential opportunities to the discerning investor in the large innovative biotechs, clinical research outsourcers, and even healthcare IT providers.
On September 23rd, healthcare and financial services IT provider Syntel, Inc. (NASDAQ: SYNT), who we re-profiled in the October 2014 IAS issue, rang the closing bell at the NASDAQ Stock Market in celebration of its 35th year in business. In the press release accompanying the event, CEO Nitin Rakesh stated:
“One thing that sets Syntel apart is that our growth has been one hundred percent organic over the course of our 35 years in business. A key element of this success has been our ability to continuously adapt our business model and deliver solutions backed up by solid business sense.”
Long-term shareholders have reaped the benefits of this one hundred percent organic growth, with the stock producing a 16.7% and 17.7% annual return over trailing five and ten year periods, compared with 13.9% and 7.0% for the S&P 500. However, growth has slowed significantly over the past year, stalling the stock price along with it. At the time of this writing, the stock price sits at $44, exactly where it stood when we highlighted it last October. While the S&P 500 was virtually flat over the same holding period, we certainly aspire to more than just matching the market.
The first signs of slowing growth came when the company announced 3Q14 results shortly after our recommendation last October. After six straight quarters of double-digit organic growth, sales increased 9% in the third quarter, and management lowered guidance for fourth quarter sales growth to the 4%-7% range. As a result, the shares got off to a bad start, gapping down over 10% to their 52-week low beneath the split-adjusted $40 mark. Interestingly, the main blow to Syntel’s near-term growth prospects was dealt by fellow IAS holding Cognizant Technology Solutions in the third quarter of 2014. Cognizant acquired TriZetto Corporation, a former partner of Syntel, erasing a significant portion of business in the Healthcare and Life Sciences division. Considering Syntel sued Cognizant over the business fallout following the acquisition, it looked like it was going to take a few quarters at the least to rebuild the Healthcare and Life Sciences pipeline. History suggested management would once again successfully adapt, but the shares looked like dead money in the near term.
After following the overall market higher in the late October rally of last year, as expected, the stock traded sideways for the next several months. However, when management released bullish guidance for 8%-12% sales growth in 2015 as part of the company’s Q4 report in February, investors jumped back on board in hopes of a faster-than-expected rebound in the business, and the shares surged to a 52-week high of $53. This came in spite of Q4 revenues growing just 5%, and the Healthcare and Life Sciences business declining year-over-year for the second straight quarter. The rally was short-lived, however, as disappointing 1Q15 results released in April sent the stock sliding back to the mid $40s. Q1 revenues were up just 1% year-over-year and down 6% sequentially. Healthcare and Life Sciences sales were down for a third straight quarter, and a slowdown in business from top Banking and Financial Services customer American Express weighed further on results. As a result, management knocked the top end of full-year sales guidance down to 11%.
In between Q1 and Q2, the stock got a nice boost from some buy-out speculation. Syntel has frequently been a subject of buy-out talk due to its strong organic growth, rock solid balance sheet, and substantial net cash position. The Times of India reported in May that private equity giant Bain Capital, who is the biggest shareholder of Genpact, was evaluating advising the firm to buy Syntel in order to bolster its banking and financial services, capital markets, and insurance IT capabilities. As is typical of buy-out speculation, ultimately nothing came of the rumors and Syntel shares traded back down to the mid $40s.
The shares have traded sideways ever since, as Q2 results were modest with revenues up 5% and EPS down 2% thanks to negative currency and lower utilization effects. Long-term shareholders could hang their hat on some bright spots in the second quarter however. The Healthcare and Life Sciences segment was restored to positive year-over-year growth, proving management can still adapt the business in pretty short order. And despite lowering the top end of sales guidance again to 8%-10% growth for the full year, that still implies nice 6%-7% sequential growth in both Q3 and Q4. At a current P/E excluding net cash of about 13, if the company’s new digital solutions “Digital One” and “SyntBots” can deliver growth at the top end of guidance in the second half, Syntel shares could soon resume their outperformance for long-term shareholders.