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Fears of a Trump dump in tech stocks are overdone

Glenn Freeman  |  16 Nov 2016Text size  Decrease  Increase  |  

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These three Aussie technology stocks are worth adding to your watchlist as macroeconomic uncertainty continues.

 

Fears of a rout in the technology sector are overdone, according to Morningstar equity analyst Gareth James.

In the wake of US election 2016, there have been numerous media reports speculating about sectors that will suffer under the presidency of Donald Trump, who is due to take office from January 2017.

US technology stocks are singled out for various reasons. On a number of occasions during his election campaign, Trump referred to the technology sector as a bubble and criticised companies such as Apple, which manufactures most of its products offshore.

Any skittishness among investors in global IT stocks could actually play into the hands of those that are more strategically-focused, says James.

"Technology stocks have fallen in recent months, creating opportunities to buy high-quality businesses at attractive valuations. Global macroeconomic uncertainty is likely to create further opportunities in the coming months, and we recommend investors monitor the sector closely," he says.

Carsales.com (ASX: CAR), Australia's largest online vehicle classified advertiser, is one company he suggests investors should keep an eye on.

With the largest online audience of buyers and sellers, Morningstar views it as having a narrow economic moat through its network effect, which draws parties from both sides of the transaction because of its market-leading inventory.

"Carsales not only attracts the largest audience of buyers and sellers of motor vehicles, but also offers a highly engaged audience to advertisers," James says.

"This is a significant competitive advantage and is attractive to the vehicle industry because vendors can now target their advertising expenditure directly to potential customers, rather than the scatter-gun approach through print and TV media."

He expects Carsales will continue to attract the majority of the car advertising market, which continues to migrate from print to digital mediums.

While it faces growing competition--particularly from News Corporation and a group of automotive dealers, which recently created a joint venture to revitalise competing website Carsguide--it has so far failed to disrupt Carsales' ability to attract the largest audiences.

"We view this as further reinforcing our view that Carsales has developed a sizeable audience and is perceived as the brand of choice to access the largest group of buyers and sellers of automotive classifieds," James says.

He also points to moat-rated REA Group (ASX: REA), which owns online property classified website realestate.com.au, as a company investors should watch. This website dominates the Australian market, with 90 per cent of real estate agents using it.

Like Carsguide, it possesses a network effect that makes it increasingly difficult for competitors to enter the space--as more buyers enter, it attracts more sellers, and vice versa.

REA has also expanded offshore, acquiring Malaysia's iProperty Group which spans the Asian market.

The group has remained mindful of the threat of competitors, who are constantly pursuing new strategies and partnerships to derail REA's domestic stranglehold. Realestate.com.au has been reinvesting cash flow to further differentiate itself by adding new services for both home buyers and vendors.

However, Morningstar also expects the overall earnings before interest, tax, depreciation and amortisation margins will flatten over the next decade--particularly as overseas investments dilute the core Australian business.

"We expect the company will continue to reinvest cash flow to remain innovative and retain its dominant market position," James says.

"High operating margins, combined with strong revenue growth, has REA Group generating an average 57 per cent return on invested capital over the next five years, well above our cost of capital, and supports our view this company has a sustainable competitive advantage or narrow economic moat."

New Zealand-based Xero (ASX: XRO) also possesses an economic moat, as the largest provider of accounting software to small-to-medium enterprises in Australia and New Zealand.

"We expect the company to continue leveraging this strong position to expand quickly in other regions such as the United Kingdom and the United States," says James.

He believes its capital-light business model should enable returns on invested capital to "comfortably exceed the weighted average cost of capital from fiscal 2020, supporting our narrow economic moat rating".

While it is currently loss-making, Morningstar forecasts strong revenue and earnings growth, and a return to profitability from fiscal 2020.

"Xero is experiencing strong revenue and customer growth driven by the transition of desktop accounting software to the cloud, a trend we expect to continue for at least the next decade," James says.

More from Morningstar

Are infrastructure stocks a good buy right now?

These ASX stocks will be winners from Trump's election victory

 

Glenn Freeman is Morningstar's senior editor.

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