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What's driving the Megaport rally?

Shares in the ASX network solutions provider have more than doubled in the past three months, but is the market is still "too bearish" on the company's prospects?  

Mentioned: Megaport Ltd (MP1), WiseTech Global Ltd (WTC)


Shares in network solutions provider Megaport (MP1) have once again surged after the company upgraded its guidance for the second time this year, but Morningstar analysis suggests the market is still “too bearish” on the tech stock.

Megaport, which offers network services to allow clients to connect between data centres and cloud environments, saw its shares jump more than 30% last week, following an upgrade in the company’s fourth quarter expectations.

In what is now expected to be its first full year of earnings before interest, taxes, depreciation, and amortization (EBITDA) profitability, Megaport now forecasts normalized EBITDA of between $19 million and $21 million in fiscal 2023, which represents a mid-point increase of around $2.5 million.

The company also expects reported EBITDA of between $24 million and $26 million in fiscal 2023, while fiscal 2024 reported EBITDA is on track to exceed the previously estimated range of $41 million to $46 million.

The resulting share price jump mirrors a previous earnings upgrade back in May, when shares in the company popped a further 40% after Megaport flagged that it’s full-year 2023 EBITDA was forecast to come in at roughly double the ‘market consensus’.

Year-to-date, the company’s shares are now up more than 55%, quite a performance, given the tech provider began the year as one of the most shorted stocks on the ASX.

 

The short position on the stock, which peaked at more than 12% of issued shares back in October of last year, had been attributed, in part, to concerns that the company would need to raise capital ahead of reaching profitability.

But with Megaport’s management now saying the company does not foresee any need to raise additional capital for the normal operation of its business, those market fears have begun to abate, with the short position sinking to around 5% in recent weeks

Megaport’s share price rally follows a strong year-to-date performance from the ASX’s tech sector, with fellow larger-cap ASX tech player WiseTech Global (WTC) posting similar returns since the start of January.

The S&P ASX All Technology index is now up around 27% since the start of the year, compared with just 5% for the cross-sector S&P ASX 200 index.

Morningstar analyst Matthew Dolgin says the market reaction to the dual upgrades has led to the stock more than doubling in that span, but notes that there is still more distance to make up before the company’s share price aligns with Morningstar’s assessed fair value.

“We maintain that the market had become far too bearish on Megaport—which never faltered in moving rapidly toward profitability while keeping sales growth high—and we believe the stock is still undervalued,” he says.

“Megaport expects its first year of positive free cash flow in fiscal 2024, and it canceled its $25 million debt facility, supporting management's previous statement that it will not need to raise cash again unless new, inorganic opportunities arise.”

Looking forward, Morningstar now expects to raise its fiscal 2024 EBITDA estimates for the company when the full guidance drops next month, but Dolgin notes that the longer-term outlook for the company remains largely the same.

“Megaport is simply continuing on the trajectory that we've expected by reaching positive free cash flow in fiscal 2024 and staying on a trend of rapid sales and profit growth,” he says.

“We are therefore not currently adjusting our fair value estimate, which is based on the long-term projections that we expect we'll maintain following the fiscal 2023 report.”

Megaport is scheduled to report its fourth quarter results on August 22. Shares in the company last traded at around a 25% discount to Morningstar’s assessed fair value of $13.00 apiece.



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