3 reasons for the increase in Technology One's fair value

Morningstar recently raised its fair value estimate for Technology One (ASX: TNE). The fair value estimate is what a Morningstar analyst thinks the stock is worth in the long term and the upgrade followed the transfer of coverage to a new analyst Roy Van Keulen.

Van Keulen was the analyst who made a big call on WiseTech (ASX:WTC). In January 2023, he had raised its fair value estimate well above what it was trading at.

At current prices, though, Technology One’s shares screen as slightly overvalued, however, it’s worth a look at why Van Keulen likes the business and perhaps add this stock to your watch list.

Technology One sells software for enterprise resource planning—think software that helps businesses run their day-to-day tasks in human resources, procurement, and finance.

Key to Van Keulen’s assessment is his view that Technology One’s market position as highly defensible. Underpinning this analysis is Morningstar’s moat rating.

Switching costs

A moat provides a gauge of a company's competitive advantages and overall strength. One key source of this competitive advantage are switching costs.

Switching occur when it is difficult for customers to switch from one product to another product which is the case with Technology One given its product range as well as the “quality” of its public sector customer base.

Headquartered in the vibrant suburb in Brisbane’s Fortitude Valley, Technology One has amassed a customer base that includes “some of the most sound a company could wish for, coming essentially in different shades of government”. Indeed, in its first half results, Technology One announced “customer wins’ with 25 large scale customers including local councils, and universities, some located in the UK and New Zealand.

“We expect Technology One’s growth in the long term to be driven by increased development and adoption of its products, especially by its local government and education customers in Australia and New Zealand, which are its most dominant verticals and account for around half of revenue,” Van Keulen says.

High retention rates

Technology One also boasts high retention rates. “Impressively annual annual customer retention within Technology One’s recurring business segments has averaged over 99% during the past decade,” Van Keulen notes highlighting that this is a world-leasing score exceeding comparable companies such as wide-moat Workday.

Top marks for capital allocation

Not surprisingly, Technology One’s moat has been updated from narrow to wide. This means that a company has the ability to protect and grow its earnings for at least 20 years.

Technology One also gets an upgrade on the capital allocation front—up from standards to exemplary. This is because of its “sound balance sheet, exceptional investment efficacy” and the prudent way it pays its shareholders.

It’s also prudent with acquisitions. Van Keulen highlights that its recent acquisition of Scientia in 2021 was “strategically valuable”.