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2 moat stocks riding tech rally

Glenn Freeman  |  27 Aug 2018Text size  Decrease  Increase  |  
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These Australian-domiciled software companies delivered solid results this earnings season, in a tech sector that continues to prioritise revenue over profit.

Profits are now considered an almost negative attribute among local technology companies, says Morningstar equity analyst Gareth James.

"Perhaps in an attempt to satisfy the market’s appetite for revenue growth and disdain for profits, MYOB (ASX: MYO) is increasing its reinvestment over the next two years," James says.

Fellow technology player Altium (ASX: ALU) reported record revenue growth of 26 per cent for the year, marking its sixth consecutive year of profitability.

Xero (ASX: XRO), which won't release full year results until September, and Appen (ASX: APX) – reporting half-year results tomorrow – saw share price growth of around 12 per cent last week.

tech stocks

An obsession with revenue over profits persists among local tech sector investors

In its half-year results last week, narrow-moat accounting software company MYOB reported $45.6 million in after-tax profit, down 6 per cent on last year.

But revenue was up $218.5 million, 7 per cent, for the six-months to 30 June, and underlying earnings before interest, taxes, depreciation and amortisation jumped 3 per cent to $92.7 million.

James says the result is in line with his expectations, and the company is on track to meet MYOB management's full-year guidance of 8 per cent revenue growth. The sector leader in serving small and medium-sized businesses in Australia and New Zealand, it has around 50 per cent market share.

Subscriber numbers increased 61 per cent on the same period 2017, and management says it is on track to hit its target of 1 million by 2020.

Morningstar regards MYOB as holding a narrow moat, given its dominance in the accounting practice segment, and the "stickiness" of these software users - with low willingness to switch providers.

However, there are headwinds. James believes the ongoing transition to cloud-based products represents a "rare window of opportunity" for competitors to steal market share
But MYOB's SME division accounts for around 65 per cent of earnings, "and we expect cloud customer growth to be its leading earnings growth driver," James says.

WiseTech beats guidance, wows market

Earlier last week, WiseTech Global (ASX: WTC) reported a 44 per cent jump in revenue to $221.6 million in FY18, beating its own guidance. The company also forecast similar growth for 2019, further surprising investors.

Shares in the narrow-moat logistics software company soared 27.8 per cent to $19.98 by the market close last Thursday, trading above $20 on Friday evening.

Management reported a full-year net profit of $40.8 million, up 28 per cent from last year, on Wednesday 22 August.

The result was stronger than many expected. Management also announced a dividend of 1.65 cents fully franked.

WiseTech was founded in 1994 as a software provider to the Australian logistics sector and has grown organically to become leading supplier of logistics software as a service (SaaS).
It has more than 6,000 customers, including 19 of the largest 20 third-party global logistics suppliers. Revenue has increased at a compound annual growth rate of 34 per cent between fiscal 2013 and 2018.

Morningstar analyst Gareth James says, “We were extremely surprised by the market’s reaction to WiseTech’s 2018 financial results.

"The 28 per cent increase in its share price [on 22 August 2018] implies the company had significantly exceeded consensus estimates or made a particularly material announcement," he says, though it had done neither.

"It’s possible that the lack of free float is partly driving share-price volatility, with founder and CEO Richard White still owning 51 per cent of the company," he says. 

Morningstar has increased its earnings forecasts for WiseTech to reflect its implied organic growth rate and likely future contributions from recent acquisitions. Revenue forecasts have also been increased.

However, "we struggle to justify the market price," says James.

He points to management's claim that the underlying earnings margin is 48 per cent, rather than the headline 35 per cent, when stripping out the effect of recent acquisitions.

"We’re inclined to wait for further evidence before taking this claim on face value.

"We remain disappointed by the level of disclosure by WiseTech regarding the underlying performance of the business. We don’t believe the company provides enough information on the key drivers of organic revenue growth," he adds.

WiseTech’s share price was trading at $20.23 at time of publication, more than 3.5-times Morningstar’s 6.20 fair value estimate.

 

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Glenn Freeman is senior editor, Morningstar Australia

Roger Balch is a freelance contributor for Morningstar Australia

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

 

is senior editor for Morningstar Australia

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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