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Tech rout sweetens top trades

Vikram Barhat  |  25 Mar 2021Text size  Decrease  Increase  |  
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As the concern over aggressive fiscal spending, the rapid reopening of the economy and a spike in inflation bubbled, jittery investors bailed or booked profit pushing Big Tech off a cliff, and creating some opportunities.

The selloff over the past couple of weeks broke the ongoing tech rally that pushed valuation to record highs. While the pullback pushed the Nasdaq into correction territory - defined as a drop from a recent peak of at least 10 per cent - it created attractive openings for opportunistic investors.

A spike in bond yields further triggered a market rotation away from growth stocks, which are particularly sensitive to inflation pressures. As a result, some blue-chip stocks plunged between 10 per cent and 20 per cent in market value in stark contrast to their stellar 2020 performance. Although the market, and tech stocks, have since rebounded and recouped some of the losses, the high-quality names are still off their all-time peaks and remain compelling long-term growth stories.

Morningstar US Sector Heatmap

Source: Morningstar Direct. 1D return is as of Mar 24, 2021, 6:01 PM EDT, other returns are as of Mar 24, 2021.

The following tech stocks are market leaders in their domains and while not immune from short-term market volatility, they boast strong fundamentals and favourable secular trends that create a long growth runway. The recent weakness in their stock prices has little bearing on their business prospects nor their potential as solid long-term allocation bets.

Amazon.com Inc (AMZN)

  • Last close: US$3,087
  • Fair value: US$4,000
  • Value: 22 per cent discount
  • Economic moat: Wide
  • Forward P/E: 60.24
  • Star rating: ****

Data as of 25 March 2021

With colossal competitive advantages, built primarily on scale and size, the online retail giant dominates its served markets, especially e-commerce and cloud services. “AWS [Amazon’s cloud infrastructure] has driven profitability for the entire company—although it represents 10 per cent to 15 per cent of revenue, it generates 60 per cent to 65 per cent of total operating profit dollars for Amazon,” says a Morningstar equity report.

Ecommerce juggernaut, Amazon (AMZN) is the world's highest-grossing online retailer. The company clocked a staggering US$386 billion in net sales and approximately US$482 billion in estimated physical/digital online gross merchandise volume in 2020. Retail remained the biggest revenue generator representing nearly 83 per cent of the total, followed by Amazon Web Services (12 per cent), and advertising services and co-branded credit cards (6 per cent). More than a quarter of non-AWS sales came from the international market, led by Germany, the United Kingdom, and Japan.

The tech major recently reported blowout fourth-quarter results, including a 44 per cent revenue growth year over year to US$125.6 billion, handily surpassing most analyst estimates. It also reported strong EPS and upside to its revenue for the next quarter.

“Amazon remains well-positioned to prosper from the shift toward e-commerce during the COVID-19 pandemic (with particular strength in groceries and staples) in the near term, but also the secular shift toward e-commerce in the long term,” says Morningstar equity analyst Dan Romanoff, who recently raised the stock’s fair value from US$3,630 to US$4,000.

Price v Fair Value, 1 Yr | AMZN

Source: Morningstar Premium

Apple Inc (AAPL)

  • Last close: US$120.09
  • Fair value: US$98.00
  • Value: 23 per cent premium
  • Economic moat: Narrow
  • Forward P/E: 28.01
  • Star rating: **

Data as of 25 March 2021

iPhone maker Apple (AAPL) sells a wide variety of consumer devices including smartphones, tablets, PCs, wearable and streaming devices, and subscription services. The company derives nearly 40 per cent of revenue from the Americas while the iPhone contributes the bulk of its total revenue.

The tech major boasts highly sticky products that tend to lock consumers in its iOS ecosystem and nudges its loyal army of subscribers to its other products and services. “Apple's products run internally developed software and semiconductors, and the firm is well known for its integration of hardware, software and services,” says a Morningstar equity report, stressing that Apple’s competitive advantage is underpinned by its “ability to package hardware, software, services, and third-party applications into sleek, intuitive, and appealing devices.”

This expertise enables Apple to capture a premium on its hardware, unlike most of its peers. The company’s first-quarter results topped all expectations, led by the iPhone segment. “Apple’s iPhone revenue grew 17 per cent year over year to a quarterly record US$65.6 billion, thanks to the new 5G iPhone 12 family,” says Morningstar sector strategist Abhinav Davuluri, who recently upped the stocks fair value from US$85 to US$98, incorporating a stronger near-term outlook due to the current 5G iPhone cycle and tailwind of work- and learning-from-home trends boosting Mac and iPad sales.

Davuluri projects strong double-digit iPhone growth in 2021 but cautions growth rates will moderate in the coming years.

Price v Fair Value, 1 Yr | AAPL

Source: Morningstar Premium

Tesla Inc (TSLA)

  • Last close: US$630.27
  • Fair value: US$349
  • Value: 81 per cent premium
  • Economic moat: Narrow
  • Forward P/E: 153.85
  • Star rating: *

Data as of 25 March 2021

Global EV leader, Tesla (TSLA) makes electric vehicles and sells energy generation and storage products for residential and commercial customers. The company delivered just under 500,000 vehicles in 2020, garnering its first full-year profit, over US$700 million.

“Tesla has a chance to be the dominant electric vehicle firm long term and is a leading autonomous vehicle player as well as a vertically integrated sustainable energy company with energy generation and storage products,” says a Morningstar equity report, but cautions competition is brewing.

Prompted by the stellar performance and improving operating margin, Morningstar sector strategist David Whiston recently raised the stock’s fair value from US$306 to US$349. The change in fair value also incorporated an increase in “total vehicles delivered over our 10-year forecast period by about 25 per cent to 28.4 million,” by which point “Tesla’s gigafactories may become terafactories as Tesla seeks to grow its cell capacity to 3 terawatt-hours by 2030 from 0.1 terawatt-hours in 2019,” says Whiston.

However, the ongoing semiconductor shortage and its impact on the auto industry, including Tesla’s production, forced Morningstar to lower 2021 deliveries forecast for Tesla down to 800,000 from 950,000. “That is still about 60 per cent growth from 2020 which is in line with guidance of growth this year above the firm’s planned annual growth rate of 50 per cent,” assures Whiston, who forecasts growth rates of 50 per cent through 2023, but expects the rate to decline after that.

Price v Fair Value, 1 Yr | TSLA

 

Source: Morningstar Premium

Netflix Inc (NFLX)

  • Last close: US$520.81
  • Fair value: US$250
  • Value: 108 per cent premium
  • Economic moat: Narrow
  • Forward P/E: 53.19
  • Star rating: *

Data as of 25 March 2021

Steaming heavyweight, Netflix (NFLX) offers subscription-based video content globally except in China. The largest provider in the US, Netflix has been expanding rapidly into overseas markets and now has more subscribers outside of the US.

The streamer boasts a large number of subscribers that use different devices across geographies generating a robust data set that current competitors can't rival. “The firm has used its scale to construct a massive data set that tracks every customer interaction,” says a Morningstar equity report, adding that the firm then leverages this customer data to calibrate its content purchasing decisions and produce original shows with mass appeal.

The strategy has been paying rich dividends both in terms of increased revenue and a growing global subscriber base. During the fourth quarter of 2020, Netflix clocked a 22 per cent revenue increase (to US$6.6 billion) compared to a year ago. “Netflix ended an impressive 2020 with strong subscriber growth, beating our estimate,” says Morningstar equity analyst Neil Macker, who recently revised the stock’s fair value from US$200 to US$250.

The streaming giant scooped a staggering 8.5 million net new additions, ending the quarter with more than 203 million global paid subscribers, up 22 per cent from a year ago. Europe, Middle East and Africa (EMEA) was the strongest segment, accounting for over half of the net subscriber additions for the quarter and over 40 per cent of net additions for the year.

Macker believes consumers will continue to use subscription video on demand services like Netflix as a complementary service. However, he thinks increased competition from the likes of Disney and WarnerMedia will "constrain Netflix's ability to raise prices without inducing greater churn".

"We expect that Netflix will expand further into local-language programming to offset the weakness of its skinny offering in many countries, he says.

"This will likely generate a competitive response from the firm's global and local rivals, which will augment their own first-party content budgets. In turn, we think Netflix's international expansion will continue to hamper margin expansion."

Price v Fair Value, 1 Yr | NFLX

Source: Morningstar Premium

 

 

is a Toronto-based financial writer.

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