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You've been warned on ASX IPOs

Brian Han  |  23 Nov 2020Text size  Decrease  Increase  |  
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This is an extract from Morningstar senior equity analyst Brian Han's monthly column Brianstorm ($). Morningstar Premium subscribers can view the full version and previous columns here. Become a Morningstar Premium member today.

A common side effect of a rising equities market is a burgeoning initial public offer, or IPO, pipeline. The S&P/ASX 300 Index has been on a tear since the covid-induced low in late March 2020, as interest rates continue to plummet and FOMO (fear of missing out) returns with a vengeance.

The rush of IPO-hopefuls keen to take advantage of this favourable backdrop has been further fuelled this year by several unique dynamics. Firstly, the inexorable rise of the technology sector, both in Australia and in the US, has encouraged many companies even with a whiff of anything online or digital in their business models to explore a secondary listing.

Secondly, the working, playing, and everything else-from-home phenomenon triggered by the coronavirus lockdown has propelled the stock prices of many companies catering to this trend on the bourse. There has been a significant pull-forward in demand for anything consumers can lay their hands on to alleviate their boredom at home or to set up shop at home.

Top-performing ASX 300 stocks catering to COVID-induced “In-Home” phenomenon

Exhibit 3: Top-performing ASX 300 stocks catering to COVID-induced “In-Home” phenomenon

Source: Morningstar

The desire to exploit these dynamics has resulted in the flurry of IPOs on the Australian Stock Exchange since April 2020, post the full-blown coronavirus outbreak in late March 2020. The first glaring feature of this list is the lack of profitability among these companies, with just 10 of the 36 debuting on the board making money at the operating earnings level.

The opportunism doesn’t end there. Of the 36 companies just listed, we believe 12 fit into the bucket of those taking advantage of the insatiable demand for anything technology, digital, cloud or online. It seems appetite and valuation multiples for these companies grow depending on the number of times these buzz words are touted in the prospectus. It matters not some of these companies are merely using modern-age capability such as online, to do old-age businesses such as shopping, lending and payment. We also believe 4 of the 36 companies just listed fit into the bucket of those catering to the “Doing Things from Home” trend.

Judging by the performance of the shares since listing, riding these themes has mostly been a profitable strategy for investors. For instance, the average return on the IPO price for “Technology” bucket of stocks is 105 per cent since listing, and the same for the “In-Home” bucket of stocks is 23 per cent, admittedly with material divergences between stocks. In comparison, the ASX 300 index is up 29 per cent since the beginning of April 2020.

However, this buoyant IPO environment indicates rising risk tolerance among public investors. Whether this thematic-based investing, without regard to near-term earnings or even longer-term fundamentals, is closer to the beginning of its journey or the end, only time will tell. On the one hand, there was a time when a track record of earnings (even just a couple of years) and an established industry position, or at least a trajectory towards it, were pre-requisites to an IPO. On the other hand, perhaps we are entering a “this time, it’s different” era of investing where themes and blue-sky potential trump underlying earnings and fundamental prospects.

One thing seems clear. The corporates themselves are more cautious when it comes to splashing money around doing deals, judging by the slump in mergers and acquisitions activities in Australia this year to-date. It may be a sign that corporates are more circumspect with their money given we are still in the midst of a pandemic, facing a highly uncertain macroeconomic environment and there is consequently a need for capital prudence. On the contrary, public investors in the secondary market seem more trigger-happy with their capital, eager to take chances with IPOs, perhaps with FOMO, TINA (there is no alternative) and BENNI (buy everything now, no interrogation) all playing a part in their infatuation with new listings.

It is through this prism we caution investors with respect to the IPOs still to come down the conveyor belt. Of the 21 due to list before the end of the year, only 5 are profitable. Furthermore, 7 firmly belong in the “Technology” bucket (only 2 profitable), while 2 appear to cater to the “In-Home” thematic (1 profitable).

This list is not even counting non-banker lender Liberty Financial (which has been trying to list for years), Fantastic Furniture (for a second coming on the ASX), forensic software company Nuix (of which Macquarie is trying to sell down its 66 per cent stake), Alarcon (a law firm whose partners are monetising some of their ownership interests) and Dalrymple Bay Infrastructure (operator of the world’s largest metallurgical coal export terminal whose value its owner Brookfield is hoping to partly crystallise).

We are not making any recommendations on these upcoming IPOs. Investors will get plenty of that from the sponsoring or underwriting brokers to these issues. We are, however, urging investors to delve a little deeper into the drier bits of their prospectuses (sections such as risks, purpose of funds, financial information, forecasts), rather than get too excited by the prettier bits (colourful front sections with smiling customers, fancy photos and hockey-stick growth charts).

Human nature is such that many people gravitate towards things that are newer and shinier. But they are not necessarily better, just as grass is not always greener on the other side. And grass is mostly red, rather than green, when it comes to profitability of most companies in this year’s IPO pipeline. That is not to say you won’t make a paper profit in the near to medium term on the issue price of these ASX entrants. But in many cases, that may be more a function of the conducive market than sound long-term sustainable fundamentals.

is a senior equity analyst in the equity research team at Morningstar

Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

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