Morningstar Best Ideas List: WiseTech looks cheap after tech selloff

-- | 24/03/2022 Text size Decrease

Emma Rapaport: Hello, and welcome to Morningstar. I'm Emma Rapaport. Today, joining me is Gareth James. He is an equity strategist at Morningstar. Gareth, thanks very much for joining us. Gareth James: Thanks, Emma. Rapaport: So, we're here to talk today about the Morningstar Best Ideas list and the fact that you've added WiseTech to the list. You say as part of the report that you've added them after two major events – a massive decrease in the stock price and then just general negative sentiment towards the tech sector. So, I want to tackle those two things first. As the technology analyst for the last however many years what have the last three months been like for you to see this massive rotation out of tech stocks and what does it mean for a company like WiseTech? James: Yeah, sure. So, what we've seen in recent months is we've seen bond yields rise on the expectation that inflation is going to be quite high this year. So, the implication for technology stocks is quite negative, because technology stocks, generally speaking, are growth stocks, and growth stocks are very vulnerable to rising interest rates. So, it has quite a negative impact on the evaluation of technology stocks. So, we've seen some pretty significant falls in the last few months. WiseTech hasn't been immune to those falls, but it hasn't impacted our fair value for the company. So, we think that the shares have become more attractive and that's encouraged us to put it on the Best Ideas list. Rapaport: So, this negative sentiment within the technology sector, that's the US and Australia alike. Do you have any expectation around – the US raised rates for the first time in I think 18 months today – do you think that that sentiment is going to switch at all over the next few months? James: No, I think that's likely to continue. So, what we saw over the past two years is that from March 2020 we saw an incredibly strong rally in equity markets, and what we call high beta stocks or volatile stocks were the biggest winners of that rally. So, things like technology stocks went up significantly. Now, that rally, in my opinion, was largely driven by falling interest rates. So, interest rates obviously went to practically 0 in most Western countries. So, now what we're seeing is we're seeing economies move beyond that stage, and that's going to be a long process which is going to continue for a while. So, I think, we're going to continue to see interest rates continue upwards, and I think for those technology stocks that have gone up significantly, I think we've probably seen their best days for the time being. Rapaport: So, let's move to talking about WiseTech in particular. I remember a few years back you had some pretty significant concerns around disclosure, accounting policies, around earnings, around the high costs of research and development. Late last year you turned very bullish on the stock. So, can you explain how that switch in your own personal sentiment came about? James: Yeah, sure. So, WiseTech has always been a stock with very high market expectations. So, the kind of earnings multiples, so for example, price to earnings multiple that the stock trades on, has always been incredibly high. And what that means is that investors are expecting incredibly high earnings growth. Now, from our perspective, to get comfortable with taking that view that there will be a very high earnings growth going forward, we really need to see some hard evidence and we need to be very confident about the financial statements of the company and the disclosure and these kinds of things. Now, once WiseTech listed, for the first few years, we didn't really have confidence that there was sufficient disclosure at the company. So, we weren't confident in agreeing with the market that earnings were going to be as strong as the market was assuming. What happened late last year was the company significantly improved its disclosure, they provided a lot more information to the market and that gave us the comfort that we needed to increase our fair value estimate significantly and be much more aggressive with regards to our long-term earnings growth expectations. So, that saw us make a really significant increase in our fair value. And since that time, we've been much more positive on the stock. The share price has come back a bit. And now, the stock has come onto the Best Ideas List as a result. Rapaport: Right. So, you say that there are a lot of attractive qualities in this company – an economic moat, a large global market. Can you give me your thesis as to why you've put it on the best ideas list now? And why it's trading at a discount to your fair value?  James: Yeah. So, I think, WiseTech has obviously been caught up in the sell-off, the broad sell-off for technology stocks, which is understandable. But we don't think it's linked to the fundamental performance of the company. So, we haven't moved our fair value estimate down, but the share prices have weakened. So, that's meant that the share price is now below the fair value, and that's the main driver behind putting the stock onto the Best Ideas List. The stock was already a stock that we considered to be high-quality. So, like you say, it's got a narrow economic moat, which is based upon customer switching costs. It's got a very large global addressable market. We think there's going to be strong growth, at least for the next 10 years for the company. And it's a very innovative company as well, for example. So, it's constantly improving its products, and it's used by the largest logistic companies in the world. So, it's got very high-quality clients as well. So, there's lots of things that we like about the company, but now it's cheap as well, which is why it's gone onto the Best Ideas List. Rapaport: And is it fair to say amid all this disruption in global supply chains that this is actually potentially even a good time to be WiseTech? James: Yeah, that's right. I mean, WiseTech is relatively new software and it's replacing an old software that doesn't work very well, which is inside of all sorts of logistic companies around the world. So, WiseTech's software is extremely user-friendly. It's based in the cloud. It's a very clever software. And the events that are happening in the world, such as supply chain disruption, those kinds of things are only going to encourage logistic companies to switch to the more modern, more sophisticated software such as WiseTech's software, and WiseTech is really one of the leading providers in the world in this space now. So, it's really in a good space to benefit from this shift towards cloud-based software. Rapaport: Well, thank you very much for joining us today, Gareth. James: Thanks, Emma. Emma Rapaport: Hello, and welcome to Morningstar. I'm Emma Rapaport. Today, joining me is Gareth James. He is an equity strategist at Morningstar.   Gareth, thanks very much for joining us.   Gareth James: Thanks, Emma.   Rapaport: So, we're here to talk today about the Morningstar Best Ideas list and the fact that you've added WiseTech to the list. You say as part of the report that you've added them after two major events – a massive decrease in the stock price and then just general negative sentiment towards the tech sector. So, I want to tackle those two things first. As the technology analyst for the last however many years what have the last three months been like for you to see this massive rotation out of tech stocks and what does it mean for a company like WiseTech?   James: Yeah, sure. So, what we've seen in recent months is we've seen bond yields rise on the expectation that inflation is going to be quite high this year. So, the implication for technology stocks is quite negative, because technology stocks, generally speaking, are growth stocks, and growth stocks are very vulnerable to rising interest rates. So, it has quite a negative impact on the evaluation of technology stocks. So, we've seen some pretty significant falls in the last few months. WiseTech hasn't been immune to those falls, but it hasn't impacted our fair value for the company. So, we think that the shares have become more attractive and that's encouraged us to put it on the Best Ideas list.   Rapaport: So, this negative sentiment within the technology sector, that's the U.S. and Australia alike. Do you have any expectation around – the U.S. raised rates for the first time in I think 18 months today – do you think that that sentiment is going to switch at all over the next few months?   James: No, I think that's likely to continue. So, what we saw over the past two years is that from March 2020 we saw an incredibly strong rally in equity markets, and what we call high beta stocks or volatile stocks were the biggest winners of that rally. So, things like technology stocks went up significantly. Now, that rally, in my opinion, was largely driven by falling interest rates. So, interest rates obviously went to practically 0 in most Western countries. So, now what we're seeing is we're seeing economies move beyond that stage, and that's going to be a long process which is going to continue for a while. So, I think, we're going to continue to see interest rates continue upwards, and I think for those technology stocks that have gone up significantly, I think we've probably seen their best days for the time being.   Rapaport: So, let's move to talking about WiseTech in particular. I remember a few years back you had some pretty significant concerns around disclosure, accounting policies, around earnings, around the high costs of research and development. Late last year you turned very bullish on the stock. So, can you explain how that switch in your own personal sentiment came about?   James: Yeah, sure. So, WiseTech has always been a stock with very high market expectations. So, the kind of earnings multiples, so for example, price to earnings multiple that the stock trades on, has always been incredibly high. And what that means is that investors are expecting incredibly high earnings growth. Now, from our perspective, to get comfortable with taking that view that there will be a very high earnings growth going forward, we really need to see some hard evidence and we need to be very confident about the financial statements of the company and the disclosure and these kinds of things. Now, once WiseTech listed, for the first few years, we didn't really have confidence that there was sufficient disclosure at the company. So, we weren't confident in agreeing with the market that earnings were going to be as strong as the market was assuming.   What happened late last year was the company significantly improved its disclosure, they provided a lot more information to the market and that gave us the comfort that we needed to increase our fair value estimate significantly and be much more aggressive with regards to our long-term earnings growth expectations. So, that saw us make a really significant increase in our fair value. And since that time, we've been much more positive on the stock. The share price has come back a bit. And now, the stock has come onto the Best Ideas List as a result.   Rapaport: Right. So, you say that there are a lot of attractive qualities in this company – an economic moat, a large global market. Can you give me your thesis as to why you've put it on the best ideas list now? And why it's trading at a discount to your fair value?   James: Yeah. So, I think, WiseTech has obviously been caught up in the sell-off, the broad sell-off for technology stocks, which is understandable. But we don't think it's linked to the fundamental performance of the company. So, we haven't moved our fair value estimate down, but the share prices have weakened. So, that's meant that the share price is now below the fair value, and that's the main driver behind putting the stock onto the Best Ideas List. The stock was already a stock that we considered to be high-quality. So, like you say, it's got a narrow economic moat, which is based upon customer switching costs. It's got a very large global addressable market. We think there's going to be strong growth, at least for the next 10 years for the company. And it's a very innovative company as well, for example. So, it's constantly improving its products, and it's used by the largest logistic companies in the world. So, it's got very high-quality clients as well. So, there's lots of things that we like about the company, but now it's cheap as well, which is why it's gone onto the Best Ideas List.   Rapaport: And is it fair to say amid all this disruption in global supply chains that this is actually potentially even a good time to be WiseTech?   James: Yeah, that's right. I mean, WiseTech is relatively new software and it's replacing an old software that doesn't work very well, which is inside of all sorts of logistic companies around the world. So, WiseTech's software is extremely user-friendly. It's based in the cloud. It's a very clever software. And the events that are happening in the world, such as supply chain disruption, those kinds of things are only going to encourage logistic companies to switch to the more modern, more sophisticated software such as WiseTech's software, and WiseTech is really one of the leading providers in the world in this space now. So, it's really in a good space to benefit from this shift towards cloud-based software.   Rapaport: Well, thank you very much for joining us today, Gareth.   James: Thanks, Emma.