ASX tech stocks: Broker views and one fundie’s top pick

Glenn Freeman

Livewire Markets

One of the most maligned investment sectors of 2022, technology share prices have tanked. After pushing beyond 16,000 points last November, the Nasdaq-100 is down more than 30% year to date. It’s a similar story in Australia, where the S&P ASX All Technology index has slid by the same amount in 2022 so far.

In the following article, I look at the views of several brokers to help get a handle on where valuations sit, particularly for some of the largest or most popular local technology stocks. I also ask an Australian portfolio manager, Justin Woerner of Elston Asset Management, whether he believes it’s time to start scooping up bargains in the space.

But first, let’s take a look at some of the sector’s biggest movers in recent times. Falling share prices saw the following trio of tech firms removed from the S&P/ASX 200 index in September:

  • Location-based services provider Life360 (ASX: 360)
  • Payments firm EML Payments (ASX: EML)
  • Financial technology company Zip Co (ASX: Z1P)

Shares in the first of these, Life360, are down more than 30% over the last 12 months, despite gaining 60% in the last three months to 19 October.

EML Payments ranks among the top 20 worst performers of the index in the last three months, its share price declining 32% in this period and 72% in the preceding 12 months.

Zip Co shares have fallen more than 90% in the last year but have remained flat over the last three months, currently trading at 62 cents a share, up from around 50 cents at the start of July.

A few other tech names rank among the ASX 200’s worst performers of the year:

  • artificial Intelligence software firm Appen (ASX: APX) shares are down 52% in the last three months, and declined 72% over 12 months.
  • Mining software firm Codan (ASX: CDA) has seen its shares decline 33% and 60% over three months and 12 months.
  • Data centre provider NextDC (ASX: NXT) stock price is off 20% and 24% over three and 12 months.
  • Iress (ASX: IRE) shares dipped just under 20% and 21% over three and 12 months.

What the brokers think

Macquarie upgraded Richard White’s logistics software firm WiseTech (ASX: WTC) to Neutral from Underperform on 9 September.

“WTC is trading at a premium versus peers. That said, we think the premium can be justified on higher outlook certainty with their global rollout business model and very low churn rates,” writes Macquarie.

“To see further upside from current valuations however would require greater confidence on the growth outlook beyond the coming three years and successful execution of CargoWise (this is the firm’s flagship technology software platform).”

Management has indicated the latest rollout of CargoWise, its Neo iteration, should roll out within the next two years, but won’t be monetised within this timeframe.

Altium (ASX: ALU)

Bell Potter analyst Chris Savage downgraded circuit board software firm Altium to a Hold in mid-September,

“At our updated price target of $40.00 the expected excess return is less than 15%, so we downgrade our recommendation to HOLD,” Savage writes.

“We continue to be positive on the outlook for Altium but now see the stock as around fair value, trading on an FY23 EV/EBITDA and PE ratio of 36 times and 58 times.”

He also emphasises a lack of short-term potential catalysts for the stock, given Altium does not tend to make many announcements outside of results.

“And we don’t expect the company to upgrade its guidance at the AGM in November given it will still be relatively early in the financial year.”

Appen (ASX: APX)

Earlier this month, in response to a trading update from Appen management on 6 October, Wilsons analyst Ross Barrows downgraded the firm to Underweight from Market Weight. This shift was made on expectations that customer demand was contracting. A key risk he sees here is a more concentrated customer mix, alongside a lack of visibility on revenue, and weaker global digital advertising revenue. Wilson’s target price was slashed to $2.41 from $4.

While analysts from JP Morgan, Jefferies, RBC Capital Markets and Canaccord Genuity maintained their ratings, they each lowered their price target for the firm. These range between $2.60 and $3.

The stock was trading at $2.62 at the close on 27 October.

Xero (ASX: XRO)

Accounting software firm Xero was upgraded to Neutral from Underperform by Macquarie on 17 October, and the stock’s price target also increased to $74 from $70.

“First-half results are unlikely to surprise to the upside, but our estimated outlook for tailwinds in the second half of FY2023 has not been priced in by the street, in our view,” writes Macquarie.

XRO was trading at $76.74 at the close on 27 October.

A fundie’s perspective

Of course, Australia’s technology sector – which in itself is an imperfect definition because it encompasses so many different things – is much broader than this basket of WAAX stocks. To get a broader view, I spoke with Justin Woerner of Elston Asset Management. He acknowledges there are some cheap companies in the sector, singling out a few of the biggest fallers in the year so far:

  • Cloud-based call recording AI company Dubber (ASX: DUBis down 88%
  • Online print-on-demand marketplace Redbubble (ASX: RBLis down 85%, and
  • EML Payments (ASX: EML) is down 81%.

“This isn’t surprising in the current environment because technology businesses tend to be less mature and rely on long-term revenue growth to justify valuations,” says Woerner.

“Higher interest rates have worked to discount valuations. So, most of the price damage has been due to contracting PE ratios rather than weakening earnings.”

As an extension of this, it’s logical for investors to see bargains – but he urges caution. This is evident in his own Emerging Leaders strategy, which currently has just under one-third of the portfolio invested in tech.

With an emphasis on Quality in the sector, he believes companies need to be assessed on their individual merits.

“If you're willing to look through the short-term volatility, we see long-term value for several of the higher quality technology businesses,” Woerner says.

That said, he also highlights what he regards as a strongly pessimistic view on local, smaller technology firms.

Source: Elston Asset Management
Source: Elston Asset Management

How Elston finds companies

Taking a five-year view, and building in a decent margin of safety, Elston seeks companies with:

  1. Large addressable markets, with structural tailwinds to assist them in growing earnings.
  2. Sustainable competitive advantages: businesses need to have strong moats and the ability to fend off competition and deal with uncertainty
  3. Strong value propositions: there needs to be a strong reason for customers to buy the business’s services. This is particularly meaningful for younger businesses, technology included, who are still in the early stages of product adoption.

Do companies need to be in the black?

The short answer is yes.

“It is critical to assess a business’s ability to continue to fund its operations. We will only invest in businesses where the existing level of cash at the bank and future cashflows is adequate to continue to fund the business,” Woerner says.

Profit is a key distinction between successful and unsuccessful companies, something that he believes has been borne out by the numbers.

“Unprofitable businesses in the ASX All Technology index have underperformed the profitable businesses on average by 17% over the calendar year through to 24 October,” he says.

“It’s become more expensive to raise equity and debt, and may no longer be an option for some management teams, especially those with weak business models.”

If you could only hold one tech stock…

A company Woerner nominates is network-as-a-service provider Megaport (ASX: MP1), which he believes is very attractive at current prices (trading at $6.21 at the close on Thursday 27 October 2022). The company has been in the financial press in recent months with concerns about its cash burn and wide variations in quarterly financial results.

“We think this business is generally poorly understood and combined with a high short interest, makes it very volatile, so it's not for the faint-hearted,” Woerner says.

Although cash burn is higher than he would prefer, he believes the company is well positioned to achieve free cash flow breakeven for three key reasons:

  1. A largely recurring revenue base gives management high levels of visibility and predictability
  2. We think the current liquidity is likely sufficient to see them through to free-cash-flow breakeven.
  3. Management has several levers to pull if necessary.”

Woerner believes Megaport has been sold down unfairly amid market volatility and the variation in the company’s quarterly results.

“We think it's unreasonable to expect growth to be linear and steady each quarter, especially within an environment of challenging trading conditions. We haven't found anything that suggests the opportunity for Megaport has changed materially,” he says.

Woerner sees plenty of reasons to expect success, including a large addressable market and structural tailwinds – and greater network challenges that only boost the demand for the services provided by Megaport.

“We think management is very capable, and Megaport’s flywheel already has strong momentum.”

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Glenn Freeman
Content Editor
Livewire Markets

Glenn Freeman is a content editor at Livewire Markets. He has almost 20 years’ experience in financial services writing and editing. Glenn’s journalistic experience also spans energy and automotive, in both Australia and abroad – including the...

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