Further downside for Technology One?

We take a look at the prospects for Technology One (TNE) and whether the technicals are suggesting further weakness or not.

TNE is an end-to-end provider and consultant of enterprise software, focussing on mid-sized enterprises, the government sector and education institutions. The business model entails developing and marketing the software, implementing the solution for clients and providing ongoing support for clients.

The Company expects to see strong continuing growth in licence fees, revenue and profit, with the typical skew to the second half. This outlook was provided at the FY16 results announcement and reiterated in January 2017, when the Company confirmed that a contract dispute with one of its clients, Brisbane City Council, will not have a material impact on the Company’s earnings target for FY17.

Having weakened from a recent 1-year forward P/E of >40x, the Company is currently trading on a 1-year forward P/E of ~32x. In context, consensus estimates indicate 15-16% EPS growth in FY17, with EPS growth accelerating to around 18% in FY18 and FY19, reflecting the expected earning expansion driven by the Cloud strategy.

At current levels, notwithstanding the recent price weakness, we still consider that the stock is priced for perfection. To this end, we struggle to see why the stock is still trading on such a large premium to its forecast earnings growth (Price-to-earnings-growth multiple of ~1.8x). This is given that the medium-to-longer term potential for considerable earnings leverage from new products contributing to profit needs to be put in perspective, with the downside risk to the underlying earnings performance from the migration to Cloud.

Having said that, we consider that a premium for TNE is warranted. However, the market’s propensity to pay large premiums for quality companies has clearly waned and as such, in the absence of a major positive catalyst (e.g. major contract announcement; significant upgrade to guidance), we see limited upside potential from current levels.

The chart for TNE shows that it is in danger of falling further. Since peaking last year, the moves down have been very impulsive and it has now become clear that a head and shoulders has formed. The neckline of this has now broken and the most likely scenario is that TNE continues to fall towards levels under $4.50.

Michael Gable is managing director of Fairmont Equities. Any advice is general only. Fairmont Equities uniquely combines both fundamental and technical analysis. Visit www.fairmontequities.com to access our free blog and educational videos.