How bad could this “WAAAX selling” become?

James Gerrish

Market Matters

The Australian IT stocks had became so popular in recent times that the dominant players were named the WAAAX stocks i.e. Wisetech (WTC), Appen (APX), Altium (ALU), Afterpay Touch (APT) and Xero (XRO). While these are all exciting companies with great prospects and we should applaud them for the success they’ve had, we simply saw valuations become too high. P/E’s are not as relevant here given the companies are in growth mode however using Altium as an example, this is a $4.2bn producing revenue of ~$200m, a multiple of 20x sales. I’m a happy seller of most businesses on that metric, my own included!

However, when momentum traders and FOMO (Fear of Missing Out) is dominating proceedings stocks tend to run much further than common sense would usually dictate. Suddenly now I’m reading numerous reports around the “WAAAX off” theme but at MM we would rather stand back and say “great we’ve avoided the current carnage but where could panic selling create opportunities”.

The growth stocks have thoroughly enjoyed the economic tailwind of falling bond yields (interest rates) but since they’ve plateaued in September the sector buyers appear to have vanished on mass. Also the improvement in trade relations between the US & China has led to some definite rotation back into the value stocks, considering there has been many years of outperformance by the growth stocks common sense suggests that far more than a few weeks rotation is ahead of us.

Technically we remain short-term bearish with an initial target ~5% lower but if we return to the sectors medium-term rhythm we could return to the late 2018 lows, almost 20% lower – caution is warranted even after the current 10% pullback.

MM remains bearish the Australian IT Sector.

ASX200 Software & Services Index Chart

Interestingly the correction by our IT stocks has not been accompanied by the US NASDAQ which has continued to make fresh all-time highs. However when we stand back and compare the 2 groups we see far more quality and proven track records in the US group e.g. Apple (AAPL US), Microsoft (MSFT US), Amazon (AMZN US) and Facebook (FB US). In the past 6-months we’ve said we like the US tech space to outperform our own and we stick with this opinion into 2020.

ASX200 Software & Services Index v NASDAQ Chart

Moving onto the 5 stocks within the named WAAAX group:

1 Wisetech Global (WTC) $26.09

Global provider of cloud-based software solutions for the logistics sector WTC has been hammered over 35% since being on the receiving end of a damning report from Hong Kong hedge fund J Capital which basically called WTC a big sell with allegations around inflated profits – the report was well written and investors have clearly listened. This was a stock priced for perfection, not question makes over its accounting practices.

We can see a trading opportunity around $23.50 but only for the aggressive player, to us it’s simply in the too hard basket.

MM is neutral / bearish WTC at current levels.

Wisetech Global (WTC) Chart

2 Appen Ltd (APX) $19.96

APX is a global leader in the machine learning & artificial intelligence space but its shares have tumbled well over -35% from their 2019 highs as the stock demonstrates that crazy valuations usually come down to earth at some point. APX has more foundation to it in terms of earnings and their customer base has proven to be very sticky which doesn’t seem to be the case with WTC. That suggests their products have real competitive advantage.

APX is trading on a P/E for 2019 of ~40x – lofty but when anchored to expected earnings growth of ~30% over the next couple of years this is a business we are more comfortable with.

MM is growing more positive on APX below $20

Appen Ltd (APX) Chart

3 Altium Ltd (ALU) $31.34

ALU develops electronic PCB software, including design automation (EDA) software for the Microsoft Windows operating system, the company believes they can continue to grow until 2025 with a target then of ~$US500m revenue. China is a growth area for ALU hence the trade wars haven’t helped the stock but in a world where technology growth appears almost guaranteed ALU’s goals appear realistic.

The stock is very expensive on traditional metrics trading on an estimated P/E for 2020 of 46.5x however their Altium 365 product is cutting edge and this should underpin future growth. The current almost 20% pullback could become a major opportunity if the negativity towards the sector gathers momentum as we believe it will.

MM likes ALU around $28-$29.

Altium Ltd (ALU) Chart

4 Afterpay Touch (APT) $25.94

Afterpay APT is a story we haven’t fully embraced at MM which has looked daft at times but today its nice to have avoided the current 30% correction. Broking powerhouse UBS recently dropped a bomb on APT’s share price citing concerns around competition in the US, an area of intended huge expansion for the buy now pay later operator.

UBS has a target for APT of $17.25, still over 30% lower and with the stock trading on a P/E for 2020 of 665x!! there’s certainly plenty of room for a correction on valuation grounds. At this stage, we think 2020 will be a year characterised by higher competition and higher regulatory scrutiny.

MM can see APT again testing the $20 area.

Afterpay Touch (APT) Chart

5 Xero Ltd (XRO) $67.50

Lastly XRO which has just reported 1H20 results this morning booking subscriber growth of 30% and revenue growth of 32% - these numbers look strong with market expectations for around 25% subscriber growth - importantly, they also booked free cash flow of $4.8m. They surpassed 2m subscribers which is a few more than MM at this stage - this is a real milestone for the business. Interestingly, it took them ~10 years to get their first 1m and only 2.5 years to get their 2ndshowing the power of the platform and their distribution strategy.

This is clearly a great business which has enjoyed 2019 to date. Today should have another solid day today however ultimately we believe it’s too rich at current levels. We are looking for a pullback with a simple mild valuation rerating by the sector.

We feel patience should reward those in XRO at some point.

MM likes XRO around $57.

Xero Ltd (XRO) Chart

Conclusion (s)

MM sees at least another 5% downside for the Australian IT sector and potentially 20%.

At this stage the stocks we are keenest on are APX & ALU, while we could buy XRO around $57.

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James Gerrish
Portfolio Manager
Market Matters

James is Portfolio Manager & Primary Author at Market Matters, a daily investment report with over 2500 subscribers that offers real market insight. He is also Senior Portfolio Manager within Shaw and Partners heading up a team that manages...

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