We continue to be positive on the technology sector in Australia as, in an environment of low interest rates and low growth, we believe there are a number of good quality stocks in the sector with reasonable to strong growth outlooks. We acknowledge that many stocks in the sector have had a strong re-rating over the past year or so but we believe there is still some value in the sector with a number of good quality stocks on reasonable forward PE ratios. Our goal is to find good quality tech stocks with strong growth outlooks that are currently trading on forward PE ratios of around 30x or less and that, over time, can rerate up to over 30x as has happened with stocks like WiseTech Global (WTC) and Altium (ALU).
The Citadel Group (CGL)
Citadel is a software and services company that provides integration and managed services solutions to state and federal governments and the private sector in Australia. The stock is currently trading on an FY18 PE ratio of c.25x and so, in our view, is being priced by the market as a mix of both software and services which is probably reasonable. Over time, however, we believe the company will become more like a pure software company and so will get re-rated by the market and trade on a forward PE ratio of c.30x or more. We believe this transition will become increasingly evident during 2018 and so the re-rating will gradually occur over the next 12 months or so. BUY, PT $7.50
Technology One (TNE)
Technology One is an end-to-end provider and consultant of enterprise software in Australia, New Zealand, Malaysia and the UK. We regard Technology One as one of the highest quality listed tech stocks in Australia but, for that reason, it is not cheap and trades on an FY18 PE ratio of c.30x. The share price – and PE ratio – has recently fallen, however, due to a contract dispute which caused the rate of earnings growth to slow in FY17. The dispute has now been resolved, however, and so the outlook is for a strong rebound in earnings growth in FY18. We therefore see the pullback in share price as a buying opportunity and expect the stock to re-rate and return to a forward PE ratio of c.35x or more. BUY, PT $6.20
Appen is a services company that provides language data and services to enterprise and government customers. Appen was a key pick of ours in 2017 and the stock performed well on the back of another year of strong earnings growth. The company recently, however, made a large and transformational acquisition which increased the customer diversification and also provided a strong earnings growth outlook for the next few years. The stock is now trading on a 2018 PE ratio of c.30x but, with the strong growth outlook and the exposure to the fast growing artificial intelligence (AI) market, we believe the stock can further re-rate to a forward PE ratio of c.35x or more. BUY, PT $9.00