Equities

After listing on the ASX in 1999, Altium (ALU) suffered for more than a decade as a relatively unknown and unloved microcap. Around the end of 2012, armed with a new leadership team, things started to improve. Even then, all the signs were there for those that looked. Sales were growing rapidly, margins were expanding, and the company was starting to generate cash.

TMS Capital have held the stock since 2015, when the market was just beginning to appreciate the scale of the company's opportunity. This time last year, TMS’ Ben Clark wrote that “if Altium hit their 2025 newly installed revenue target you will make very strong returns from this point.” It wasn’t the first time he’d told the Livewire audience about Altium though; in fact, it was his number one stock for 2017 when it traded at just $8 per share (currently $41.60).

With the outstanding performance the company’s put in over recent years, and it’s recent appearance on our most-tipped stocks list (again), I decided to get in touch for an updated view on the company, and to hear what he expects when Altium reports on Monday afternoon. He also shares another company with a long runway of earnings growth.

Hi Ben, could you tell us about your view on Altium when you last wrote about them? Did things play out as expected?

Altium is a rare company in Australia in that it reports and presents its earnings results after the market closes. It’s a separate topic but we’d like to see a lot more companies do this, its amazing how many companies release 50 slide complex presentations twenty minutes before the market opens and don’t hold their presentation clarifying any questions until mid-morning. This typically leads to wild share price volatility on the open which isn’t ideal for many shareholders. Giving investors time to digest a result and clarify any questions makes a lot of sense.

Having said all that, at the time the company had just released its 1H result and my summary of it was that the new long dated revenue target was significant news and gave us a flavour for the trajectory the CEO felt the business could achieve. In the post we maintained our view that if Altium can hit these new long-term numbers the share price returns over that time frame would be very strong.

The CEO also gave upgraded EBITDA margin guidance and this along with the revenue projections saw the share price jump 20% the following day. The share price move at the time was somewhat surprising to us given the debate that was occurring in the market at the time about how expensive the WAAAX cohort of stocks were. It really was a continuation of a theme we have seen for a number of years though; concerns and debate around valuation over stretches of time but when the numbers have been released the market has clearly been prepared to pay for the growth being delivered.

What’s your current view on Altium?

Our view on Altium has not changed, our fund has owned this stock since inception, and it remains a top five holding. We continue to look five years out at what this company is aiming to achieve and use the six-monthly results to check off whether we think the company is moving toward their stated objectives. The CEO’s long-term goal is to create a digital platform that the global electronics industry uses to design, manufacture and distribute products, a $2tn marketplace. Altium remains a highly attractive long-term investment if the company continues to move toward this goal and can hit its 2025 revenue target.

Another point I’d make on this is that its highly unusual for companies to release long dated revenue or profit targets to the market. In fact, there is only one other company we have seen commit to it in recent times which is Seek (also owned) who in August issued an aspirational revenue target of $5bn by FY25. An obvious question investors may ask is why don’t we see more of this? Surely boards would like to see their management teams commit to longer dated targets, particularly given LTI’s are meant to be structured to align shareholders with management over the long term.

Part of the answer, we believe, is that the average tenure of a CEO for an ASX200 company is just 5 years and 2 months. It’s not easy for a management team to set a long-term target when its highly likely they won’t be there to see it through, whilst new CEO’s will be understandably reluctant to inherit a predecessor’s projections. We are a massive believer in investing in companies alongside a heavily invested CEO who has a well enunciated long-term vision and will be there to take ownership of its achievement. Altium certainly meets these criteria.

What are your expectations for Altium for the coming results in February?

We believe this result may be a little more muted than some we’ve seen in the recent past. Investors reacted very positively post recent results to the news that EBITDA margins were likely to exceed 40%, the target of 100K users and the 2025 revenue goal of US$500m.

In this result we believe its less likely there will be any new longer-term forecasts given and will more focus on the shorter-term journey towards these goals. We think its more likely that FY20 guidance will be confirmed rather than upgraded.

We also believe that the news on China could spark interest and be a positive. This is an area the company has long struggled with but appears to have broken through in the last 18 months. Finally, there should be some commentary around the launch and take-up of Altium 365, the new software release which Aram has said will see a step change in the technology it can offer its users.

Are there any other companies on the ASX right now that are displaying similar attributes?

Reece (REH) has been a very high-quality long-term growing business although over the last couple of years the shares have largely range traded. This can mainly be put down to weaker domestic housing starts along with subdued renovation activity and generally poor sentiment to the sector.

The company has been run by Peter Wilson for the last twelve years who took over from his father, Alan, who ran the business for 38 years prior. The Wilson family own approx. 70% of the shares on issue and well and truly meet the criteria discussed above.

In 2018 the company announced the game changing acquisition of Morsco, the third largest plumbing distributor in the US. Morsco is almost entirely exposed to the Sun Belt region, particularly Texas, where the rate of population growth is twice as strong as the overall country. More people moving to the region means stronger housing construction and renovation activity. This acquisition to date has delivered as expected and importantly provides the company with a future long-term growth engine versus the more mature ANZ business. Peter Wilson at the time described it as ‘a once in a lifetime opportunity’. The revenue split between the two regions is almost exactly 50/50.

The Australian business has been experiencing significant headwinds in recent years with dwelling approvals falling markedly from 232K in 2018 to 155K forecast for 2020. Around half of Reece’s sales are driven by new build residential construction, a quarter from renovation activity (slightly lower) and a quarter from non-residential commencements (roughly flat). Despite this the company has been able to grow the bottom line during this difficult period through its control over pricing, new product innovation and strong cost discipline. Every time we listen to the company present, they continually reiterate their long term thinking, proud culture and their willingness to reinvest back into the business.

A great barometer of the quality of any business is how it performs when times are tough.

Markets, of course, look forward and in the medium term we are getting more bullish on Reece. As housing prices continue to recover, we are starting to see signs of a forward turn in residential approvals which will be helped by the rebuilding effort after the bush fires. Renovation activity should also accelerate whilst the commercial component looks strong. This combined with the continued growth of Morsco and hopefully acceleration of it as the Wilson family start to apply their expertise will hopefully lead to an acceleration of earnings.

We would be very confident around the long-term trajectory of this company’s earnings.

Thanks for sharing with us today Ben.

More on Altium

Altium was one of Livewire's 10 most tipped big-caps for 2020. Read more here.

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ian goldstein

yes EBITDA margins were likely to exceed 40%, how can you justifier the EBITDA . Its like saying my profit margins are great but it does not include all the costs of the business!