Four beaten up tech stocks

Investors are hoping that the sharp sell-off of ASX-listed technology stocks since the November – which has stripped 30% from the value of the S&P/ASX All Technology Index – has ended, but there are still plenty of nervousness from those holding the big tech names.

This mirrors what is happening in the US, where tech investors are torn between further concern and a feeling that bargains are everywhere in the tech space. 

It should not be only about companies that saw high price/earnings (P/E) ratios unwound quickly as the prospects of higher interest rates and quantitative tightening unnerved markets; it should be about identifying companies that are well-placed to benefit from strong trends in the particular markets they serve. 

Here are four tech stocks that fit that description, and which look to offer compelling value at present. 

 

1. Pro Medicus (PME, $47.28)

Market capitalisation: $4.9 billion

One-year total return: 10.8% 

Estimated FY22 (December year-end) yield: 0.6% fully franked (grossed-up, 0.8%)

Analysts’ consensus target price: $58.00 (Thomson Reuters, seven analysts), $49.74 (FN Arena, two analysts)

Source: nabtrade

 

Imaging technology provider Pro Medicus is one of Australia’s most successful tech stocks, having taken its imaging software successfully to the global market. Pro Medicus’ Visage file compression and streaming technology has been a game-changer for radiologists, because it can stream large, high-resolution files directly, rather than needing to compress and send them. The software allows radiologists to view reports and X-rays on their mobile devices. Pro Medicus has led the move of radiology imaging to the cloud, and the “cloud native” nature of its technology gives the company a huge strategic advantage over its “legacy” competitors in the medical picture archiving and communication system (PACS) marketplace. For example, Pro Medicus has nine of the top 20 hospitals in the US as customers for its Visage imaging platform – its closest legacy PACS competitor has four. 

Pro Medicus has announced plans to parlay its very strong position in radiology in the North American, European and Australian markets and expand into other medical imaging fields, including cardiology and ophthalmology.

In this way, the company is tapping-into a range of favourable trends, including growth in the imaging services industry driven by an ageing population, overall population growth, disease spread, the burgeoning use of AI in medicine, and mandatory requirements for electronic medical records and transaction-based licensing in US hospitals.

In FY21, Pro Medicus won six new contracts – including a deal with the North Carolina-based Novant Health, which was the equal largest deal the company has ever signed, and its seventh major North American contract in less than 18 months.

Pro Medicus is travelling extremely well – but prior to the tech sell-off, it had reached a P/E of more than 150 times expected earnings. 

The market has cut this back to just over 100 times, and while that is still eye-watering to a traditional value investor, the analysts that follow the stock think it has restored PME to good value. 

There is always the risk that Pro Medicus’ competitors catch up with in terms of product capabilities, but it could hardly be faulted on its track record of keeping ahead. With the stock price down one-third in the wake of the tech sell-off, PME looks to be sound buying. Its revenue and earnings growth looks to be robustly underpinned as new contracts start to contribute – and management says there is a solid pipeline of opportunities for new contracts in the year ahead.

 

2. Megaport (MP1, $13.08)

Market capitalisation: $2.1 billion

One-year total return: 0.1% 

Estimated FY23 yield: no dividend expected

Analysts’ consensus target price: $20.00 (Thomson Reuters), $19.00 (FN Arena, five analysts)

Source: nabtrade

 

Down 40% since mid-November, Megaport (MP1) also looks to be on the rebound, with analysts retaining price targets well above the current price. 

Megaport is a global “network-as-a-service” (NaaS) provider – it offers its customers “elastic interconnection services” using “software-defined networking” to connect them to cloud services and third-party data centres worldwide. Translated, this means that Megaport allows customers to easily and flexibly buy dedicated data connections to service providers, especially cloud service providers (CSPs) including Amazon, Microsoft, Google, IBM, Salesforce.com and many others on the platform. Megaport doesn’t restrict users to one data centre operator or cloud service provider.

Broker Morgans describes the business as follows. There are about 120 cloud “on-ramps” around the world, where companies can connect to use the CSPs’ equipment. This is well short of the near 6,500 data centres in existence worldwide. To use the cloud, the two sets of data centres need to be connected – which is where Megaport comes in, linking data centres, cloud platforms and businesses, who pay only for what they use, for as long as they want to use it, with no locked-in pricing. Megaport calls the service “network on demand.”

Megaport has the prized “network effect,” in which a product or service becomes more valuable to its users as more people use it. This usually takes a long time to develop, and Megaport is no exception, but once in place the network effect is a potent contributor to a sustainable competitive advantage. The number of services per customer grows over time, and thus, so does average monthly revenue per customer – this is a very strong trend with Megaport and is driving rising gross profit margins.

Megaport was positive at the EBITDA level in FY21, but not at net profit/earnings per share (EPS) level, as it is investing in a global expansion program focused on driving higher customer usage through the existing Megaport platform. This heavy investment will preclude net profit arriving for some time, but the analysts that follow Megaport are very confident that all the other important numbers for the company are on a rising trend. 

 

3. Nitro Software (NTO, $1.92)

Market capitalisation: $364 million

One-year total return: –36.8% 

Estimated FY23 yield: no dividend expected

Analysts’ consensus target price: $4.40 (Thomson Reuters, seven analysts), $4.15 FN Arena (two analysts)

Source: nabtrade

 

Listed in December 2019 at $1.72, the San Francisco-based Nitro Software – which was founded in Melbourne in 2005 – is a digital workflow company that specialises in PDF tools, eSignatures and e-ID, and industry-leading analytics through its Nitro Productivity Suite, on a Software-as-a-Service (SaaS) basis. Nitro enables organisations to drive better business outcomes through 100% digital document processes and fast, efficient workflows. Nitro has more than three million licensed users, and more than 13,000 business customers, in 157 countries.

Nitro Software cruised fairly smoothly (apart from the COVID Crash of February-March 2020) to highs of $3.82 in November before the tech slump, but is now trading at just above half of that peak price. That near-halving of the share price has opened-up what looks to be really good value for this company, that is helping to drive digital transformation in organisations around the world – a big growth market. 

Broker Goldman Sachs recently estimated Nitro’s total addressable market (TAM) at US$34 billion ($48 billion). At the moment, says Goldman Sachs, Nitro holds 0.15% of that market; but the broker thinks that by FY40, NTO could lift that to 1.4% – which would imply nine-fold growth in Nitro’s current revenue base.

COVID lockdowns may have shown the way forward for Nitro, as companies operated successfully in a wholly digital environment. Nitro says that lockdowns drove, around the world, a 108% increase in electronic signature requests and a 61% increase in digital signing. In Australia alone, it says the printing of documents decreased by 70%. The company believes these changes “can and should be permanent to improve workplace productivity and efficiency dramatically.”

This could turn out to be an extremely powerful trend, and Nitro is investing to capitalise on it. The company recently raised $140 million to buy Belgian eSign SaaS business Connective NV, which it says will cement its position as a global SaaS player, giving it access to fast-growing European markets. With Connective incorporated, Nitro will become the third global player in the fast-growing enterprise eSign market.

It’s not just digital tools driving productivity that is the tailwind behind Nitro Software, it’s also data security, and how high-trust eID-driven solutions are critical to this. These are powerful trends and Nitro is well-positioned to be a global leader. The analysts that follow Nitro Software think you’re buying it now for a steal. 

 

4. Xero (XRO, $111.80)

Market capitalisation: $16.9 billion

One-year total return: –12.6% 

Estimated FY23 yield: no dividend expected 

Analysts’ consensus target price: $140.23 (Thomson Reuters, 12 analysts), $134.17 (FN Arena, six analysts)

Source: nabtrade

 

Down 28% since the start of November, cloud-based small business accounting software specialist Xero is another stock that most analysts see as having been discounted back to appealing value.

Xero dominates the small-to-medium sized enterprise (SME), or small-business, accounting market in Australia and New Zealand, and from that base has moved into North America and Europe, and also South Africa and Asia. It also has a formidable network effect: partners (accounting and finance app developers) want to connect to Xero’s three million customers (especially as it grows North American subscriber numbers from the current 308,000), and in turn Xero is always looking to offer new products and services to its “ecosystem.”

Just as the market turned a bit ugly for the tech giants, in November, Xero brought out half-year results for the six months to September 2021. There were some concerns from the market looking at the result – Intuit and its QuickBooks product is proving a very formidable foe for Xero in North America, and UK competitor Sage is also not to be taken lightly. International subscriber numbers growth was slightly under expectations, and so was revenue growth (up 26% in constant currency terms), which puts pressure on the second-half number to meet full-year consensus forecasts. 

Longer-term, however, most analysts see good prospects for Xero to grow, as newer services such as payroll invoicing and expenses tracking increase the attractiveness of the offer, and boost average revenue per user (up 5% in the first half, to NZ$31.32) and ultimately, the gross margin, which is running at 87.1%. 

Xero reported a net loss of NZ$5.92 million for the half-year, a big difference to last year's NZ$34 million net profit. EBDITA fell by 19%, from NZ$121 million to NZ$98 million, while free cashflow plunged from NZ$54 million during the same period last year to NZ$6.4 million. On the face, those would be alarming trends, but the declines were largely due to product design and development costs surging by 51%, to NZ$166.8 million, which consumes one-third of operating revenue. But that is contributing to very strong growth, and the consensus is that there is still massive room for Xero to grow. At some point, when it judges that it can wind-down the necessary investment in growing the business, XRO will be a highly profitable company.

At the moment, analysts see nice value in Xero, with about 25% upside implied by consensus price targets. 

 

 

All prices and analysis at 07 February 2022. This information was produced by Switzer Financial Group Pty Ltd (ABN 24 112 294 649), which is an Australian Financial Services Licensee (Licence No. 286 531This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice. This article does not reflect the views of WealthHub Securities Limited.