Sharp falls in global technology stocks in the past two months have taken wind from the sails of internet optimists. But the sell-off is also creating opportunities in some higher-quality Australian tech stocks.
The global barometer of tech stocks, the US NASDAQ Composite Index, has fallen from a 52-week high of 4,371 points in early March to 4,130 points. In fairness, the NASDAQ rallied from about 3,400 points a year ago, so a pullback or consolidation was inevitable after such strong gains.
The NASDAQ has solid support at 4,000 points, having bounced off that level twice times this year. Chartists will watch whether that support holds again and if a “triple-bottom pattern”, considered a bullish signal, is at play. I see the NASDAQ trading in a range for a while after an 18-month bull run.
Fundamentally, some local internet stocks look interesting after recent price falls. Hotel and accommodation booking group Wotif.com Holdings is down from a 52-week high of $5.63 to $2.40 after a downgrade in guidance in December and greater competition from offshore rivals.
Wotif.com, a high-quality business, is near value territory. Morningstar rates it an “accumulate” and has a fair value of $3.20. Three analysts have a buy recommendation, three have a hold and two have a sell, according to consensus forecasts. That shows the market’s mixed view on the company.
Like other successful internet stocks, Wotif.com has a high Return on Equity (ROE) – 51 per cent in FY13 – and a capital-light business model that provides strong profit margins. A well-known brand in the travel and accommodation market and a large community of users are other attractions.
Greater local competition, due to more aggressive market-entry strategies from global rivals such as Expedia and Priceline.com, is inevitable in the next few years for Wotif.com, as is lower operating margins. But continued growth in online travel remains a huge tailwind for it and other leading online travel providers.
There is speculation that Wotif.com could be a takeover target of a large overseas rival if its valuation continues to fall. That view makes some sense, but investors should never buy stocks on the basis of takeover alone. A better strategy is focusing on undervalued quality companies that are sound long-term investments, regardless of takeover.
At $2.41, Wotif.com trades on a forecast Price Earnings (PE) ratio of 11 times FY15 earnings and an 8.5 per cent fully franked dividend yield, according to consensus estimates. With some prominent internet companies trading on PEs of 30-40 times earnings, Wotif.com has a more reasonable valuation at current prices.
Still, I wouldn’t be surprised to see it retest the 52-week low of $2.29, or head lower, given challenging trading conditions. If it does, Wotif.com will offer solid, not screaming, value.
New Zealand auctions and classified site Trade Me Group has also lost some love this year, down from a high of $4.55 to $3.74. Its first-half FY14 result was subdued due to higher costs as the business repositions for the next growth stage.
Consensus forecasts have Trade Me on a prospective FY14 PE of 18.7 times, falling to 16.6 times in FY15. Three analysts rate the stock a moderate or strong buy, according to Morningstar. A trailing 4 per cent unfranked yield is another attraction.
Although Trade Me’s growth trajectory will slow in coming years, I cannot see too much wrong with its recent performance. It dominates the New Zealand online auctions and classified markets, with about 3.4 million active user accounts – an asset that would be hard to replicate. About 650,000 people visit the site daily.
Trade Me would be more interesting below $3 – a possibility if global weakness in tech stocks persists and, locally, if high PE stocks suffer from profit taking. At current prices, Trade Me warrants a spot on portfolio watchlists given the strength of its business model and position in New Zealand.
The final tech stock that has caught my eye this year is accounting software provider Reckon. Like Wotif.com and Trade Me, it is near value territory after recent price falls. It might also be a takeover target if there is consolidation of the lucrative accounting space market as bigger local and global players jostle for market share, and as cloud computing changes the industry’s dynamics.
Newcomers, such as Xero, have attracted huge attention. But Reckon has a strong brand, excellent market position and a large, sticky user base of small business clients. An attraction of accounting software is high switching costs once a business gets used to a record-keeping system.
Reckon’s FY13 result was below expectation. The take up of its Reckon One has been slower than expected according to some analysts, and aggressive competition from the likes of Xero – and the threat of cloud computing – have also weighed on its share price. Reckon has a lot of ground to make up in cloud computing and it will not be an easy market for it to enter.
Even on, Reckon is among the market’s higher-quality small-cap companies, and the accounting software market has excellent long-term fundamentals: a huge market of small enterprises and high profit margins that characterise successful software providers.
Active investors should pay closer attention to Reckon at current prices, while long-term value investors might wait for prices well below $1.80 as global weakness in tech stocks continues and the Australian sharemarket enters the seasonally weak May/June period.
The three companies above are good quality and offer more compelling valuations after price falls. But there is no urgent need to buy just yet – it is hard to find a re-rating catalyst in the next quarter or two – meaning better value ahead for patient investors who are prepared to watch and wait.
Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at May 14. 2014.
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