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In search of the best tech stock

In search of the best tech stock

By Staff Journalist 20.11.2011


Stock pickers rarely do a proper analysis of sectors or stocks within each sector to find the hidden gems, or standout stocks that may provide much-needed diversification in a portfolio. In this week's column we study the Information Technology sector (XIJ).

Much-maligned after the tech wreck of 2001, the IT sector had clawed its way back from 2003 lows and was a strong performer following the GFC. By early 2010 the IT index (XIJ) had managed to push even higher than before the GFC struck. However it has been downhill since then, with the index tumbling from 736 points in April 2010 to 509 points today - a fall of 31% in just 18 months. Although the bleeding has slowed somewhat, the sector is still down 14% over the past year versus a drop of 8% for the All Ordinaries. 

Chart: XIJ 1 year price chart as at 18/11/11 

Only six of the 24 largest stocks by market cap managed a gain for the year, with the top gainer iProperty soaring 156%. And of the 18 stocks that sported losses, 11 tumbled by more than 20%, led by the former billion dollar company Silex Systems. After plunging almost 60% over the year Silex now has a market cap of less than $400 million.

However analysts say that the outlook for listed IT services companies is better than it has been for many years. There is a notable increase in IT spending by state and federal governments, as well as IT modernisation initiatives by the larger banks – CBA alone is committing over $1 billion to core-banking upgrades. IT services may only account for less than 1 per cent of the market’s total capitalisation, but some solid performing stocks are starting to put the sector back on the radar.

“Since the tech wreck, IT stocks may still be seen as volatile growth opportunities,” says equities analyst James Samson, of Lincoln Indicators. “However, this attitude is changing as more companies begin to place greater emphasis on the role IT plays. High levels of customisation within IT systems coupled with an entrenched need for quality have become accepted traits of many businesses. IT is now a far greater priority in the strategy and success of a business. With the evolution of cloud computing, the hype has begun in tech markets once more.”

Consequently, Samson argues IT companies are presenting investors with much more stable investment opportunities than in the past, while retaining growth traits.

Patersons Securities believes that with most stocks in the sector looking relatively cheap, investors could be rewarded for taking early positions with the hope of making gains over the long haul. And Daniel Rolley, Investment Analyst with Atom Funds Management says the bulk of the recovery may not hit until full year 2012 as IT spending lifts towards the end of the year. He says buying into the sector before the pipeline of growth is factored into prices may well be a prudent move.

Rob Hopkins, managing director of Smallco Investment Manager is also bullish on the outlook for IT. Even though they ran fairly hard over the five years to 2010, there is plenty of upside for IT stocks, says Hopkins. Having created near monopolies he believes that the best days for most stocks in the sector are ahead of them.

Sectors: Technology Hardware & Equipment, Software & Services, Semiconductors

Code: XIJ

1 year return: -15.35%

Industry Group: Information Technology

Largest Company: Computershare Ltd (SPU), $4.5 billion market cap

Top gainers (12 months): iProperty Group +156.1%, Integrated Research +33.3%, Hansen Technology +26.9%

Biggest losers (12 months): Silex Systems -58.6%, Infomedia -55.4%, Customers Limited -44%


Top Gainer - iProperty Group (IPP) +156.1%
Market capitalisation: $178 million
Price/earnings ratio:  - times
Share price: $1.05

CHART 

Chart: Share price over the year to 18/11/2011 versus ASX200 (XJO)

Recently listed as the 4th fasted growing Australian company in the BRW Fast 100 and having won several awards in Asia, iProperty Group (IPP) has had a stellar 2011. Although the online property group with a large footprint in Asia is still to turn a profit, the company has achieved strong year-on-year revenue growth.  Investors have cheered the news, sending shares skyrocketing 156.1% over the past 12 months.

In reality this stock should probably be listed in the Media industry group of the consumer discretionary sector, along with its direct competitor REA Group, owner of Australia's no.1 real estate website realestate.com.au. In fact, IPP's CEO is the ex-CEO of REA's Australian operation. We covered REA Group as a rising star in the Media industry group three weeks ago, pointing out that several brokers had buys on REA Group due to its strong growth and expansion plans.

Interestingly, Rob Hopkins, MD of Smallco mentioned in the article that REA had been eyeballing French property group SeLoger.com, France's leading property portal. Well, just last week SeLoger proceeded to buy 12 million shares of iProperty Group from its founders, increasing its stake in the company to 16.1%. This puts iProperty Group firmly in the sights of not only SeLoger, but also REA Group.

Failing a takeover bid, the company will need to show investors that it can handle the move into the next stage.

iProperty Group got up quickly. It listed just three months after forming, now five years ago. New offices and websites around Asia provided a large increase in revenue, however costs have increased too. Growing quickly on borrowed funds is one thing, turning a profit is another. REA Group successfully managed to make the transition from start-up to stalwart, it remains to be seen whether IPP can follow in its footsteps.

 

Biggest Loser - Silex Systems (SLX) -58.6%
Market capitalisation: $394 million
Price/earnings ratio:  - times
Share price: $2.32

CHART 

Chart: Share price over the year to 18/11/2011 versus ASX200 (XJO)

Steven Hing of Zodiac Securities says Silex “appears to be the only company in the world that can placate both the pro-nuclear and pro-solar ranks at the same time”. Silex is a high technology company with five core businesses. These include Laser Isotope Separation Technology (for uranium enrichment), Solar PV Panel Manufacturing, Solar Systems Concentrating PV Technology (a solar power station in Mildura), Translucent Earth Abundant Materials Technology and Chronologic Instrumentation Technology. “From its laser-based isotope separation process to possibly increasing computer semiconductor speed 100-fold, there’s plenty to get excited about,” Hing says. “If successful, Silex’s technology would be truly revolutionary and there’s no denying this company has exciting potential. Although the company is several years away from any sizeable recurring income streams, it’s in a comfortable position after a capital raising in December 2010.”

 

Largest by market cap - Computershare (CPU)
Market capitalisation: $4,523 million
Price/earnings ratio:  18.39 times
Share price: $8.06

CHART 

Chart: Share price over the year to 18/11/2011 versus ASX200 (XJO)

Often referred to as a global registrar, administering more than 100 million shareholder accounts for more than 14,000 corporations across 20 countries, Computershare lived up to its reputation for acquisitions after recently agreeing to buy Bank of New York Mellon Corporation’s shareowner services business for $US550 million cash.

The market responded positively to the news, but the risk is regulatory hurdles, such as obtaining US anti-trust clearance. If the deal isn’t approved within a year, Computershare will pay a $30 million break fee to BNY Mellon. However, besides this acquisition, Georges says the company offers diverse services, such as specialised records management, strategic investor relations and market intelligence.

“With its scale, expertise, strong balance sheet and low capital requirements, Computershare should generate solid long-term growth,” he says. “Diversification across many regions, and increasingly in non-equity market activities dampen earnings volatility. The combination of global scale and sophisticated technology underpin a strong competitive advantage.”

Andrew Inglis of Shadforths has a buy on the company, pointing out that CPU is the world’s largest share registry business and this provides a scale advantage over its competitors. "With outdated share registration systems in several countries, there’s considerable scope for further industry efficiencies and consolidation," he says, adding "CPU’s takeover of Bank of New York Mellon’s substantial share registry business will be a major catalyst for CPU."

After recently reporting a disappointing 15% in first half earnings a swag of brokers have downgraded their price targets for CPU. RBS has a hold on the stock, but has reduced its price target from $9.95 to $9.40. Credit Suisse, Citi, JP Morgan and UBS have all cut price targets, but remain mostly positive about the outlook for the company with their targets remaining 10-15% above the current share price.

 

Rising Star - Integrated Research (IRI) +33.3%
Market capitalisation: $80 million
Price/earnings ratio:  - times
Share price: $0.48

CHART 

Chart: Share price over the year to 18/11/2011 versus ASX200 (XJO)

Given iProperty Group should be in the consumer discretionary sector, Integrated Research (IRI) - a software company that produces performance monitoring tools for global financial institutions and networks - is really the top gainer for the sector over the past year. After hitting its lowest point in two years of 25 cents on June 10, IRI has surged in the past few months. It rocketed from 27 cents on July 4th to its current price of 48 cents, a whopping 78% gain in just four months amidst the background of a falling Australian market.

Founded in 1998 and listed in 2000, IRI was hammered along with the rest of the sector back in 2001. But it lived to fight another day and has managed to steadily grow its business with a minimum of fuss. IRI now boasts 4 of the top 10 banks in the world amongst its clients, and a strong profit increase this year sent the share price in the right direction.

IRI is a classic survivor of the dot com mania, actually listing at the height of the bubble at $1.40 per share. It didn't stay there long, with its share price crashing to lows of 10.5c by mid-2003. It has taken years to resurrect investor confidence; now the company boasts a blue-chip client base that includes the world’s largest bank, stock exchange, aviation and telecommunications company.

As a micro-cap in the IT sector, the stock doesn't get a lot of coverage from analysts. Nonetheless, Shawn Uldridge from William Shaw Securities has been covering the IT minnow and likes what he sees. Uldridge has placed a firm buy on this software company involved in producing performance monitoring tools for global financial institutions and networks. "We expect much higher profits going forward despite challenging currency movements," says Uldridge. "With a recent market capitalisation of about $80 million, the company is small, cheap and offers massive growth potential."

IRI's dependence on its partnership with Aviva and competition from other IT firms who produce better, faster solutions pose risks to the company's upward march. However having survived the tech wreck and then the GFC in a tumultuous 10 years it has shown that the company has what it takes to stick around for the long term.

 

Solid Performer - Reckon (RKN)
Market capitalisation: $344 million
Price/earnings ratio:  - 21.15 times
Share price: $2.58

CHART 

Chart: Share price over the year to 18/11/2011 versus ASX200 (XJO)

In times such as these, most investors are looking for low-risk stocks. And Merrill Lynch believes that Reckon (RKN) fits the bill, placing a "low-risk buy" on the financial software firm. It has a $2.78 price target on the company, an 8% premium to Friday's closing price.

With several companies conducting a fierce bidding war earlier this year for Australia's other software titan MYOB, Reckon could well be next on the list. Private equity firms Bain, Kohlberg Kravis Roberts (KKR) and Sage battled it out in a bid to gobble up MYOB for $1.3 billion. Bain won the battle, leaving Sage's new CEO Guy Berruyer with empty hands. And a fat acquisition wallet. With RKN's market cap at just $344 million, Sage - or KKR - could easily pick up the company.

Takeover speculation aside, RKN's numbers and outlook look good, according to analysts. A few months back it announced earnings growth of 8% for the 6 months to June 30, 2011, despite being adversely impacted by weak economic conditions in the UK and NZ, adverse exchange rates and a sluggish retail sector in Australia. “It is pleasing to see solid organic revenue growth in our core businesses, and that the continual push for further efficiency gains is bearing fruit,” said Clive Rabie, Reckon’s Group CEO. “Within the constraints of difficult market conditions, and the consequential delays in decision making, we continue our historical strong new product sales growth which in turn adds to our maintenance revenue base by adding new clients to the business each year.”

It says that its QuickBooks and Quicken accounting software has continued to experience strong growth in its direct business, although it has been impacted by weaknesses in the retail sector. However this retail sluggishness is being offset by substantial new customer growth as a result of their online offering, QuickBooks Hosted.

“The group is well positioned as we pursue cloud computing opportunities in all of our businesses, as well as expanding our addressable markets in both the Professional and nQueueBillback Divisions,” said Rabie. “Our relationship with Intuit remains strong and we are excited about the opportunities that could arise from this partnership over the coming years.” 

Intuit isn't the only partnership that may bear fruit over the coming years. Earlier this year RKN took a 5% stake in Melbourne IT and announced that it was looking to work more closely with the IT company on a number of projects.

The financial software firm has been a standout performer over the past 10 years, hardly breaking its stride as the GFC rocked most stocks around the world. The 10-year chart below tells the tale: 

 Chart

However several analysts believe that RKN is already sitting at fair value and as a result have a hold on the stock. James Samson, Lincoln Indicators says that despite the somewhat defensive nature of its business and a reasonably solid 2011 financial report, he believes the shares are fully priced at current levels. Likewise, Morningstar has downgraded it to a Hold as it believes the stock is worth no more than $2.60.

 

Sector: Information Technology


Company Code Last Price Market Cap 1 yr change Div yield EPS P/E
iProperty Group IPP $1.05 178,004,165 156.1% 0% -0.01  -
Integrated Research IRI $0.48 80,093,977 33.3% 8.3% 0.05 10.74
Hansen Tech HSN $0.98 152,779,734 26.9% 6.2% 0.09 11.21
Reckon RKN $2.58 344,055,054 16.6% 3.1% 0.12 21.15
Technology One TNE $1.10 333,717,401 10.8% 3.9% 0.06 17.03
Carsales.com CRZ $4.72 1,104,347,042 6.9% 4.2% 0.25 18.88
GBST Holdings GBT $0.95 63,180,633 -3.1% 4.2% 0.02 45.67
Legend Corporation LGD $0.29 63,053,604 -5.1% 6.2% 0.04 7.84
Bravura BVA $0.15 91,229,247 -6.5% 0% -0.03  -
Iress Market Tech IRE $7.65 971,825,477 -11% 5% 0.36 21.27
Computershare CPU $8.06 4,478,652,316 -16.5% 3.5% 0.44 18.21
Cordan Limited CDA $1.22 199,437,366 -18.8% 7.4% 0.13 9.14
UXC Limited UXC $0.52 159,605,290 -20% 0% -0.07  -
DWS Advanced DWS $1.25 164,791,640 -20.8% 8.8% 0.13 9.58
Melbourne IT MLB $1.39 112,672,767 -20.9% 10.8% 0.18 7.88
SMS Management SMX $5.15 351,694,427 -25.4% 5.8% 0.44 11.63
eServGlobal ESV $0.46 90,549,945 -28.7% 0% 0.2 2.32
CSG Limited CSV $1.08 305,172,899 -29.9% 5.1% 0.16 6.91
ASG Group ASZ $0.87 149,167,493 -31.9% 8.6% 0.1 9
Redflex RDF $1.70 187,587,518 -32.8% 2.9% 0.09 18.22
Oakton OKN $1.54 143,983,361 -37.6% 5.5% 0.14 10.96
Customers Limited CUS $1.07 144,310,212 -44% 4.7% 0.14 7.69
Infomedia IFM $0.20 60,655,371 -55.4% 12% 0.03 6.04
Silex Systems SLX $2.32 394,710,873 -58.6% 0% -0.2  -

 *Only stocks with a market cap of more than $50,000,000 have been included, there are other small- and micro-caps in the  industry group.

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