Increased remote working and digitization of businesses during the pandemic saw a worldwide increase in IT spend. According to Gartner, a research firm, the global IT spend is expected to increase 6.2% to reach US $3.9 trillion in 2021. Cloud computing, core business applications, security, and hyper-automation to lead the growth. In Australia, spending on IT by utilities, government, education, and healthcare proved resilient. Spending is likely to reach $95.8 billion in 2021, up by 3.6% over the previous year, as cited in the report by the research firm. Analysts are expecting remote working trends and increased digital customer interactions to stay after the pandemic. The education and healthcare sectors are in a bright spot where spending is expected to grow by 8.6% and 8.2%, respectively. The adoption of the Internet of Things (IoT), virtual care, patient monitoring and collaborative learning earn the top spot.

The government is spearheading the transition with the aim of becoming a digital economy by 2030. It had previously chalked out a $4.5 billion network investment plan with an objective of taking ultra-fast broadband to regional and metropolitan cities in Australia. It also planned to invest $1.67 billion in cybersecurity in a move to strengthen Australia’s critical infrastructure. The government was expecting the digital business plan to boost Australia’s Gross Domestic Product (GDP) by $6.4 billion a year by 2024. The government had previously implemented Digital Business Plan with a commitment of $800 million in digital technologies, as detailed below.

Figure 1. Digital Push by the Government:

Data Source: Department of the Prime Minister and Cabinet, Chart Created by Kalkine Group

The digitization of the economy provided an uplift in retail sales. Australians showed increased engagement in online shopping. Online spend has peaked at $50.46 billion in 2020, up from $32.1 billion in 2019, according to the Australian Post. Online retailing accounted for 16.3% of total retail spend, a phenomenal growth supported by the pandemic and lockdown restrictions. The virus outbreak to further strengthen the e-commerce growth, which is expected to post a compound annual growth rate (CAGR) of 10.3% between 2020 and 2024, according to GlobalData. Australians continue to prefer electronic payments over cash. The data by The Australian Bureau of Statistics illustrates the promising growth of online retailing in recent times.

Figure 2. Growth in Millennials to Drive the Online Shopping:  

Data Source: The Australian Bureau of Statistics, Chart Created by Kalkine Group

In the recent pronouncement, as part of budget 2021-22, the Morrison Government has unleashed a Digital Economy Strategy with an investment of $1.2 billion. The strategy accelerates the transition to the digital economy by 2030. It is a step forward, bringing emerging technologies and Artificial Intelligence (AI) to every sector. Earlier, the government had set up a JobTrainer Fund with an investment of $1 billion in embracing digital skills. The government has taken measures to improve internet and mobile connectivity in peri-urban areas. It is enhancing myGov and My Heath Record systems as part of the plan.The government also brings Australian Small Business Advisory Services to build digital capability to Small Medium Enterprise (SMEs).

Figure 3. The Government’s Ambitious Budget Plan for Digital Economy:

Data Source: Prime Minister of Australia, Chart Created by Kalkine Group

The government aims to thrive digitization in start-ups with all-new ‘born’ businesses to become completely digital. The digitally intensive industries are expected to employ more than 10% of the workforce in Australia. The government plans to increase digitally skilled graduates to more than 15,000 per year. As part of the plan, the government aims to build emerging technologies and ramp up digitization in priority sectors, as mentioned below.

Figure 4. Building Emerging Technologies and Digitization in Key Sectors:

Data Source: Digital Economy, Chart Created by Kalkine Group

Key Risks: The increasing share of the aged population in Australia may slow down digital transition plans. The expiry of various government support programs may hurt household spending. Increasing household debt and de-growth in wages may curtail online retail spending. Digital spending by the manufacturing sector is expected to post a marginal growth in 2021. According to Gartner, manufacturing accounted for ~17% of total digital spending in 2020. A handful of manufacturing companies withdrew their capital expansion plans. In a survey by the Australian Bureau of Statistics, nearly two-thirds of businesses are adversely affected by the pandemic safe controls, and three in every ten businesses are experiencing supply-chain disruptions.

Figure 5: Key Risks Affecting Digitization Plans: 

Source: Analysis by Kalkine Group 

Outlook:  The Australian government is mulling IT spend on public services. In a recent report by Gartner, the government IT spend is likely to clock $13 billion in 2021, an increase of 6.2% over the previous year. Higher spending on software, telecom services, and IT services is likely to embrace remote working and connected public services. The government public sector IT models are likely to see quicker adoption of available technology. The report mentioned that government spend on IT platforms across the globe is expected to grow 5.1% in 2021 to reach US $483 billion. Australian companies are increasingly spending on risk management and security. In the light of a recent security breach, the government has framed the Security Legislation Amendment (Critical Infrastructure) Bill 2020 and mandates risk management practices across companies. In a survey by Gartner, about 67% of companies in Australia and New Zealand expressed cybersecurity was the no. 2 priority for new spending. Spending on security is expected to increase by 8.0% in 2021 to reach $4.927 billion in Australia. Considering the developments in digital technology, we have figured out 4 stocks on ASX that are set to see the momentum.

(1) Altium Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)

(M-cap: A$ 3.30 Billion, Annual Dividend Yield: 1.52%)

Aiming 100,000 Subscribers by 2025: Altium Limited (ASX: ALU) develops and commercializes electronic products software for the US and international markets. In FY20, revenue stood at US$189.1 million, up 10% YoY, reflecting double digits growth for the 9^th year in a stretch. ALU was able to keep costs in-line with its ‘Rule of 50’ plan. It had posted EBITDA growth of 13.3%, with a margin reaching 38.0% in FY20. Seats as well as subscriptions attained a double-digit growth. Seats grew by 15% (9,251), and subscriptions jumped 17%, surpassing the goal of 50,000 subscribers to reach 51,006. Further, the company closed the year with a cash balance of US$93.1 million post dividend expenses of US$33.6 million. Meanwhile, operating cash flow reported at US$56.5 million as compared to US$69.1 million in pcp. Cash flow was squeezed by additional terms to some customers and offering monthly payment plans to others on the back of COVID-19 impact on their businesses, rise in cash tax payments, and the implication of attaining multi-year sales contracts with payment terms for the contract life. 

During H1FY21, ALU reported a 4% drop in H1FY21 revenue to ~US$80 million over pcp driven by economic slowdown on the back of extreme COVID-19 conditions in the US and Europe, and a difficult situation for license regulation activities, post COVID-19 in China. Further, the EBITDA margin fell to 33.8% from 38.3% in H1FY20. Further, new perpetual license seat sales fell by 15% to 3,590, while the subscription business grew 12% in its subscriber base in the last twelve months to reach 52,157 subscribers.

Outlook: ALU is focused on attaining dominance over PCB design software tools to encourage and even augment secondary stakeholders to take its cloud platform Altium 365 that brings transformation in the electronics industry. ALU forecasts FY21 revenue to be at the lower end of the range of US$190-US $195 million and EBITDA margin to be in the range of 37% to 39% in FY21. In the long run, ALU targeted to reach US$500 million in revenue by 2025 and 100,000 subscribers.

Valuation Methodology: EV/EBITDA Multiple Based Relative Valuation (Illustrative)

EV/EBITDA Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs ALU (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted 3-month and 6-month negative returns of ~19.71% and ~35.80%, respectively. It is currently trading below the average of the 52-week high price of $40.210 and 52-week low price of $24.740, indicating accumulation opportunity. The stock underperformed the market volatility index as the pandemic affected IT spend by businesses. We have valued the stock using the EV/EBITDA multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). We believe that the stock might trade at a slight premium as compared to its peer median EV/EBITDA (NTM Trading multiple) considering its strong momentum in subscriber base, cost savings plan (‘Rule of 50’ strategy) and long-run target. For the purpose, we have taken peers such as WiseTech Global Ltd. (ASX: WTC), Pointerra Ltd. (ASX: 3DP), Brainchip Holdings Ltd. (ASX: BRN), to name a few. Considering its H1 FY21 EBITDA margin ahead of its peers, strong momentum in its cloud platform, healthy subscriber base, and valuation, we give a “Buy” recommendation on the stock at the current market price of $24.880, down by 1.231% on 10^th May 2021. 

(2) Pushpay Holdings Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)

(M-cap: A$ 1.76 Billion, Annual Dividend Yield: 0%)

Taking Organic and Inorganic Way to Increase Customer Base: Pushpay Holdings Limited (ASX: PPH) offers a donor management system to the faith sector, non-profit organisations, and education providers in the United States, Canada, Australia, and New Zealand. In FY20, PPH grew its customer base by 3,247 customers to 10,896, a jump of 42%. Further, it had acquired 100% interests of Church Community Builder that grew customers by 2,716. Customer numbers also comprise 1,442 mutual customers, which utilise both Pushpay and Church Community Builder solutions. Meanwhile, revenue grew to US$127.5 million, up 33% YoY and operating revenue grew to US$127.5 million, up 33% YoY. EBITDAF reported at US$25.1 million, a jump of 1,506%, while operating cash flow increased by US$26.3 million from negative operating cash flows of US$2.8 million in pcp. Importantly, it attained its total processing volume forecast for FY20 by US$1.4 billion, to US$5.0 billion, up 39% YoY.

In H1FY21, PPH grew its customer base by 2,991 to 10,896 customers for twelve months period ended 30 September 2020. Further, operating revenue grew to US$85.6 million, up 53% YoY, and total revenue grew by US$29.2 million to US$86.6 million, up 51% in H1 FY21 over pcp. Meanwhile, EBITDAF increased by US$17.1 million to US$26.7 million, up 177% YoY. Importantly, NPAT grew by US$6.9 million to US$13.4 million, up 107%. Finally, operating cash flow grew by US$18.1 million to US$27.0 million, up 203%.

Outlook: PPH expects the growth momentum to continue in FY21 on the back of continued execution of strategy to gain additional market share in the medium-term. Meanwhile, looking forward to potential strategic acquisitions to widen the current proposition and add phenomenal value to the current business. Further, it increased its EBITDAF guidance to be in the range of US$54.0-US$58.0 million for FY21, despite uncertainties and impact of COVID-19 restrictions and the broader US economic environment status. 

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative) 

EV/Sales Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs PPH (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted 3-month and 6-month negative returns of ~10.23% and ~22.67%, respectively. It is currently trading below the average of the 52-week high price of $2.272 and 52-week low price of $1.405, implying an opportunity for accumulation. The stock performed well over the market volatility index but fell subsequently. We have valued the stock using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). We believe that the stock might trade at a slight premium as compared to its peer average EV/Sales (NTM Trading multiple) owing to strong customer addition and upward revision of guidance for FY21 despite the challenging environment. For this purpose, we have taken peers such as Megaport Ltd. (ASX: MP1), Tyro Payments Ltd. (ASX: TYR), NEXTDC Ltd. (ASX: NXT), to name a few. Considering the healthy revenue growth in H1 FY21, strong EBITDA margin ahead of its peers, valuation, and trading levels, we give a “Buy” recommendation on the stock at the current market price of $1.540, down by 3.751% on 10^th May 2021. 

(3) Data#3 Limited (Recommendation: Hold, Potential Upside: Low Double-Digit)

(M-cap: A$ 917.69 Million, Annual Dividend Yield: 2.41%)

Service and Consulting Revenue to Drive Future Growth: Data#3 Limited (ASX: DTL) offers information technology (IT) solutions broadly in Australia. In FY20, total revenue grew by 14.9% to $1,625.9 million, driven by the continued strong momentum in public cloud revenues that grew by 60.4% to $581.0 million. Despite a fall in services revenues by 5.1% to $204.9 million and Business Aspect consulting revenues fall by 38.6% to $16.2 million, the gross margins of both businesses have increased, and net profit margins fell slightly. Further, the adverse sales mix affected gross profit, which had de-grew by 8.1% to $188.0 million. Meanwhile, total profit after tax grew by 30.5% to $23.6 million. The board declared fully franked dividends of 13.9 cents per share for FY20, up 29.9% YoY, with a payout ratio of 90.6%.

In H1FY21, total revenue grew by 19.2% to $856.7 million and added $346.1 million of public cloud-based revenues, a jump of 37.4%. Further, gross profit grew by 1.2% to $89.7 million, and total gross margin decreased to 10.5%, indicating a shift in sales mix, with growth in Software Licensing & public cloud revenues. Meanwhile, net profit after tax grew by 7.9% to $9.4 million. On the back of strong financial performance and solid balance sheet, DTL declared an interim fully franked dividend of 5.50 cents per share, a 7.8% rise on pcp, indicating a payout ratio of 90.3%.

Outlook: DTL expects growth in the Australian IT market and anticipates that the company is well-positioned to capitalize on that opportunity as it continues to expand its offerings for the best fit as per the changing requirements of the customer. The sound H1FY21 performance and pipeline of opportunities for H2FY21 provide DTL confidence that it will achieve the FY21 financial objective, being to deliver sustainable earnings perspective. 

 

Valuation Methodology: EV/EBITDA Multiple Based Relative Valuation (Illustrative) 

EV/EBITDA Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs DTL (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted 3-month and 6-month returns of ~+4.98% and ~-7.67%, respectively. It is currently trading above the average of the 52-week high price of $7.300 and 52-week low price of $4.100. The stock outperformed the market volatility index. We have valued the stock using the EV/EBITDA multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). We believe that the stock might trade at a slight discount as compared to its peer median EV/EBITDA (NTM Trading multiple) as the company’s consulting revenues continue to underperform due to COVID-19 restrictions on IT spend. For this purpose, we have taken peers such as Computershare Ltd. (ASX: CPU), NEXTDC Ltd. (ASX: NXT), Appen Ltd. (ASX: APX), to name a few. Considering the growth in profitability in H1 FY21, strong balance sheet, dividend distribution, we give a “Hold” recommendation on the stock at the current market price of $5.910, down by 0.839% on 10^th May 2021.

(M-cap: A$ 1.16 Billion, Annual Dividend Yield: 0%)

Acquisition of Limelight Health to Provide Rise in Subscription Revenue: Fineos Corporation Holdings Plc (ASX: FCL) is engaged in the development and commercialization of enterprise claims and policy management software in the life, accident, and health insurance domain worldwide. In FY 20, revenue grew to EUR 87.8 million, an increase of 39.8% YoY, and an 18.6% rise on prospectus forecast of EUR 74.0 million. Reported rise of 37.9% in subscription revenues over FY19. Further, EBITDA reported at EUR 14.0 million, an increase of 51.7%, and upon a prospectus forecast of EUR 2.4 million. On 14 August 2020, FCL acquired Limelight Health, Inc., a provider of end-to-end quoting, rating, and underwriting Software-as-a-Service (SaaS) for a total consideration of US$75 million. Meanwhile, the closing cash balance reported at EUR 39.8 million for FY20, primarily indicating funds raised at the IPO and cash flow generation in H2FY20, partially nullifying the repayment of a EUR 16.7 million loan and interest in Q1FY20. The cash balance and debt-free status on 30 June 2020 aided a healthy balance sheet to fund future growth initiatives.

In H1FY21, the revenue grew by 20.1% before the addition of the acquisition of Limelight Health that added a further 10% to bring a total revenue increase of 30.1% over pcp. Further, subscription revenue jumped organically by 35.1% over pcp, and the addition from Limelight Health, increased by 51.5% over pcp. On a statutory basis, FCL reported a net loss after tax of EUR 5.1 million, down from a net profit after tax of EUR 0.1 million in H1FY20, led by the higher operating expenses. Goodwill of EUR 34.5 million has been recorded on the acquisition of Limelight business product suite.

Outlook: Total Revenue for FY21 with Limelight Health is projected to be in the range of EUR 102-105 million, after impacts from foreign exchange. Further, it anticipates 30% growth in subscription revenue, ex-Limelight Health to be ~EUR 4 million in FY21. Meanwhile, signed a new deal in February 2021, in ANZ reflecting the first in the region to feature on the FCL Platform in the cloud.

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative) 

EV/Sales Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs FCL (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted 3-month and 6-month returns of ~+0.82% and ~-9.53%, respectively. It is currently trading below the average of the 52-week high price of $5.750 and 52-week low price of $2.950. The stock’s performance dropped to be in line with the market volatility index. We have valued the stock using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). We believe that the stock might trade at a slight premium as compared to its peer median EV/Sales (NTM Trading multiple) on the back of strong growth in software and services revenues and new order expectations. For this purpose, we have taken peers such as Dubber Corp Ltd. (ASX: DUB), Nearmap Ltd. (ASX: NEA), Family Zone Cyber Safety Ltd. (ASX: FZO), to name a few. Considering the strong contribution from Limelight Health acquisition, healthy subscription revenue growth, valuation, and trading levels, we give a “Hold” recommendation on the stock at the current market price of $3.750, down by 3.101% on 10^th May 2021.

Comparative Price Chart (Source: Refinitiv, Thomson Reuters)

Note: Investment decision should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the Valuation has been achieved and subject to the factors discussed above.

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