I. Sector Landscape and Outlook
The Technology Software and Hardware sector is broadly classified under Technology. The sector covers computer hardware, telecom equipment, Internet of Things, Robotics, computer system design, software programming & engineering, among several others.
The technology sector is the sixth-largest in Australia contributing ~$122 billion to the economy, according to Digital Industry Group Inc., an industry body. The sector employs about 580,000 workers. Technology shapes the Australian services sector with unmatched capabilities such as the use of blockchain in financial services, immersive simulation technologies in education, the use of robots in medical procedures, and the deployment of IoT in agriculture. Artificial intelligence, data communications, and vision systems provided extensive support to the mining industry for extraction and identifying new reserves. It is worth mentioning that Australia is a world leader in silicon-based quantum computing research.
Australia is an incubator for start-up companies in technology. A handful of tech companies catered to providing financial services, education and support, medical technology, and agriculture. Through various digital activities, the technology industry provided an indirect contribution of $53 billion to the economy, according to Digital Industry Group Inc.
Figure 1. Wide Adaption and Strong Prevalence in Services Sector:
Data Source: Australian Trade and Investment Commission, Chart Created by Kalkine Group
Australia boasts one of the finest research institutes. The University of Technology Sydney’s Centre for Artificial Intelligence is a world research centre in AI. The centre provides advanced algorithms in the areas of computational intelligence, business intelligence, computer vision, data science, among others. Australia has many remote mines and oil and gas facilities. It had deployed modular and mobile equipment for deeper extractions and to get insight on the grade qualities of orebodies. The government is investing $700 million into the space sector with the goal to triple the size of the sector to $12 billion by 2030. Western Australia has a proven track record in providing robotics for space-related activities such as in-orbiting servicing, satellite gateways, among many others.
Rapid digital transformation, government’s tax incentives, increased early-stage investment, and increased R&D spend by companies contributed to the robust sector growth. According to the Australian Trade and Investment Commission, Information Media and Telecommunications Industry posted the Gross Value Added (GVA) growth of 5.1% on an annualized basis from 1991-2019, far exceeding services sector GVA growth of 3.4%. Exports of telecommunications, computer and information services sector accounted for ~5.8% of overall services exports in 2019-20, according to The Australian Bureau of Statistics. Such exports have shown an annualized growth rate of 10.2% in exports over the past 10 years.
Figure 2. Healthy Growth Underpinned by Rapid Digital Transformation:
Data Source: The Australian Bureau of Statistics, Chart Created by Kalkine Group
In a survey by The Australian Bureau of Statistics, ~44% of businesses in Australia are active in bringing innovation in processes and development of new technologies. Wholesale Trade, Manufacturing, and IT and Telecommunication are the top sectors that were increasingly adopted technologies such as automation, blockchain, and robotics for the year 2018-19. A handful of these companies have used technology in bringing operational efficiencies and process change. The survey also mentioned that nearly one of four businesses had innovation in the development.
Figure 3. Number of Companies by Sector Deployed Innovation Through Technology:
Data Source: The Australian Bureau of Statistics, Chart Created by Kalkine Group
Through direct and indirect contribution, the technology software and hardware sector contributed nearly $122 billion to Australia’s GDP, making it the sixth-largest sector ahead of manufacturing, according to Digital Industry Group Inc. Through digital maps, social connect apps, web search, online banking, shopping, and education apps, and video streaming, the sector added savings of nearly $44 billion to consumers. Digital innovation in telehealth, online services delivery and emergency response also helped the government to realize savings of $9.3 billion.
According to the industry body, Australia is leading the OECD economies for the usage of software and hardware technologies in the workplace and the deployment of Information Communication & Technologies (ICT) skills. But the nation lagged on the amount of R&D spend in ICT. The sector revolutionizes the economy with strong productivity levels in-line with advanced economies but must grow bigger. It is expected that Australia’s technology software and hardware sector to grow to $207 billion in Gross Domestic Product (GDP) by 2030.
Figure 4. Australia’s Ranking of Information Communication & Technologies (ICT):
Data Source: Digital Industry Group Inc., Chart Created by Kalkine Group
The pandemic affected shipments of Trusted Platform Modules which are projected to decline by 17% in 2020 over the prior year, according to ABI Research. Demand for personal computers and on-premise IT equipment such as servers have been hard-hit. This will be partially offset by a rise in demand for cloud applications benefiting Hardware Security Modules. Hardware products under Trusted Execution Environments to show flat YoY growth in 2020 due to a fall in the production of smartphones but offset by strong demand for connected medical devices supporting telemedicine which had shown wide adoption during the pandemic. However, the lockdown created waves of demand for IoT, smart homes, and smart office devices.
Index Performance:
The ASX 200 Information Technology (GIC) Index generated 5-year returns of ~163.67% as compared to ~30.59% by the ASX 200 Index. Enriched contribution by leading research institutes in Australia, increased spend on process innovations by companies, government’s various support programs, and rapid digitization in manufacturing, mining, healthcare, and other sectors that helped to post strong index gains.
Figure 5: The ASX 200 Information Technology (GIC) outperformed ASX 200 Index by whooping ~132.78% over the last five years:
Source: Refinitiv (Thomson Reuters) as on the close of 18 March 2021 (does it need updation)
Key Risks and Challenges:
The Technology Software and Hardware sector is exposed to regulatory and legislative risks that restrict data sharing between government agencies. The sector has a backdrop of limited domestic technology workforce and restrictions on skilled workforce migration. In a report by Deloitte, Australia lagged other economies in digital leadership with technology workers make-up just 9% of the total workforce. To catch-up, Australia needs to add over 60,000 new technology workers every year to 2025.
A shift in population demographics may cut-off the digital transformation initiatives. The increasing share of the aged population in Australia may affect adaption and technology reach. With pandemic affected cash flows of several businesses, spend on digital trends and innovation may get impacted. According to Globaldata, spending on hardware is estimated to fall 6.8% in 2020 as against the growth of 11.5% in 2019. ICT spend in the travel and leisure sector will be the most affected, followed by transport and logistics, and manufacturing sectors on the backdrop of lockdown restrictions and the pandemic.
Figure 6. Key Risks in The Technology Software and Hardware sector:
Sources: Analysis by Kalkine Group
Outlook:
In the recent budget, the federal government committed an additional $2 billion to encourage research and development by home-grown companies through the R&D Tax Incentives program. This will boost participation from several small and medium companies in Australia in setting-up technology platforms and applications. To address the skills shortage, the government has set-up a 2020 Cyber Security Strategy for upskilling and reskilling in technology besides it also empowers women participation in STEM programs. The government granted universities $1 billion in new research funding and $459 million to the nation’s research hub, The Commonwealth Scientific and Industrial Research Organisation (CSIRO). It also earmarked $1.1 billion in the next nine years in overhauling the government’s IT systems such as $116.3 million towards myGOV, $97 million towards rebuilding My Health Record, and $35.6 million in GovERP, among others.
II. Investment theme and stocks under discussion (ERD, IRI, AD8, CAT))
After understanding the sector, let us now look at four companies listed on the ASX. The price potential of the companies under discussion has been analysed based on the ‘EV/Sales’ method.
1. ASX: ERD (EROAD Limited)
(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$302.19 Million)
EROAD is a technology and service company providing electronic solutions to the transport industry, supporting regulatory compliance, and commercial services to heavy vehicles.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 28.71% on 18 March 2021. We believe that the stock might trade at a discount as compared to its peer median EV/Sales (NTM Trading multiple) considering the inherent risk with customer renewals are solely sensitive to macro-economic factors and tech spend are based on capex plans by companies. For the said purposes, we have taken peers such as Codan Ltd. (ASX: CDA), Smart Parking Ltd. (ASX: SPZ), Catapult Group International Ltd. (ASX: CAT).
2. ASX: IRI (Integrated Research Limited)
(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$380.59 Million)
Integrated Research Limited provides software solutions in variety of services, including data collection and storage, performance tracking, event automation, help desk applications, job scheduling, and resource management.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 26.18% on 18 March 2021. We believe that the stock might trade at a slight discount as compared to its peer average EV/Sales (NTM Trading multiple) considering the significant exposure to international counties such as Asia-Pacific, Europe, performance of which may be influenced by Brexit and other geopolitical tensions. For the said purposes, we have taken peers such as TechnologyOne Ltd. (ASX: TNE), Infomedia Ltd. (ASX: IFM), Janison Education Group Ltd. (ASX: JAN). The stock delivered annualized yield of 3.28%.
3. ASX: AD8 (Audinate Group Limited)
(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$570.37 Million)
AD8 is a developer and seller of digital Audio-Visual (AV) networking solutions. It has developed its own technology platform for distribution and deployment in the AV products of its Original Equipment Manufacturer clientele.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 15.66% on 18 March 2021. We believe that the stock might trade at a premium as compared to its peer median EV/Sales (NTM Trading multiple) considering the product pipeline in Dante platform and growth plans. For the said purposes, we have taken peers such as Codan Ltd. (ASX: CDA), Seeing Machines Ltd. (ASX: M2Z), Altium Ltd. (ASX: ALU).
4. ASX: CAT (Catapult Group International Limited)
(Recommendation: Hold, Potential Upside: Low Double Digit, Mcap: A$378.81 million)
CAT is a developer and supplier of wearable tracking devices, software, and video analytics solutions to improve the performance of sports persons and athletes.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 18.76% on 18 March 2021. We believe that the stock might trade at a discount as compared to its peer average EV/Sales (NTM Trading multiple) citing general risk factors in renewal subscriptions as it is influenced by macro-economic factors such as interest rates, unemployment rate, exports, etc. For the said purposes, we have taken peers such as Audinate Group Ltd. (ASX: AD8), Ava Risk Group Ltd. (ASX: AVA), Smart Parking Ltd. (ASX: SP2).
Note: All the recommendations and the calculations are based on the closing price of 18 March 2021. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).
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