Top Picks In The Technology, Media and Telecom Sector

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Following the recent reporting season, brokers assemble their highest-conviction selections in the technology, media and telecoms space.

-Morgan Stanley expects ongoing volatility in the TMT sector
-While Citi expects a swing to durable growth as interest rates peak
-Brokers recommend several key stocks in common
-Share price swings following February results season

By Mark Woodruff

Following the February reporting season, analysts review their outlooks for the Technology, Media and Telecom (TMT) sector and settle upon their highest-conviction stock ideas.

Some of these key picks repeat across different broking houses for names such as Telstra ((TLS)), Carsales ((CAR)), REA Group ((REA)), Xero ((XRO)) and NextDC ((NXT)).

In general, the analysts expect stock performance will continue to be driven by the macroeconomic backdrop with ongoing volatility due to the twin impacts of slowing economic growth and rising interest rates.

Morgan Stanley still foresees ongoing share price volatility and suggests investors concentrate on high-quality names, with positive free cashflow, strong balance sheets and a clear runway to profit growth.

More positively, Citi expects pressure will be ease soon on the Technology and Communications sector as interest rates peak, and suggests investors will switch their focus to durable growth.

Confining its research to the Technology sector, Goldman Sachs leans toward reasonable valuations in the current interest rate environment, and companies where management has exerted tight cost control, or is in the process of implementing cost-out programs.

High levels of recurring revenue, defensive end-markets and ownership of mission-critical products are further attributes the broker is seeking.

From among its Buy recommendations, Goldmans singles out the more “offensive” Xero and Life360 ((360)), which are currently trading at low valuations and are progressing to free cash flow profitability.

Additionally, the analysts prefer profitable “defensive” exposures with resilient end-markets such as REA Group, Data#3 ((DTL)) and Macquarie Telecom ((MAQ)), in an environment where profitable tech continues to trade at a large premium to non-profitable.

Companies with high labour costs as a percentage of opex are expected to trim their sails as a way of moving up the profitability ladder.

Morgan Stanley prefers Telstra, WiseTech Global ((WTC)) and Carsales from within its research coverage of the Telcos, Technology and Internet/Classifieds sub sectors, respectively.

The broker appreciates Telstra’s defensive qualities and forecasts a return to rising earnings and dividends. It’s felt extra value can also be unlocked in a variety of ways from InfraCo.

WiseTech has a realistic opportunity to be the global leader in a very large market, while the analyst for Carsales believes the market is underestimating the earnings power for the Australian business, with higher-risk international operations lending further growth potential.

In order of preference, Citi’s top picks in the Technology and Communications sector are SiteMinder ((SDR)), Xero, Domain Holdings ((DHG)), REA Group, NextDC and Serko ((SKO)). Bottom-ranked are Zip Co ((ZIP)) and Appen ((APX)).

This broker sees downside risks to its forecasts for both Netwealth Group ((NWL)) and HUB24 ((HUB)) due to recent market volatility, which impacts upon funds under administration (FUA) and may also restrict flows.

Macquarie’s picks

Early in March, Macquarie suggested it was too early to acquire stocks that experienced cyclically-driven earnings downgrades in the reporting season.

This broker expressed a preference for the defensive earnings at Telstra and Carsales or shares in structural growers such as IDP Education ((IEL)) and NextDC. All are rated Overweight.

Upon delving further into its body of research, Macquarie also gave Neutral-rated Seek ((SEK)) and Xero special mentions. The former may be close to execution of its dynamic pricing strategy in A&NZ and Asia, while the latter’s profit outlook could change drastically with a renewed focus on profits over revenue growth.

Less positively, the broker observed from results season stocks that were structurally impacted.

Appen’s core annotations business is suffering as big tech companies execute on cost-out programs, while the broker also noted subscriber growth for Altium ((ALU)) in both China and the rest-of-the-world is not meeting expectation.

Also, due to declining audiences, Nine Entertainment ((NEC)) and Seven West Media ((SWM)) are suffering from higher cost per mile (CPM) in advertising lingo – or cost per thousand impressions. This means advertisers are getting less on a greater ad-spend, leaving TV markets more exposed to this economic cycle, explained Macquarie.

Morgan Stanley couldn’t disagree more on Nine Entertainment and includes the company among its highest-conviction stocks. While conceding advertising markets are currently challenging, the broker highlights a 6.5% cash dividend, an under-leveraged balance sheet and market share gains across most of its operating businesses.

Beyond the four high conviction stock picks mentioned previously, Morgan Stanley also likes Seek, Xero, News Corp ((NWS)), Pexa Group ((PXA)), NextDC, and both REA Group and Domain Holdings in the real estate space.

Share price swings following February results

Earnings revisions following February results have largely been reflected in subsequent share price reactions.

Up to March 21, for stocks within Citi’s Technology and Communications coverage, WiseTech Global shares experienced the largest percentage uptick while Domain Holdings and REA Group also outperformed.

Fineos Corp ((FCL)) suffered the largest percentage decline, with Megaport ((MP1)) not far behind. 

The broker factors in a $50m equity raise in the December half for Fineos, lowers its rating to Neutral (high risk) from Neutral and slashes its target to $1.39 from $2.50.  On the other hand, it’s felt the sell-off in Megaport shares is overdone.

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