Tech stocks overheating
Tech stocks around the world are on a high. It is no different in Malaysia but can these stocks deliver in terms of earnings growth?
IT has been said that a tech stock bubble exists in the United States – a country long associated with dominance in the information technology (IT) sector.
With stock prices reaching new highs everyday, it’s not difficult to see why.
But some argue that US tech companies are now a different breed from the dotCom days of the late 1990s and early 2000s.
While there was a lot of euphoria surrounding that era, many tech companies now have consistent earnings growth to justify interest in their stocks.
Recall the likes of Cisco, Intel and Oracle which were at one time the darlings of investors.
They have largely been replaced by Facebook, Netflix, Apple and Alphabet.
In China, a country which is fast building a reputation for tech companies, Baidu, Alibaba and Tencent have also gained fame among global investors.
The business structure of the established tech companies of today is one that is asset-light, enabling them to scale up very fast, experts believe.
This also allows them to have an edge over their predecessors.
In July, the US S&P 500 technology sector broke the record it created in March 2000 – the peak of the dotCom bubble – lending support to this notion.
Even so the valuations of US tech companies are generally in line with the broader market, unlike in those days when the gap was wider.
Currently, most US tech stocks are trading at 19.4 times their 2017 earnings, while the S&P 500 is trading at 19 times price earnings (PE), according to July
Bloomberg data.
It is worth noting that there are exceptions.
Online shopping site Amazon. com is trading at a massive 248 times its current earnings.
Netflix, which provides streaming media and video-on-demand services, is trading at 218 times.
However, there are other top tech stocks which are trading at more realistic valuations which, in turn, keep the sector balanced.
Apple is trading at 18 times its current earnings, Facebook at 39.5 times and Alphabet at 30 times.
Presumably, it is for this reason that investors are not selling just yet.
The domestic scene
Can the same be said of Malaysian tech stocks, which have also been getting a lot of attention from investors?
In a market where the benchmark index has gained just slightly over 8% year-to-date, many of the tech and tech-related stocks have gone up at least two-fold over the same period.
Among the highest valued tech-related stock is GD Express Carrier Bhd (GDex), which is trading at a whopping PE of 100 times.
GDex’s major shareholder and chief executive officer (CEO) Teong Teck Lean often downplays discussions about his courier company’s valuations, preferring to focus on its growth opportunity as a key enabler amid the rise of e-commerce here.
GDex, which embraced technology in the early years of its business, has also managed to secure many big investors.
Singapore Post Ltd and Yamato Holdings Co Ltd had bought stakes in GDex on different occasions, once when the latter’s value was 50 times its earnings and when it was 70 times.
However, not everyone has remained positive about GDex’s prospects.
Kenanga Research says: “We believe foreseeable positives are already well priced-in at current levels with the share currently trading at 104 times forward PE.”
Kenanga has slashed its profit forecast for GDex by 13%-19% for the financial year 2018 (FY18) and FY19, as it expects margin pressure stemming from intense competition in the express delivery business.
“There is increasing competition in the industry with the entry of new players coupled with continued fight for market share among the established players,” it says in a report.
With the lower earnings forecast, the research house has also lowered its target price for the stock to 45 sen from 48 sen previously.
It last traded at 66 sen. Apart from GDex, there are many other listed tech companies that are trading at high PEs.
Notably, the higher the PE ratio, the higher the expectations of the investors in terms of earnings growth.
This begs the question – are the firms overvalued?
And if so, is it time to sell? As a market observer points out, it is logical to a certain extent, for a stock like Apple to trade at a PE that is lower than many Malaysian semiconductor players which are producing products and services for tech giants including the iPhone manufacturer.
Scarcity premium
Fortress Capital Asset Management director Geoffrey Ng says there is a “scarcity premium” ascribed to the domestic tech stocks.
In Malaysia, some investors are averse to tech stocks, as many are perceived to be small firms with unsustainable profits.
The perception is not surprising, considering that many tech firms have gone bust amid intense competition and the inability to retain workers.
Ironically, many ACE Market companies are in the tech space.
Tech companies should be evaluated on a stock-specific basis, says Ng, who tracks the sector.
“Many of the companies serve domestic or regional markets and therefore are niche players compared with global tech stocks.
“Many of the technology service providers that trade on Bursa Malaysia offer solutions in collaboration with international technology principals.
“Hence, their enterprise value depends less on the intangible value of the technology but more on the sustainability of their earnings model,” Ng adds.
On a global scale, he says that there is no tech bubble.
He believes that the global tech stock sector has become mature since the last bubble in 2000.
“We have seen growth from both the demand side namely users adopting technology on a daily basis using smartphones and the Internet of things (IoT).
“We have also witnessed the evolution of tech business models which emphasise more on sustainable earnings growth and assetlight balance sheets compared with those in the past dotCom bubble.”
Meanwhile, Danny Wong, CEO of Areca Capital, believes that “a bubble is building up” for global tech stocks.
“No one knows when it will become too big to manage. The tech stocks need to show real earnings to justify the upbeat expectations,” he says.
On the local front, Wong, who manages over RM700mil in funds, points out that valuations are not “too much of a concern”, specifically for the semiconductor players.
“Most of them are enjoying actual capacity expansion effects (real earnings growth) and are not selling future growth stories,” Wong says, adding that the semiconductor firms are “genuinely boosted by orders.”
Rakuten Trade research vice-president Vincent Lau opines that the local semiconductor companies, which are part of the larger IT ecosystem, are “not cheap”.
“Although they are not cheap, we believe they still have some legs to run,” he says.
Lau says the upcoming launch of a new iPhone model, as well as the continuous rally of the so-called Fang – Facebook, Amazon, Netflix and Google (now Alphabet) – stocks, will continue to fuel the current tech stock movement around the world.
He points out that changes within the automotive industry, like the development of new technologies where cars are becoming “connected” to the Internet, have been one of the drivers of the increasing demand for microchips.
According to the World Semiconductor Trade Statistics organisation, global economic recovery is set to drive semiconductor sales this year, with the Asia-Pacific region expected to record a 12.4% growth.
It says that the global semiconductor industry is on track for another record-breaking year in 2017, after recording all-time high sales worth US$339bil in 2016.
In a sweet spot
Like many local semiconductor players, JF Technology Bhd is involved in the design and manufacture of test probes and test sockets for the semiconductor industry. The company, however, is trading at a PE of 38 times. Is this justified?
According to the company’s chairman and managing director Datuk Foong Wei Kuong, the demand for microchips is no longer dependent on smartphone and computer sales.
“Previously, the semiconductor business was cyclical but today, there is emerging demand for microchips from the automotive and IoT sectors,” he says.
IoT has been hailed as the next big digital revolution, connecting millions of everyday objects using inexpensive microsensors so that things like thermostats, cars, door locks and even pet trackers have network connectivity.
Foong reckons that the company is in a sweet spot as a testing equipment manufacturer within the semiconductor sector.
“A microchip is like a car which needs to change its tyres every now and then. Test equipment for these microchips, which we design and produce, are generally wear-and-tear products,” he says.
JF Technology generated a 32% profit margin for its fourth quarter ended June 30.
For Systech Bhd, which makes proprietary and franchise IT solutions for multilevel marketing companies, earnings growth is sustainable, as the company is banking on a new segment – cyber security.
Founder and CEO Raymond Tan believes that his company, which stock trades at over 50 times its current earnings, will continue to see a rise in profits, therefore justifying its high PE.
He says cyber security has become increasingly important not only for banks but also the corporate sector domestically and internationally.
“I don’t think we are expensive even though our PE is 50 times, because we will continue to deliver profits,” he says.
Systech, which has been in the business of IT solutions for more than a decade and has a 30% local market share plans to tap new and existing customers for its cyber
security business.
The company, which will monitor the traffic on networks of firms which hire it and raise the red flag if it detects anything “suspicious”, is in a net cash position and has been paying dividends to its shareholders on a regular basis.
Systech took over the listing status of beleaguered Viztel Solutions Bhd in 2011 and has been more aggressive in sealing its position within the IT sector since then.
Promising trends
In its report last month, UOB Kay Hian said it was positive on the prospects of the Malaysian technology sector. “Homegrown companies have been raising their capabilities and diversity in product and service offerings in the past few years, and will ride on the upcoming trends of proliferation of laser light applications, popularisation of industrial automation, evolution of the automobile sector, and other promising trends.”
The house, which has an “overweight” recommendation on the sector, has a “buy” for Globetronics Technology Bhd because of the “strong comeback of its sensor segment that provides revenue visibility.”
It is also upbeat on Inari Amertron Bhd and ViTrox Corp Bhd “for their near-term earnings growth and longterm prospects, although the current valuations have largely factored in the foreseeable prospects.”
Nevertheless, investors ought to tread with caution.
The Malaysian stock market is already trading at a higher value of 16.7 times earnings compared with, for example, Singapore’s 11.5 times. Many local tech stocks are trading at even higher values.
The jury is still out on whether these companies can deliver on their profit projections.