MoneyTalks: Beaten-down tech stocks could reward the patient investor in ’23

MoneyTalks is Stockhead’s regular drill down into what stocks investors are looking at right now. We’ll tap our extensive list of experts to hear what’s hot, their top picks, and what they’re looking out for.

Today we hear from Equitable Investors director Martin Pretty.

What’s hot right now?

Pretty says there’s a case for arguing that what is hot “right now” is simply whatever was not hot before Christmas.

“This has been quantified in the US, where the worst 10 per cent of S&P 500 stocks have led the market in early 2023 with a 10 per cent gain, using Bespoke Investment Group’s analysis,” he explains.

In the area of ASX small cap stocks (ex-resources), Pretty says the bottom 10 per cent of companies by returns from the past 12 months have outperformed early in 2023, averaging a 3.2 per cent gain compared to a 2.1 per cent move for the top decile from 2022 and 2.1 per cent for the middle third of stocks.

And there are a few reasons that can be attributed to this phenomenon, he says.

“A fresh and optimistic approach to stocks with the New Year; investors searching for “value” lying on the battlefield that was 2022 and a continuing revival of the market’s almost-forgotten use of traditional valuation metrics that still look difficult to justify for some of the stocks that did not take a dive in 2022,” he says.

“But at the smaller end, where liquidity has diminished significantly (the value of trade in S&P/ASX Emerging Companies stocks fell 41 per cent year-on-year in the December quarter), it doesn’t necessarily take much for prices to jump either way on a small shift in demand.

“We would not presume to make a bold assumption about whether the trend will be sustained in the short-term or not in a contradictory market environment like the one we are presented with today where large cap stocks trading like interest rate rises are just about over while the housing market is knuckling down for rising rates and gold trading up like the global economy is in trouble while demand-sensitive oil is also up.”

Here are some of the beaten-down stocks from 2022 Equitable Investors has an interest in and think will stand on operating performance and valuation grounds over time.

Top picks

VEEM (ASX:VEE)

VEE is a WA-based marine propulsion and stabilisation systems maker who has seen its market cap drop from around $130m at the end of CY2021.

“VEEM’s current business is really centred around marine vessels, with a focus on propellers and gyroscopic stabilisers (gyros), which brings it into the realm of defence work as well, with Australia’s submarines being serviced out of WA,” Pretty explains.

“Beyond the negativity from the broader market, the decline in market value for VEE has really been about the gyro opportunity being slow to kick into gear, along with cost inflation.

“Revenue in FY22 of $54.2m was down 9 per cent on FY21 and dragged EBITDA down 30 per cent to $6.1m.”

At its AGM in late November, the company said key propulsion customers were forecasting continued high demand and many boat yards booked out to 2023-24.

“Its gyro business was expected to see stronger sales in FY23 with a “strong level of quality leads and enquiries” – overall, the company was expecting its half-year earnings to return to traditionally higher levels,” Pretty adds.

PROPHECY INTERNATIONAL (ASX:PRO)

Adelaide-based software developer Prophecy International had a market cap of $95m at the end of calendar 2021 and has slid back all the way to $44m currently – even as its annualised recurring revenue (ARR) surged 71pc over the previous financial year, Pretty says.

“A material portion of that $44 million is reflective of cash in the bank – just under $12 million.

“Across its two key lines of software, PRO had ARR of $19.4m as at September 30, 2022 (up 5.4 per cent since June 30) – the cash and ARR figures alone start to make PRO look very interesting to us.”

PRO has two silos – snare cybersecurity software was originally designed to meet the needs of Australian-based intelligence agencies and logs network activity, isolating security events that may be of interest and eMite is a business analytics tool for contact centres that pulls siloed data into one place and turns it into real-time, out-of-the-box reports to track contact centre performance.

“Snare generated $7.4m revenue last financial year but has only recently begun transitioning to subscription pricing rather than the old perpetual software licence model,” Pretty says.

“That meant segment sales in the most recent September quarter were down 43% year-on-year – yet with 83 per cent of new Snare customers selecting the subscription pricing, it should be contributing to ARR growth more than it has in the past.”

8common (ASX:8CO)

Expense management software company 8common saw its market cap drift to $22m from $40m at the end of calendar 2021 while it continued to make headway with the roll-out of its “whole-of-government” opportunity.

It also commissioned the first customer of its CardHero debit cards that integrates a Mastercard with its expense management software.

In its last quarterly, Pretty says 8CO reported 43pc year-on-year revenue growth to $1.6m for the three months to September, with a 7pc lift in users and a 21pc lift in average revenue per user.

“It burned $470,000 and held $2.5m cash,” Pretty says.

“Back in August 2021, 8CO’s Expense8 expense management software solution was mandated as part of “GovERP”, a project to standardise software across federal departments.”

More than 90 Commonwealth agencies with upwards of 130,000 employees participating in the shared services program would offer Expense8 and another 89 agencies could opt in.

“This meant 8CO would add around 110,000 users – but it wouldn’t happen overnight,” he says.

“Just before Christmas 2022, 8CO announced the latest incremental step in picking up these government customers – a $2.1m contract for 5,400 users.

“That brought the total value of contracts under the GovERP program past $4.0m with further agencies to be onboarded under the GovERP agreement during the remainder of FY23 and into FY24.”

The views, information, or opinions expressed in the interviews in this article are solely those of the interviewee and do not represent the views of Stockhead.

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