Interactive Investor

Darktrace among UK tech stocks backed to flourish

11th January 2022 15:50

Graeme Evans from interactive investor

Wall Street’s army of tech stars grab all the headlines, but these UK-listed companies could generate big returns for investors, argues one City expert.

The valuation of Darktrace (LSE:DARK) continues to divide the City after the cyber security firm's fourth earnings upgrade since its April flotation sent shares up by as much as 20% today.

Analysts at Berenberg are backing the former FTSE 100-listed stock to return to the 1,000p level seen in September, whereas counterparts at Peel Hunt remain at 473p despite the company's better-than-expected second quarter performance.

Shares settled 9% or 35.2p higher at 430p, with Darktrace among a number from the tech sector to show a recovery after interest rate fears led to big selling in previous sessions.

The mood in London was helped by a positive note from investment bank Jefferies picking

Darktrace as well as Softcat (LSE:SCT), Micro Focus International (LSE:MCRO) and Computacenter (LSE:CCC) as the London-listed stocks best placed for digital transformation.

It noted that Gartner is forecasting an annual growth rate in global software spend of 12.2% in the five years up to 2025, prompting Jefferies to look for the best opportunities in the three categories spanning subscription, security and IT services.

Jefferies said: “Digital transformation has been an ongoing theme in the sector for the past five years. We see no signs of this abating and, in our view, the Covid-induced working-from-home environment has only strengthened and elongated the current demand cycle.”

Security is one of the fastest-growing sub-sectors, driven by a convergence of factors as working from home expands the surface attack area and makes systems much more vulnerable to increasingly sophisticated criminals.

Jefferies added: “The only security approaches that can protect against these unknowns are AI-driven platforms. We think Darktrace is well-positioned to capture this demand and it is our preferred way to play structural growth in security.”

Its confidence has been boosted by today's update, which showed that the company now expects a year-over-year increase in recurring revenues of between 37% and 38.5% compared with 34% to 36% forecast previously.

The company added 926 net new customers in the first half of the financial year, a rise of 40% and also 2% higher than Berenberg's most bullish scenario. The broker also noted the progress in monetising the existing and new customer base.

Berenberg referred to its own survey of businesses that showed 65% of Darktrace users are planning to spend more with the company.

It said: “Darktrace’s shares have clearly been caught in a web of misinformation, which we think today’s update and our survey will serve to break. We think the share price is unlikely to stay at current levels for long.”

Shares fell sharply in the autumn after Peel Hunt introduced a “sell” recommendation based on  what it believed was a disconnect between the valuation and the revenue opportunity.

The selling pressure was exacerbated when original private equity investors took advantage of the end of their lock-up period to offload some of their shareholdings at a profit.

The broker removed its “sell” recommendation after today's update but still remains cautious. Peel Hunt said: “Although we see these upgrades as positive, as flagged earlier, many investors were already expecting a beat and raise strategy.

“Given the share price has now approached our target price, we pause for breath and move from sell to hold.”

Jefferies, meanwhile, continues to have a target price of 800p on Darktrace.

Among its other recommendations in the sector, the City bank now rates Micro Focus International at 600p compared with 510p previously. Shares in the enterprise software company today rose 9% or 35.9p to 452.8p.

On Computacenter and Softcat, it said the stocks were among the lower risk ways of playing the rising tide of digital adoption.

Jefferies said: “IT services are enablers of digital transformation and are exposed to the underlying growth in the market. Importantly, we see them as technology and business model chameleons, which are not tied to specific technologies but can adapt to service client demand.”

Computacenter is valued by Jefferies at 4,100p compared with today's price of 2,736p, while FTSE 250-listed rival Softcat is rated at 2,310p against the current level of 1,649p. Both stocks rose by more than 2% today.

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