Interactive Investor

Stockwatch: could this new story underpin the market rally?

The revival of US flotations is another prop for a nascent bull market. Our companies analyst explains.

9th June 2020 11:13

Edmond Jackson from interactive investor

The revival of US flotations is another prop for a nascent bull market. Our companies analyst explains.

Sceptics would say, the rebound in US stocks – one again near to all-time highs – is chiefly due to stimulus from the Federal Reserve, as if once the market is hit with dire second-quarter company results this summer, an almighty reality check will follow. 

Yet, it is interesting to note how, by improving sentiment, the stimulus has revitalised flotations, which I suggest are a vital means of sustaining a bull market, now underway, with new stories.

The economist Professor Robert Schiller has written on how important stories are in financial markets, on crowd psychology. And you could say I’m one of various story-tellers around. When I look at stocks to write about, it’s not altogether about the value equation, I’m thinking how does this stack up as a story?

Success in my specialist activity could be described as creating a convincing and engaging read out of raw economic essentials and that is usable content for investors. So, I’m perhaps more alert than most to the supply of potential.

Flotations replenish a market desperate for new narratives

Stocks tending to perform well in a liquidity-fuelled market are, I suggest, going to be strongly about their story. The most dramatic recent example in the UK market has been the parabolic chart for Novacyt (LSE:NCYT) from February to early April, when its story of Covid-19 testing kits was perfect timing. I would say that the stock’s downtrend since then (which a non-executive director has just bought into) has nothing to do with fundamentals but the story losing freshness.

So, it is a very important feature in the last week or so, how American enterprise has led the world by introducing new stories, including the IPO market. You could say that it’s partly one reason why Wall Street is the global Pied Piper.

My pick of these US flotations – or to at least follow – is Shift4 Payments (NYSE:FOUR) which is a leader in secure payment processing. Not only does its story remind you of the hugely successful PayPal (NASDAQ:PYPL), it is clearly understandable and appealing – by way of orchestrating various payments you make, say in a leisure resort over a week, to one consolidated bill when you leave.

That makes total sense and Shift4 is global leader. As a story it’s A1, which is why it was able to price its shares at $23, above the expected range of $19 to $21, although the shares still opened at $33.10 on the first day of trading and closed at $35.15 on Day Two.

Source: TradingView. Past performance is not a guide to future performance.

For a company founded in 1999 now capitalised over $2.8 billion, yet posting annual losses (see income statements) of over $50 million (£40 million), it is no value stock. Yet for story selection, it is prime. I discuss further below. 

Also setting the flotations context, Warner Music Group (NASDAQ:WMG) has attained a $15.8 billion valuation after listing at $12.8 billion.

It does have established profits growth, being a global leader in its field, although we’re looking at 40x earnings and net gearing of around 400%, with hefty interest charges.

Those should reduce however after a £1.9 billion made it the biggest US flotation of 2020 so far. 
Am I cynical to assume a story involving music fashions will appeal more to liberals while conservatives are likely to identify security in a payments processor? We all have our biases. 

As a story, ZoomInfo Technologies (NASDAQ:ZI) has better appeal than Warner, although I can’t confidently say what extent of durable moat it may have for its “business intelligence solutions” – who knows when an even more attractive story might break?

It has raised $935 million, which should cut costs of its $1.2 billion debt, and has achieved a market cap of $17.1 billion with its stock at $44.69 after listing at $21. Clearly, its story is going down well in a context where tech-investors have been devoid of anything new, during Covid-19, in a context also of the Nasdaq market attaining record highs.

ZoomInfo operates a proprietary platform using artificial intelligence and machine learning – with a cloud-based solution. Despite a somewhat nebulous concept to grasp, potentially with others the blue sky, last year it doubled subscribers to 202,000. It’s definitely a stock to be aware of, if more likely to illustrate my point how new stories are adding another leg to the US bull market – and by implication, equities generally.

Strong rebound in US payments affirms a V-shaped recovery

Another reason I focus this flotations piece on Shift4 is what it tells us about the underlying US economy – which is music to Donald Trump and his re-election hopes, but also investors. The consensus of economists has been pretty gloomy, and many investors have dissed talk of a V-shaped recovery, yet Shift4 affirms this.

Serving over 200,000 businesses, its CEO said last Friday: “We have tons of data and started to see the recovery in late March through April, then really accelerate in May.” After payment volumes dropped 70-75% in late March they have rebounded 120% from that period”. This confirms to the most optimistic scenario outlined by economists at the start of the pandemic, where not only does the US rebound swiftly, but there is pent-up demand. 

Shift4’s evidence now begs the question of a short to medium-term scenario where spending in some areas of the economy could be even greater, like for like. You quite wonder whether government pay cheques, a feature of the UK besides US, are being applied not only to cut consumer debt (UK figures have cited a record £69 billion reduction in its £221 billion pike lately) but also squirrel funds for having a good time once restrictions ease. Few have been able to spend much more in the last two months or so, than on technology like a Netflix subscription or a new device.

What’s also remarkable from Shift4’s figures, is their deriving substantial business from the hospitality industry – which you would think is now poised for an upturn, along such “pent-up demand” logic. Shift4 handles payments for hotels, resorts, restaurants and the like: an attractive niche given leisure businesses often employ varied e-commerce software across their operations, enabling guests to check out with one bill.

Shift4 Payments, Inc   
Income statements   
$ million31/12/2018 31/12/2019
Total revenue560.6 731.4
Cost of revenue-410.2 -552.4
Gross profit150.4 179.9
Operating expenses-137.6 -181.3
Operating profit12.8 -2.3
Interest expense-47.0 -51.5
Other expenses-19.5 -2.8
Pre-tax profit-53.7 -56.6
Taxation-3.8 -1.5
Net income-49.9 -58.1
Earnings per share ($)-1.3 -0.8
EBITDA59.5 58.1

It also handles online bookings for Hilton Worldwide Holdings (NYSE:HLT) and many other Las Vegas businesses. Maybe it has benefited lately by adapting to help similarly agile restaurants provide curbside collections.

The customer base is very well-diversified, with none over 1% of payment volumes, and growth opportunities are perceived in speciality retail, or anywhere running varied software, like United Parcel Service Inc (NYSE:UPS). Processing fees linked to volume and appear highly recurring in the sense Shift4’s software is embedded and on multi-year contracts. So, although profits have yet to kick in, investors feel confident about top-line growth.

I would have preferred to see the $345 million raised being applied more specifically for investment objectives than debt reduction and “general corporate purposes,” yet Shift4 seems established on a growth curve that as a story triggers association with PayPal. The stock could ease once excitement abates, though on a 2-3 year view looks well positioned, so broadly: Buy.

Mind how liquidity is still distorting stock markets

Has central bank rigging of markets so comprehensively taken over from valuation to make a nonsense of historic comparisons? Already, analysts who confidently asserted that the stock market does not bottom until the latter stage of a recession, have been made to look fools.

The last US bull market peaked in February on 23.1x, the second-highest price/earnings (PE) multiple in history, and the latest  bear market has been the shortest bear market in history, ending with a multiple of 18.5x (based on historic profits). 

Moreover, GMO, the Boston-based asset manager led by Jeremy Grantham (originally of Doncaster) points out in its latest letter that the US market PE is in the top 10% of its history, while the US economy is in its worst 10%.

I find Grantham’s comparison a bit cute as Shift4 is now evidencing a strong rebound, but his caution is justified in the sense that to assume equities can hold their values implies mean-reversion has been abolished by central banks; that their actions will not ultimately meet with a reality check. 

I suggest one is still possible, akin to the “Fed taper tantrum” a few years ago, although the Fed had reverted to stimulus measures well before Covid-19 struck. But the economy and corporate fundamentals might be strong enough by then to absorb it.

The current lesson of 2020 is “follow liquidity”

Central banks have prompted speculation, buying interest-bearing assets and replacing them with cash. A pass-the-parcel game has ensued, replicating down the chain to smaller traders - witness high levels of turnover just lately in small-cap UK recovery stocks.

In such monetary context, flotations are perfect material to keep the show running – and the success of last week’s batch will encourage more. On this basis at least, the new bull market is gaining legs.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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