Three tech-savvy firms to watch

In his FTSE Sector Watch column, interactive investor's head of markets finds niche players in a sector that looks set for expansion.

Occasionally stocks are not necessarily where you might expect to find them, and the software and computer services sector is one such example, comprising just four stocks.

AVEVA (LSE:AVV) (not to be confused with insurance company Aviva (LSE:AV.), which is not only also in the FTSE 100 but next on the alphabetical list) and Sage Group (LSE:SGE) can be loosely grouped together.

Equally, the other two shares have similarities – listing platforms Rightmove (LSE:RMV) and Auto Trader (LSE:AUTO) are the websites, indeed, marketplaces, of choice in their respective fields.

As defined by the London Stock Exchange (we are limiting the scope of this article to the FTSE 100), the sector comprises the following companies.

Auto Trader Group operates the UK’s largest digital automotive marketplace. The company is engaged in connecting car buyers to car sellers by offering a broad range of vehicles accessed by a powerful search capability. The brand has been established for over 40 years, and has built a network of highly engaged consumers searching over 450,000 cars from a diverse retailer base. In 2013, it successfully completed the transition from a print title and became a fully digital marketplace.

Aveva Group provides engineering design, information management and software solutions for oil and gas, marine, power, petrochemical and chemical, and other markets such as AEC fabrication, paper and pulp, mining and pharmaceuticals. It describes itself as a “global leader”.

Moreover, its engineering, planning and operations, asset performance, and monitoring and control solutions service over 16,000 customers across the globe.

Rightmove operates in the UK residential and commercial property industry, connecting people to properties.Its activities include resale and lettings property, to new home developers and housing associations. It claims to be the UK’s number one property portal and the UK’s largest property marketplace. The firm says it has “strong network effects, as our property audience and the properties our customers advertise create a ‘virtuous circle’.”

Sage Group is a global supplier of accounting, payroll and business management software. It serves medium-sized and smaller businesses in the areas of accounting, enterprise resource planning, payroll, and accountancy related software. The company claims that it provides “everything your business needs to manage accounting and financials, operations, people, payroll, and payments. We have solutions for businesses of any size, complexity and industry.”

It is notable that there are only four stocks in this sector, given that investors tend automatically to turn to the US when thinking of investing in technology shares. And with some reason; the likes of Apple (NASDAQ:AAPL), Alphabet (NASDAQ:GOOGL), Facebook (NASDAQ:FB) and Amazon (NASDAQ:AMZN) have grown into major social influencers, with share price performances to match. At the time of writing, over the last five years Apple shares had jumped 140%, Alphabet 155%, Facebook 161% and Amazon an astonishing 466%.

This is a far cry from the late 1990s where, leading up to the dotcom bubble and bust, there were close to a dozen TMT (technology, media and telecom) shares within the FTSE 100. More recently, ARM Holdings was a UK success story until it was acquired by SoftBank of Japan in 2016 for £24 billion.

Tale of the tape

Source: Digital Look, as at 3 January 2020

UK aiming to up the ante in technology

UK technology stocks tend to be more niche, and as such can be found dotted around the lower reaches of the market by value. But this may change over time as the UK attempts to energise its technology offering.

The recent 2019 Tech Nation report stated that globally, high-growth digital tech firms raised more than £245 billion over the four years to 2018. Of the global total, 5.2% was raised by firms in the UK, while US tech scale-ups raised £120.9 billion – 49.3% of the global total –and Chinese scale-ups raised £49.9 billion, 20.4% of the global total.

While the UK therefore remains some way off the pace in terms of size, it is nonetheless growing, and is also looking to promote some sector specialism tie-ups, such as the fact that Cambridge and London are aligned with Tokyo, Moscow, Beijing and Boston for ‘adtech’ investment.

Meanwhile, the online platform sellers as represented by Auto Trader and Rightmove are in strong positions within their markets. They both benefit from powerful ‘network effects’ whereby buyers are attracted to the websites with most listings, as are sellers who pay for the privilege. Equally, this momentum means that they do not require larger marketing spends in order to attract new third parties to use their sites, since they are already embedded as the ‘go to’ platforms.

Of course, this also means that new entrants have a relatively low barrier to entry if the site is entirely digital, particularly if they can enter the market with lower fees, for example. This is the kind of disruptive behaviour in which the likes of Amazon could excel.

Indeed, the performance of all four shares in this sector has been impressive over the last year, to the extent that most are seen as being up with events for now. Note that such growth shares often carry a lower dividend yield, as they tend to plough profits back into the business.

Three stocks to watch

Auto Trader: the company’s powerful position within its sector ratchets up the pressure on its competitors due to its pricing power. At the same time, the company generates significant amounts of cash partly due to its cost-effective online nature. The operating profit margin stands somewhere around a whopping 70%, so the company has clearly capitalised on its dominant position. Its joint venture with Cox Automotive in the form of the new ‘Dealer Auction’ seems promising.

This unbridled success unfortunately leads to some question marks over the immediate future. In its own guidance, the company has highlighted that operating costs will increase, that the income from the manufacturers’ side of the business will decrease, and that generally new and used car sales are starting to show some signs of slowing.

As such, the stock is potentially at a crossroads. The company is attempting to manage down expectations and the general view of the shares is that the price is up with events, with the market consensus currently standing at a hold.

Aveva: Aveva’s meteoric share price rise (104% over the last year) resulted in its promotion to the FTSE 100 in June 2019. The Cambridge based group hasn’t looked back since 2018’s transformative tie-up with part of France’s Schneider Electric (it took a 60% stake in Aveva) increased the company’s presence in the key North American market and  reduced dependency on the cyclical oil and gas sector.

Aveva, a specialist in engineering design and 3D visualisation, is benefiting from serving industries at the early stages of their digitalisation growth curve, with the increasing use of technology reflecting the need to reduce both capital and operating costs. The industrial internet-of-things, data visualisation and artificial intelligence are among potential solutions. By combining with Schneider, it now has a much broader revenues mix through Schneider’s specialisms in food, beverages and pharmaceuticals. The market consensus on the shares is now a strong hold.

Rightmove: the company was created in 2000 as a joint venture between four of the UK’s largest property agents: Halifax, Countrywide, Royal & Sun Alliance, and Connells. Rightmove retains first-mover advantage, and the popularity of its website is proving difficult for competitors to catch, let alone overtake. Advertising for estate agents has shifted increasingly online, with adfees rather than housing sale numbers a key measure of success. Predictable cash flows reflect the subscription nature of the business, coupled with low working capital requirements.The company’s profit margin is around an impressive level of 50%.

For investors, as is often the case with online businesses, the correct valuation of the business is a tough call. A one-year forward price/earnings (PE) ratio broadly in line with the 10-year average offers little guidance. Housing market sentiment and the outcome of Brexit will dictate near-term prospects. The current market view of the shares is a sell.

Richard Hunter is head of markets at interactive investor, Money Observer’s parent company.

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