Tony featherstone: two tech stocks i like

Was the sell-off in tech stocks the start of a larger correction or a buying opportunity?

If only it was that simple. The tech industry has terrific prospects, but I wouldn’t aggressively “buy the sector” now. Selective buying of quality tech stocks is key.

There are times for momentum-based sector ideas. Now is not one of them because the sector ran too far, too fast in the past six months.

The time to buy was in March, when I nominated tech as my preferred sector during COVID-19. Over several columns, I nominated tech Exchange Traded Funds (ETF) and local stars such as Xero, WiseTech Global, Altium and JB Hi-Fi (a tech retailer).

In Australia, the S&P/ASX All Technology Index is up 93% from its March low. The US Nasdaq 100 Index is up around 60%, despite heavy falls this month.

Investors who piled into technology ETFs during the March meltdown have done well.  Those who buy tech ETFs now in anticipation of similar gains will be disappointed.

It could take time for the Nasdaq 100 to reclaim its previous high. The US Presidential election in November is a headwind and economic and pandemic risks abound.

But for all the recent gloom, the Nasdaq is back to where it traded in mid-August. If a 10% sell-off is the worst of it after stratospheric gains this year, investors should be relieved.

Still, I wouldn’t be buying tech ETFs during this sell-off, in anticipation of tech indices quickly recovering lost ground and scooting to new heights. Tech valuation risks are too high.

I would, however, use the sell-off to identify tech companies that are key beneficiaries of disruption and are well down from their high. Rigorous bottom-up company selection is always better than top-down analysis, and especially so in the elevated tech sector.

The long term outlook for technology is better than ever. Disruption is just starting in many sectors; megatrends such as e-commerce, cloud computing, software-as-service and semiconductors have years of faster growth ahead as COVID-19 forces business, government and consumers to up their tech usage.

Then there’s 5G, which will spawn a new wave of disruptors (probably in machine-to-machine communication), just as 4G was the catalyst for Uber, Snapchat and others.

Clearly, investors need higher portfolio exposure to Australian and international companies that are driving disruption or benefiting from it. Adding quality technology companies during a sell-off is one way to achieve it. Here are two to consider:

1. Pushpay Holdings (PPH)

I nominated the digital-donations company as a stock to sell (near $4) in June 2018 after a co-founder in the company sold his stake. Pushpay steadily drifted lower over the next 18 months, slumping below $3 in March 2020. From there, it soared to $8.76 and now trades at $6.87.

Pushpay is an unusual stock on ASX. The New Zealand-based company develops payment technology for churches, schools and charities. Church parishioners, for example, use Pushpay software to donate money rather than putting it in a plate at mass.

E-tithing is big business. Pushpay has almost 11,000 customers in 19 countries. The company processed US$5bn of transactions in FY20, up 39% on the year. Pushpay’s revenue grew 32% to almost US$130 million in FY20.

Bible Belt churches in southern US states are embracing “e-collection plates”. Tithing technology encourages higher and more frequent donations from parishioners, and provides data and insights that churches use to better understand their congregation.

Parishioners, particularly younger ones who carry less cash or none at all, prefer digital donations. They can donate on the spot through their smartphone or sign up to a regular tithing plan. This smart technology solves a problem for cash-strapped churches.

COVID-19 is increasing demand for digital donations as face-to-face church services in many countries are suspended. Anecdotally, some US churches have abandoned their traditional offering plate because passing it among parishioners has health risks.

Also, tithing technology is helping churches stay in contact with parishioners who may be attending services online – and maintain donations that are no longer possible through physical collection plates.

COVID-19 has interesting implications for Pushpay. I wonder if e-attendance at church will become the norm for some people, particularly those who struggle to attend mass each week because of time, health or child-minding constraints.

Granted, it’s a sensitive conversation. For many parishioners, online church will never substitute for the real thing. My guess is that churches that are dying because of a lack of young parishioners might find they have a much larger online audience. Just as young people attend university online, some might prefer to worship that way.

Regardless, COVID-19 will limit the appeal of large gatherings at mass, at least in the next year or two, and quicken the move to digital donations. Pushpay looks like it is in a sweet spot.

After a huge rally, Pushpay has fallen from a 52-week high of $9.09 to $6.87. A sell-down by a major backer of the company in July spooked the market, but who can blame key investors for taking some profits after the stock more than doubled in a few months?

Religion aside, Pushpay is a software-as-a-service company with a first-mover advantage in a growing global market. Key risks include megachurches developing their own tithing technology to replace intermediaries, although I can’t see that happening in a hurry.

After recent falls, Pushpay warrants a spot on watchlists. If the global tech sell-off lingers, the software company would be a useful portfolio addition.

From a technical-analysis perspective, Pushpay needs to stay above $6.80, a point of previous price support.

Chart 1: Pushpay Holdings (PPH)

Source: ASX

2. Audinate Group (AD8)

Like Pushpay, Audinate soared off its March low, but has retreated in recent months. From $6.90 in early June, it trades at $5.31.

Manufacturers use Audinate chips, modules, cards and software in their audio and video products. Key customers include Bose, Yamaha, Bosch, Sony and Sennheiser.

Audinate fell after its FY20 profit release in August. Revenue dropped in May due to COVID-19. Management said the impact of the Coronavirus on sales was hard to predict, adding that second quarter (calendar year) growth was below that required for revenue growth in FY21.

Flat revenue growth is a deal breaker in emerging tech companies. After more than doubling from its 52-week low, the market needs Audinate to justify its rapid share price gains.

For all the short term pain, Audinate is a leading supplier in a global market. The company notes independent forecasts showing Audio-over-an-IP (AoIP) volumes will triple over 2020-24.

As more people work, learn and play at home, it’s a good bet they’ll spend extra on microphones, speakers, amplifiers and other audio equipment that has Audinate tech. (Coincidentally, I’ve been thinking of buying new computer speakers due to an increase in Zoom and Microsoft Teams meetings – and my need for better audio to support note taking).

Digital networking for work and study is just starting. More employees will collaborate in digital teams; university students will increasingly work in online teams; and many families will communicate through online video platforms, having used Zoom during the pandemic.

These trends will drive higher long term demand for audio and visual equipment, and technology that powers it. Audinate looks well placed to benefit.

Like other successful tech developers, Audinate has high margins and a high proportion of repeat customer orders. The company has extensive intellectual property, a bluechip global customer base and $68 million in cash on the balance sheet after an equity capital raising.

My sense is the market will want confirmation that the worst of COVID-19’s impact on Audinate sales has passed and that the tentative sales recovery in June and July is strengthening. Until then, Audinate shares could drift sideways or head lower if the global tech stock sell-off continues.

That could be a buying opportunity for long term investors who understand the risks of investing in small-cap tech companies.

Audinate has plenty of near-term challenges due to COVID-19, but networked digital connectivity continues to replace traditional point-to-point analogue cabling in the AV industry, and software-based AV systems are replacing hardware AV systems.

These are significant tailwinds for Audinate when COVID-19 noise eases.

Chart 2: Audinate (AD8)

Source: ASX