Technology stocks are once again on the march as the cost savings of the past few years begins to pay off and merger mania sets in. James Crux surveys the sector and identifies six stocks to watch.
Technology and software stocks have been one of the prime beneficiaries of the recent stock market surge. The techMARK 100 'index', the main measure of health for this once-buoyant sector, has surged 38 per cent since its March nadir. The techMARK All-share hasn't been quite so racy, but even it has posted an encouraging gain.
The reasons for the resurgence are many and varied. The big telecoms companies have led the way by reassessing their asset bases, restructuring their internal organisations and focussing on cash generation and debt management.
In the software sector – especially amongst the smallcaps – a wave of consolidation has been the main spur to growth, particulary amongst those engaged in management and accountancy software. The likes of Systems Union, CodaScisys and Touchstone have successfully subsumed rivals and look set to continue on the acquisition path.
XKO chief executive Simon Beart, whose business has also been on the acquisition trail, recently claimed that most of the mid-market software players (those companies sandwiched between giants such as Sage at the bottom and SAP and Oracle at the top) may not be around in around four years.
Away from the software consolidation sphere, other factors are cheering followers. One is the rise in government spending in this arena. Another is the increase in corporate spending. Although large corporates aren't implementing fundamental IT changes and upgrades, they are spending in certain specialist areas while the raft of mergers in the financial sector has provided a boon for those engaged in IT integration, consultancy and hardware.
Like many analysts in this area, Evolution Beeson Gregory's Lorne Daniel has a cautiously positive view on the future prospects for growth
Says Daniel: 'the sector [rating] is about 14 times, which is not cheap for the market as a whole but does reflect the growth potential of many businesses, especially software. Since the Millennium there's been a delay in the purchasing of new systems, but people need to spend money because it's the backbone of their business. Companies can't hold off forever and you will see spending in the next couple of years'.
However he cautions that 'You'll have to pick companies with products and services that will be needed'.
XKO eyes pre-exceptional profits
One exciting software venture is XKO, an outfit roughly evenly divided between supplying software/e-business applications and related infrastructure services. The group recently delivered another pre-tax line seemingly marred by losses of £545,000 in the year to March, as turnover improved from £38.9 million to £43.6 million. But note that operational profits showed a strong jump from £2.1 million to £2.6 million. Net cash inflow from operations was even better, rising from £1.9 million to £2.9 million as XKO continued to improve its overall performance in what chief executive Simon Beart acknowledged were very difficult conditions. 'Following the £2.6 million acquisition of Aran, we incurred exceptional costs mostly related to redundancies. This restructuring – and the writing-off of the goodwill associated with our acquisitions – is why the pre-tax line is not in the black.'
When XKO restructures these businesses, they usually pay for themselves within two years. It has annual contracted revenues of £15 million from an installed client base of 1,100. For the current year, it is expected to hit pre-exceptional profits of £3.2 million and earnings of 8.9p from sales of £48 million. At 57.5p a share, the forward rating is an appetising 6.5 times.
I-documentsystems — shaping up nicely
I-documentsystems supplies local councils with software and information systems. Sales rose by 64 per cent to £1.9 million in the half to 30 April and losses narrowed to £459,000 from £559,000. Andrew Fraser, chief executive, says growth will continue because the company has relationships with a core of the UK's 468 councils and can try and win business off other departments within each local authority. Another good factor is the Government's push to make e-commerce widely available across the public sector by 2005.
Research house Hardman & Co predicts losses will halve in the full year to £760,000, before a £560,000 profit is made in 2004. This gives 0.4p of earnings per share, putting the stock on a p/e of 27.5 for that year. Admittedly, the shares are not cheap, but they could provide steady growth and deserve greater interest. Analyst Andrea Kirkby says the company is 'doing well out of its local authority niche and there will certainly be a good flow of business up to the 2005 deadline for e-government.'
X-ray tool firm Bede bouncing back
Bede designs and makes X-ray analytical tools. Its depressed shares, knocked back from a 52-week high of 124p, bounced nearly 14 per cent higher to 18.5p on news of a share placing to bolster its £1 million cash pile. The company has also reported an improved order intake and narrower losses of £1 million for the first quarter to March, against £1.3 million for the previous quarter. Bede is raising about £3.65 million at 14.75p a share to cope with the expected upswing in demand for its products and to strengthen its sales force.
All this upbeat news follows the award of three orders worth more than $750,000 combined from Taiwan for its D1 X-ray tool. This is a 'high resolution diffractometer' that is used in industrial, university and government research laboratories. In layman's terms, it is able to examine the arrangement of atoms in a material. This is important because to work efficiently, a semiconductors' atoms have to line up in a very certain way – so the tool determines how well a semiconductor is going to work.
A short while back Bede cautioned trading remained difficult, but it appears market demand is returning. In 2002 Bede rolled out wider losses of £3.6 million (£400,000) as sales waned from £6.6 million to £5.9 million. This year Evolution Beeson Gregory analyst Robert Lea envisages adjusted pre-tax losses falling to £3.1 million on flat sales, then narrowing to £1.8 million on £8.9 million of turnover for 2004. 'Whilst the rest of the technology market has rallied, Bede's shares have yet to gain significantly' Lea recently mused. 'Trading is not yet out of the woods but we continue to think the risks are discounted at the current price'.
Medical device stock to mark up
Punters with a 'who dares wins' attitude might like to dabble in the fascinating milieu of medical device stocks. One of the few ventures to brave the new issues market last year, Corin is the revered reconstructive orthopaedic device manufacturer that chimed in with exceptional 2002 numbers back in April. Profits powered ahead 62 per cent to £2.8 million, earnings rose 56 per cent to 5p a share, on sales 23 per cent healthier at £17.3 million — with particularly strong sales surges in the USA and Europe. Sales were lifted by 17 per cent to £6.24 million in the UK, well ahead of market growth, and sales of its key Cormet and Rotaglide+ products grew faster than the market as a whole. Cormet is a metal-on-metal product for hip replacement, whilst Rotaglide+ is a knee replacement device offering the patient greater mobility.
Intriguingly, Alphanorm, bought for C3.9 million in September, gives Corin a direct distribution network in Germany, which is Europe's biggest orthopaedic market, and has highly complementary products. And there's plenty left to play for in an £11 billion worldwide orthopaedic market growing at more than ten per cent a year. For 2003, Evolution Beeson Gregory envisages pre-tax profits of £4.6 million on £23.8 million of sales, with earnings coming in at 7.6p a share. With the shares at 146.5p, the stock is trading on 19.3 times forecast earnings. But Corin has excellent growth prospects.
Turnaround Toad hopping forwards
Vehicle technology group Toad recently reached a new 52-week high of 10.25p. It has three exciting core businesses. Its services arm is the UK's leading mobile audio, security and multimedia installation provider to insurance, fleet and retail companies. It has a distribution division made up of Toad Audio Express, a car audio wholesale operator, and VTD, which is one of the UK's main vehicle security businesses. The division also encompasses a motorcycle security business and M3, a range of in-car multi-media systems. On top of all this Toad has a telematics business selling its Actra web-based fleet management and remote diagnostics products.
In calendar 2002 Toad hopped from losses of £1.07 million to a £220,000 net profit, as the benefits of a wholesale restructuring came through in fine fashion. 'Toad is throwing off cash like crazy,' insists Seymour Pierce analyst John Beddoe. He points out that the group's future growth should come from the services division, as Toad adds insurance replacement of lost and stolen cameras and computers to the vehicle audio equipment reinstatement market it currently serves. The new Actra telematics business could prove lucrative. It addresses an attractive niche market with solid growth prospects. For the current year, Beddoe has pencilled in profits of £950,000 giving an earnings figure of 1.28p, and a budget forward rating of 7 times. Savvy investors should hop on board.
First deserves more
On a second hand rating but possessing first class technology is crash test dummies firm First Technology. Its share price crashed last September after it warned of a slowing US market. After gaining some of the lost ground, they were marked lower on a drop in full year profits to April 2003 from £28.7 million to £25.5 million. But this figure still beat analysts' expectations, and the company enjoys healthy profit margins and strong cash generation. Though it has 'gas sensing' and 'automotive and special products' divisions, the company is best known for its 'safety and analysis' arm, which is the crash test dummies side. It enjoyed a record year with sales up 24 per cent in US dollar terms. The automotive safety and analysis market saw a buoyant year in all three major markets – Japan, Europe and the US – driven by rising side impact dummy crash testing, consumer vehicle rating programmes and more regulatory standard upgrades. The division should see more growth as regulators lay down yet more rules in the field of crash testing. With the shares down at 234p, against a 52-week high of 451p, the stock trades on just 10 times forecast earnings for 2004. Worth buying.
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