Just because a company’s share price rises strongly doesn’t mean it no longer represents ‘good value’. It could still be ‘cheap’ if its value outstrips its share price rise. Take Altium (ASX:ALU), for example, which just reported exceptional results for FY16, and forecast a very rosy FY17. Altium’s share price rocketed to an all-time high, but we think the company might still be one of the best value propositions on the ASX.
Financial newspapers are riddled, at this time of year, with columns dedicated to the analysis of reporting season – that period of a couple of months when a majority of Australian listed companies reveal their performances for the year.
Whether a particular sector did better, in aggregate, than another or whether there were more earnings ‘surprises’ than usual however matters little to you and me.
What we all care about is whether any high quality businesses have fallen into the basket we call ‘good value’. Many investors incorrectly believe that good value is only offered when the share prices of high quality businesses decline. It is true that in a broad market sell-off – something I believe we will all witness within the next few years – many businesses become ‘cheap’. But it is also true that when a business announces a result that improves its estimated valuation, it is possible that even though its share price rises, it could become cheap if its value rises by more than the magnitude of the share price rise.
In other words, even though the share price is higher than it was prior to the result, the shares are actually now cheaper.
During reporting season several companies we own in both The Montgomery Fund and The Montgomery [Private] Fund reported results that can only be described as exceptional. These include media monitoring and content provider Isentia (ASX:ISD), medical device maker Sirtex (ASX:SRX) and printed circuit board (PCB) design software distributor Altium (ASX:ALU).
In each case share prices surged following their underlying company’s respective results. In the case of ISentia, the shares have rallied 26 per cent in three days from $3.08 to $3.81. In the case of Sirtex, 14 per cent from $30.60 to $35.00, and for Altium, 32 per cent from $7.25 to $9.57.
Many investors could be forgiven for believing that the shares of these companies are now expensive. Sentiment towards affordability changes, however, when one appreciates that the underlying or intrinsic value of the business may have also increased and perhaps by more than the share price.
As an aside, this discussion reminds me of the political narrative around Australia’s debt position and the Liberal National Party’s philosophical objection to borrowing: in the absence of any discussion about the assets that might be purchased with, and funded by, the debt, fears about debt are misplaced or at least uninformed. Borrowing billions at 2 per cent to build an asset that generates cash, and can raise the price of its produce or service by at least CPI, not only benefits from being positively geared but also from an increasing valuation of the underlying asset over time.
In the case of Altium we believe while the share price has risen to circa $9.50, we believe the intrinsic value has risen to more than $12.00. And when the overall market is expensive, rendering it difficult to uncover much value, talking a little about Altium might just be worthwhile.
Altium produces software used by electrical engineers to design printed circuit boards (PCBs).
A PCB supports and electrically connects electronic components, such as capacitors, resistors or active devices, using conductive tracks and pads etched from copper sheets and laminated onto a non-conductive surface.
Printed circuit boards are used in all but the simplest electronic products because manufacturing circuits with PCBs is cheaper and faster as wiring errors are eliminated, and components are mounted and wired into a single part.
Altium currently enjoys a relatively small market share in the teens but revenue growth projections, compared to the growth of the market, suggest market gains will be impressive. More specifically, the firm has been growing by displacing dominant player Mentor Graphics PADs software with mid-sized PCB customers who represent the bulk of customers.
Altium’s customer base tends to ‘rust on’ because the costs (both in time and money) of switching to a competitor’s product is relatively high. Altium is leveraging this characteristic by transitioning its revenue model to subscription-based. Over time, we anticipate subs to dominate the firm’s revenues, providing a predictable annuity revenue stream.
Speaking of revenue, ALU reported growth of 17 per cent to US$93. Net profit after tax of US$23m was up 51 per cent over the year and while it was boosted by a lower effective tax rate of 6.5 per cent for the year compared to 29.5 per cent in FY15, pre tax EBITDA of US$27.4m was still up 21 per cent.
While revenues were impacted by currency translations, the number of Altium Designer licenses sold increased 20 per cent to 5,180 seats and the number of subscribers to the Altium Subscription product increased 11 per cent. Excluding acquisitions total costs grew by just 6 per cent.
Many analysts would have picked up that the EBITDA profit margin increased to just over 29 per cent from 28 in the prior year but what many should be aware of is that the second half EBITDA margin was nearly 33 per cent.
The 2016 full year profit reporting season will perhaps be remembered as a year where many companies ceased providing profit and revenue guidance. ALU on the other hand said it is confident of exceeding its previous revenue target of US$100m (excluding acquisitions) by the end of 2017. ALU has set itself a target of US$200m of revenue by 2020 implying 17 per cent annual growth over four years excluding acquisitions.
If low returns and low growth are the ‘new normal’ economists and market commentators are referring to, then Altium might just be one of the few abnormal investment opportunities around.