EUR 850.00 For Business Accounts Only

Morningstar | Seek Shares Offer Value Following Deterioration in Technology Sector Sentiment

Shares in narrow-moat-rated Seek have followed global technology stocks lower in recent months, falling 28% since August as technology sector sentiment has deteriorated. However, the sentiment change has not affected our earnings forecasts, and we have increased our fair value estimate by 3% to AUD 18.60 to reflect the impact of the time value of money on our financial model. At the current market price of AUD 17.10, the shares now appear undervalued. The share price implies a fiscal 2019 price/earnings ratio of 31 versus 34 at our fair value estimate and 14 for the S&P/ASX 200 index. Over the past decade, Seek’s one-year forward P/E ratio has traded between 9 and 37 times, meaning our fair value-based P/E looks expensive relative to both the market and the stock’s historical range. However, the relatively high P/E is justified, in our view, as near-term earnings are being affected by reinvestment to support revenue growth and do not reflect the long-term potential of the underlying business. Over the next decade, we forecast a relatively high underlying EPS compound annual growth rate of 11%.

Management has announced little since the fiscal 2018 financial result in August and remains under pressure from some investors due to the prioritisation of revenue growth and investment in new ventures over profitability in the short to medium term. The recent change in financial reporting layout and general complexity of the accounts is understandable but not helping build investor confidence. However, we believe management is taking the right approach, considering the relatively high revenue growth rates being achieved by the investments undertaken and the importance of market dominance and resulting network effects to software platform businesses.

Reassuringly, earnings guidance was maintained at the annual general meeting in November, including fiscal 2019 revenue growth guidance of 16%-20%, versus our 16% forecast, and EBITDA growth guidance of 5%-8%, versus our 4% forecast. Management also expects investments in early-stage ventures to cost AUD 35 million-40 million in fiscal 2019, versus our AUD 37 million forecast, and flat underlying NPAT growth on the prior year, versus our forecast of a 1% decline.

Seek continues to exploit the network effect in its core and dominant Australian business to maintain revenue growth and is successfully replicating the model in overseas markets. The strategy continues to work well in China, where its Zhaopin business reported revenue growth of 24% in fiscal 2018 and now constitutes 37% of group revenue. We expect the large addressable market to support further growth but at a declining rate due to increasing competition from peers including Tencent-owned 58.com, Microsoft-owned LinkedIn, and 51job.com. We expect Zhaopin to be a key revenue driver for Seek over the next decade; we forecast a revenue CAGR of 12% and EBIT CAGR of 15% and expect the division to make up around 50% of group revenue in the long term.

Aside from its Australian and Chinese businesses, Seek’s Asian and South American businesses constitute around 20% and 5% of group EBIT, respectively. Seek Asia, excluding China, holds strong positions in several Asian markets and we forecast a revenue CAGR of 10% over the next decade. The two South American businesses have struggled during the past couple of years due to soft economic conditions, but we don’t believe either faces structural challenges and expect both to recover. We forecast a South American revenue CAGR of 5% over the next decade and a recovery in cyclically low EBIT margins from 7% to 21% over the next decade. We also expect the portfolio of international businesses to gradually transition from regional to global network effects.