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Trading Diary

Trading Diary – 10 October 2019

We’ve sold our position in NIB Holdings (NHF) and replaced it with a new position in Data3 Limited (DTL). Despite the last few days of downside volatility, the market, in general, remains in an uptrend according to our risk management procedure. We’ll continue to allocate capital into the market until this changes.

Sell

NIB Holdings (NHF)

We exited our position in NHF with a capital loss of 8%. We also collected approximately 2.5% in dividends along the way that helped to soften the blow.

Investor confidence in the sector was low before the election when the prospect of a legislated “cap” for two years on private health insurance premiums looked likely with the election of a Labour Government. This risk passed with the re-election of a Coalition Government. 

As a result, the NHFs stock price gapped up from the bottom of a long term base to the top. It subsequently broke out above this trading range and is threatening to enter a new uptrend. However, for the time being, it appears that the stock has halted its advance.

The outlook for the business remains positive despite intensifying competition and moderating margins. Be that as it may, the latest down move in the stock triggered our sell rules and therefore we have moved to the sidelines. 

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Buy

Data3 Limited (DTL)

Data#3 sells IT products and services. 

The Product segment offers hardware and software for customers’ desktop, network, and data centre infrastructure. 

The Services segment provides consulting, project, support, and recruitment services for the design, implementation, operation, and support of IT solutions. 

Technicals

DTL broke out to new highs at the beginning of June this year. This breakout occurred in the lead up to the company announcing a record full-year result and a return to full-year profit growth. The stock subsequently gapped up a further 17% when this update was released to the market. 

Over the ensuing few weeks the stock price pulled back to close the gap before resuming its advance. Volume is up significantly in the stock as the rise has progressed. This increased volume coupled with the rising stock price indicates significant unmet demand for the stock and a tightening of supply.

We initiated our position as DTL is emerging from what looks like the second basing structure of this uptrend. The uptrend follows a long 3-year consolidation. 

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Fundamentals

Valuation

DTL ranks in the 40th percentile for value in the All Ordinaries index. 

DTLs closest comp on the ASX is Rhipe (RHP). DTL ranks much better than RHP from a valuation perspective. DTL has a P/E ratio of 26x compared to RHP, which has a P/E of 69x. DTL has an EV/EBIT ratio of 12.5x compared to RHPs 43x. 

These two companies have very different growth profiles. However, both DTL and RHP provide public cloud products and services, which are proliferating. Therefore, both can potentially capture a significant share of this new revenue. 

Growth

DTLs total revenue increased by 19.8% during FY19 to $1,415 million. Public cloud revenue accounted for 25% of this and increased by 35% during the year.

Product gross profit increased by 17.2% and gross margin decreased from 8.0% to 7.7%. Services gross profit increased by 0.6% and gross margin decreased from 38.1% to 33.9%.

Earnings returned to trend growth with EPS up 28.7% for the year. 

Return on assets and return on equity both improved during FY19.

Financial Strength

The company has a strong balance sheet with no material borrowings. DTL has not raised any external financing in the last year.

Narrative

The company is back in growth mode fueled by the adoption of the public cloud. Public cloud revenues grew by 35% during the last 12 months and now accounts for 25% of total revenue.  

Digital transformation by government and businesses across the country is now unavoidable. As a result, the entire IT market is growing. Cloud-based technology has proliferated. As a result, cybersecurity has become essential, and data analytics is now mainstream. Moreover, large scale automation (including AI and robotics) is in early adoption. 

All this points to further growth for the IT sector.

By Danny Sandler

Founder of Ocean Asset Management.