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The UK tech shares down more than 50% as growth slows and inflation bites
The UK’s technology sector has been hammered in recent months as investors ditched high growth companies for safer havens amid stock market and geopolitical uncertainty. Hot running inflation risks eating into future profits, which means investors now prefer lower growth companies which are enjoying good profit today, not waiting for bigger earnings years down the line.
This shift has had a savage impact on the wider UK tech scene, particularly on the AIM market.
According to data from SharePad, seven AIM technology companies have lost more than half their value since the turn of the year thanks to slowing growth, missed forecasts and other factors. These include IT systems supplier to government departments Made Tech (MTEC:AIM), communications software firm LoopUp (LOOP:AIM) and online marketing platform provider DotDigital (DOTD:AIM).
Business ratings internet company Trustpilot (TRST) is the only FTSE All-Share tech firm to have lost more than 50% of its value in 2022, which will make investors once again wonder about the level of risk they are taking when buying AIM shares.
WHAT HAPPENED TO ESSENSYS?
No tech stock has fallen as far as Essensys (ESYS:AIM), the provider of software services to the flexible workspace industry. Just a few months ago, fund manager Anna MacDonald of Amati Global Investors was championing the potential for an exciting 2022 for Essensys on Shares’ podcast.
She knows the company well, having followed its progress since it joined AIM in 2019, making an investment in the company in early 2021.As MacDonald pointed out on the podcast, Covid had been good for the company as people sought more flexible arrangements during stop-start lockdowns and landlords embraced changes through Essensys’ low-cost platform.
But at the start of March, Essensys said it would miss forecasts for the financial year to 31 July 2022 due to Covid-related challenges delaying progress. First-half revenue grew just 3%, hardly matching the high-growth levels that investors typically desire from a tech stock.
WHAT HAPPENED TO DOTDIGITAL?
Slowing growth has also cost DotDigital dearly this year, with inflationary pressures raising staff costs and forcing margins down, presenting additional headaches.
‘Considering the slower growth profile and risks discussed, compounded by a de-rating across the sector, we believe DotDigital can no longer sustain a premium rating,’ said analysts at Numis.Berenberg’s analysts cut their earnings forecasts for Dotdigital over the next three years, although they still believe there is scope for the company to eventually reclaim historical operating margins.
‘The company will probably have to spend circa £2 million to £3 million a year more over the next three years on new customer acquisition, to be able to maintain its low to mid-teens growth rate, but after that, earnings before interest and tax margins could return to the 20%-plus level seen thus far,’ Berenberg said.
The share price sell-off from 197.8p at the end of 2021 to the current 78.6p strongly suggests investors are not willing to wait.
WHAT HAPPENED TO MADE TECH?
At the end of February, public sector-focused digital services company Made Tech released its first results since listing in September 2021. The figures for the half year to 30 November 2021 saw gross margins fall six percentage points to 39.1% after the company was forced to take on more higher cost contractors and incur wage inflation, yet it still showed remarkably strong growth.
Revenue surged 131% to £11.7 million unaided by acquisitions, while adjusted earnings before interest, tax, depreciation and amortisation
soared six-fold to £1.2 million.The market’s response? The stock crashed from 93.5p to 50.5p in a day and has drifted even lower since. The anticipated challenges of recruitment appear ‘more acute than initially expected and Made Tech will need to leverage its Academy programme to alleviate the high proportion of contractors used to meet customer delivery requirements,’ said Megabuyte analyst James Preece.
‘Ensuring a healthy team structure with the appropriate senior experience in place to manage young talent will be crucial to its longer-term delivery success and growth,’ he added.
In Shares’ view staff costs and recruitment remain an issue for the company, yet business growth figures suggest that Made Tech is executing well.
Berenberg in early February felt the market was already pricing in a large miss on EBIT margins when the shares were trading at 118p. On that basis, things will have to get far worse for the company to disappoint what are now very low expectations, with the stock at 47p now trading on a mere eight times forecast earnings.
As larger peer Kainos (KNOS) continues to demonstrate, helping government departments embrace the digital age remains a long-run growth opportunity for suppliers, and that opportunity does not seem fairly reflected in Made Tech’s share price. We believe Made Tech is worth buying at the current depressed levels, albeit only for investors who are patient and understand there are still plenty of near-term risks to earnings and therefore the share price.