A tendency during market sell offs is to seek stocks that fall hard and look over sold. Investors think they have nabbed a bargain, but their perception of value is anchored by past share prices rather than company fundamentals. Inevitably, they destroy more wealth.
Another, often better, strategy is searching for stocks that hold their ground or even rise during share market corrections. The share-price strength tells you the smart money is reluctant to let go, even though they could take profits and rotate into fallen stocks.
Technical analysts, who favour momentum trading, use share-price charts to buy stocks that are in clear uptrends and sell those in downtrends. It almost seems too simple to buy rising stocks and sell falling ones, but momentum indicators can be effective.
Intellectual property firm IPH hit a new 52-week high as the Australian share market slumped in December and January. It has soared from $4.50 in mid-August to $9.13, making it one of the best performers this year – and a mid-cap of rare quality.
To recap, IPH listed on the ASX in November 2014 through an Initial Public Offering (IPO), raising $165 million at $2.10 a share. Demand was high: IPH spiked to $3.14 on debut and has rallied ever since in a weakening, volatile share market.
Chart 1: IPH
Source: Yahoo!7 Finance, 28 January 2016
IPH wholly owns Spruson & Ferguson, a leading intellectual property (IP) services firm in the Asia Pacific that serves 25 countries. It was the first IP firm to list on the ASX and has been followed by the $51 million IPO of Xenith IP Group in November 2015. Xenith’s $2.72 issued shares rallied to $3.45 before easing to $3.11 – another good sign in a weak market.
Chart 2: Xenith IP Group
Source: Yahoo!7 Finance, 28 January 2016
IPH was boosted after indicating at its Annual General Meeting in November that earnings momentum had continued in the first four months of the year. Guidance for first-half underlying earnings in 2015-16 of $32-34 million beat market expectation. A lower Australian dollar (about 85% of the revenue base is in other currencies) and better-than-expected contributions from businesses IPH acquired drove the earnings upgrade.
I rate IPH on five counts. First, the coming consumption boom in Asia, where another two billion consumers are expected to join its middle class by 2030, will drive sharply higher demand for products and services in the region. Western and Eastern companies will need greater IP protection in markets that are not known for protecting or respecting ideas. IPH’s growing footprint in Asia means it is superbly leveraged to this powerful, long-term trend.
The second factor is growth in patent and trademark applications in Australia. They have doubled and quadrupled respectively over the past 20 years and sustained growth seems likely as more companies focus on innovation and protecting their discoveries. The Federal Government’s recent Innovation Statement highlights a new impetus on innovation in this country and should have long-term benefits for IP service providers.
The third factor is the fragmented market for IP services. IPH is well placed to continue making accretive acquisitions that drive growth. There is a long tail of tiny one- or two-person IP firms that are targets for cashed-up acquirers such as IPH. It has shown a knack for choosing and integrating the right firms in Australia and needs to repeat that success in China/Hong Kong, South East Asia and even Russia.
IPH has the balance-sheet firepower for more acquisitions. It raised $60 million in a November 2015 placement at $7.30 a share – the top end of its offer range. Debt of only $5.3 million at the end of 2014-15 reinforces the strength of IPH’s balance sheet.
The fourth factor is the business model. Slater & Gordon shareholders will shudder at the thought of buying high-priced service firms that are growing rapidly overseas through acquisitions. But there are important differences between IPH’s business model and other professional firms that aid the conversion of its work into cash.
IPH is often paid when work is commissioned or soon after its completion, not months or even years after legal cases settle, as is the case with law firms that specialise in third-party injury claims. Earnings visibility is higher because the market is not relying on company estimates of the value of work in progress – an issue that has weighed on Slater & Gordon.
The ability to convert work rapidly into cash is an attraction. Exceptional companies have a knack of funding growth fully, or partly, through surplus cash flow and do not have to rely on raising debt or excessive share issues that dilute shareholders. IPH’s ability to become a $1.7 billion company with $5.3 million of debt is testament to its cash-generative abilities.
The final factor is management execution. Professional-services firms that grow quickly by acquisition have a knack of coming undone. Inevitably, they pay too much for acquisitions, take on too much, or underestimate regulatory risks in other countries. The market gushes about them when acquisitions are fuelling growth, and dives for cover when the music stops.
IPH has done everything it said it would and more in its first year as an ASX-listed company. Spruson & Ferguson has 128 years of history and is a recognised leader in its field in the Asia Pacific. This is not a firm that was thrown together for an IPO to raise capital, consolidate several smaller firms, and provide a fast exit for founders or private-equity firms.
But every stock has its price. At $8.94, IPH is on a forecast Price Earnings (PE) multiple of 27 times in 2016-17, based on consensus analyst estimates. That is high for any company, let alone one that only listed in late 2014. IPH is, seemingly, priced for perfection.
Four of six broking firms have buy recommendations and two have holds. A median share-price target that ranges from $7.59 to $9.05 suggests IPH is, at best, fully valued. Macquarie Equities Research has a 12-month price target of $8.62 and a neutral rating on IPH.
Nevertheless, investors who were allocated stock in IPH at listing or bought soon after should hold their shares. After such a stellar rally, IPH is due for a period of share-price consolidation or pullback and that may be occurring as the share price hits resistance around $9.15 – a point if has failed to break through twice, with conviction. But it has good long-term prospects.
Short term, technical analysts will look to whether IPH is forming a double top on its share-price chart – price behaviour that can indicate a stock has reached a top and is losing steam. It would not surprise to see IPH give back some of its recent gains, if market volatility stays high and fund managers take some profits out of IPH and rotate them into other stocks that offer better value.
Either way, prospective investors should put IPH on their watch list. Do not chase it higher at current prices, but watch and wait for better value when buying fatigue eventually catches up with IPH and more attractive prices, possibly closer to $8, are offered. My sense is that the market has got a little ahead of itself with IPH and that it’s due for a decent pullback, which in turn will create a buying opportunity.
IPH is one of the better-quality companies to join the ASX in some time. The challenge is buying at a more realistic price during lingering market corrections.
Xenith another option
Big IPO gains inevitably encourage other companies in the same industry to list and capitalise on strong investor sentiment. Think Monash IVF Group and how it initially benefited from Virtus Health’s strong showing. Or Shine Corporate coming to market after the early success of Slater & Gordon.
Xenith IP Group is another option for intellectual property exposure. It ranks in the top five firms in market share for patent and trademark applications filed in Australia, and like IPH has a long history. Xenith wholly owns Shelston IP Lawyers.
Capitalised at $102 million, Xenith is a lot smaller than IPH and a lot cheaper. It came to market on a forecast PE multiple of about 19 times and an expected 4.2% dividend yield. Xenith does not offer the same growth prospects as IPH: its focus is mostly on Australia, although a leading position in servicing Chinese companies seeking patent and trademark applications in Australia impresses.
Prospective investors might wait until Xenith releases its first earnings results as a listed company and more is known about its performance and outlook. It is one to watch, but there is no compelling need to buy just yet in a volatile market. As a micro-cap stock, Xenith suits experienced investors.
• Tony Featherstone is a former managing editor of BRW and Shares magazines. The column does not imply any stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at January 27, 2016
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
