Ask A Fund Manager
The Motley Fool chats with the best in the industry so that you can get an insight into how the professionals think. In this edition, Medallion Financial managing director Michael Wayne decides whether he'd buy or avoid three ASX shares that have plummeted in 2022.
Cut or keep?
The Motley Fool: We'll now examine three ASX shares that have plunged recently, to get your thoughts on whether they're a bargain or if you'd stay well away.
First one is Fisher & Paykel Healthcare Corp Ltd (ASX: FPH), which has almost halved year to date.
Michael Wayne: This is one that we've held since Medallion's inception but also I've held for clients even pre-dating that. It's been a terrific performer over a long period of time but a terrible performer in more recent times.
This is a company that benefited immensely from COVID and what you're seeing now is an unwinding of that COVID-induced demand. So it's returning to a pre-COVID growth trajectory, if you like. But it's a company with a very dominant position in the respiratory and acute care market. I think it's got around 70% of the global market share in that space.
If you think about being in hospital with all those surgical breathing devices and different types of ventilators, often that's supplied by Fisher & Paykel Healthcare and the good part about that part of the business is it's all consumables. Once you use a mask on someone in hospital, it's going to be thrown out, discarded and a new mask has to be purchased — so that consumable nature of that part of the business is very appealing to us.
Also, [there's] a part of the business which is a small part — it contributes less to revenue than respiratory and acute care part — that's more the sleep apnea devices and that's growing, but not growing as quickly as that other part of the business.
It's a company that was trading on very lofty multiples and in fact, it still does. In an environment where you've got rising interest rates and fears about inflation, it's often the high PE, high growth names that get hit the hardest and that's probably part of the reason for Fisher & Paykel's declines.
They also released a guidance update a couple of months ago and those numbers came in worse than the market was expecting. There was about a 26% decline in revenue and a big decline in net profit of about 50%, or even more than that. Then again, this is it cycling through that COVID period, which boosted demand and it's returning again to that normal environment. Those numbers probably seem worse on paper than reality.
Look, it's a very high-quality business. Very good balance sheet over a long period of time. They did a wonderful job in boosting margins by moving a lot of their manufacturing from high-cost jurisdictions, such as New Zealand to lower-cost jurisdictions such as Mexico. They'll continue to see some of the benefits from those changes.
Fisher & Paykel's long-term revenue growth target is 12%, its EBITDA margin is 30%. Those numbers are very attractive for any business. And we think that this is a company that if you take a long-term view, you could certainly look to pick it up at these prices.
Yeah, it's delivering very strong growth numbers, it's got a competitive advantage in some spaces that it operates and it's got a good long-term track record of delivering on those targets. We're happy continuing to hold Fisher & Paykel for clients and our long-term view, we'd be happy to buy something like that too.
MF: Next one is tech company Megaport Ltd (ASX: MP1), which has publicly tried to cut its costs down this year. The share price has plunged 60% in 2022.
MW: Yes. Megaport is another business that we've held for a while, probably from the low $3s in some cases for clients. It is a company that became very expensive and then reduced a lot of exposure for people but has come back a long way and it's looking a lot more attractive.
In our view, it's a very interesting company, it basically provides elasticity and connectivity to network services. In layman's language, it's a bit of a network-as-a-service type business model. It allows companies who operate in multiple geographical regions to swiftly access numerous cloud databases, the likes of Amazon.com Inc (NASDAQ: AMZN) and Google Cloud platform IBM (NYSE: IBM) cloud, Oracle Corporation (NYSE: ORCL), et cetera.
It enables companies, regardless of the geographical location, to access these different databases. And it also allows companies to decide when and how much access they need. They're able to control things like the speed of the data access.
We're about to move into the Spring Racing Carnival, for instance, and a lot of betting agencies will know that there's going to be a big spike in demand around this time of year. They're able to then use Megaport to increase their capacity through periods of increased demand and then scale it back when that demand subsides.
It does give companies a lot of flexibility. They've got a lot of large customers such as BHP Group Ltd (ASX: BHP), FedEx Corporation (NYSE: FDX), ING Groep NV (NYSE: ING), Tesla Inc (NASDAQ: TSLA), Zoom Video Communications Inc (NASDAQ: ZM), for instance, as well. A lot of high-quality clients.
They had a bit of a scare earlier in the year with a very disappointing third-quarter revenue and customer growth numbers but then they bounced back very strongly in the fourth quarter, a lot of those key numbers also picked up again. Revenue growth has accelerated from 35% last year to 40%, which is always very attractive. Their gross margins now exceed 62%. That was a big increase on last year. They're also seeing standing margins really across their geographical locations.
It's a very high-quality company and not a lot has really changed with the fundamentals but the valuation has come back a long way. You always, I think, want to take notes of the companies in the re-invest position because they do have a very dominant market position and they're getting a lot of customers. But not only that, they're getting their existing customers to use more and more of their services. That's an impressive factor.
You touched upon a reduction in costs and basically, what the company has been doing is they've been reducing their focus on adding new data centres to its network and instead just focusing on getting their existing customers to use their products more.
I'll give you an example here… The growth in its existing services to existing customers increased 26% last year and that's on top of the growing customer base which increased by about 16%. Good metrics all round for Megaport.
Again, this is one that we'll happily buy on a long-term time horizon.
MF: Fantastic. And the third one is one that's been around for a long time, Xero Limited (ASX: XRO), which has halved in 2022.
MW: Xero, again, it's another company that we have held a lot in the past. We do have some clients that still hold it. It's a very good and sticking business, it took them 10 years initially to get their first million subscribers and then only two, two and half years after that, to get their next million. Since then, they've managed to increase their subscriber base [by] over three million.
Basically, they dominate the markets in Australia and New Zealand and they're looking to replicate that growth in the UK, to a lesser extent, North America and the rest of the world.
They recently had an update to the market, which was a little bit underwhelming, particularly with their numbers coming out of the UK and that is a little bit of a concern for the business because the UK is a key growth driver for them going forward. That's something we want to watch pretty closely going forward, obviously the UK is going through a pretty challenging time at the moment, looking at their economy and their energy markets, et cetera. It's very hard for the business and for management to predict or provide any guidance as to how that's going to play out in the mid-term.
From a longer-term standpoint, we're still optimistic about the future. We still think the company will grow consistently over time. However, we're not as optimistic or as excited as we were in the past. There's also competition heating up — Intuit Inc (NASDAQ: INTU), through their QBO ecosystem, has overtly stated that their next focus will be in Canada, the UK and in Australia. So that will increase competition and will likely curb the annual price increases that Xero have become used to passing onto clients or to their customers. That's something, again, we're going to have to be able to watch very closely going forward.
Also, Xero, although it did turn profitable for a brief period of time in FY20, again turned [into] a loss maker in the last financial year. That's again something we want to watch closely because what that means is, a small change in revenue forecast has a big impact on their earnings growth.
At the moment, Xero, for us, would be a hold and wait and see because we do think it's still a quality business, it's just unlikely that it's going to be able to continue to grow at the rapid rates that investors have become used to.
MF: Sure. It sounds like you certainly have less conviction for Xero than the other two.
MW: Yeah, I think, at the moment. It always makes sense in our opinion to focus on those companies where the earnings momentum and the balance sheet momentum is favourable.
Those businesses that are coming out with consistently good updates, I think, are preferable to those that have recently had a negative update because it's always better to wait and see — almost wait for more certainty — before buying into something.
Yes, you might forgo the first 5%, 10% of the rally or recovery — but at least you're getting that little bit extra certainty that the company is back on the right track.
