Homegrown Tech Champions

Global technology stocks have driven equity market returns but Australian investors shouldn’t neglect tech opportunities closer to home.

Global equity market returns this year have been dominated by the performance of the US technology sector, notably the ‘Magnificent Seven’, but in particular Nvidia, which alone has contributed ~5% of the S&P 500’s 12% return so far this year. While the domestic S&P/ASX 200 benchmark (+1.4% YTD) has lagged the US S&P 500 index (+13.9% YTD) given its lower weight to the technology sector, there are two technology stocks listed on the ASX – NEXTDC and Block – covered by E&P’s technology analyst Paul Mason, which we believe should be of interest to investors. Both stocks are on the E&P Domestic Direct Equity Recommendations list, a compilation of the best ideas from current E&P Research coverage.

Positive on data centre dynamics

NEXTDC is the leading independent data center operator in the Australian market, which is now expanding via new developments in Asia and New Zealand. The growth of artificial intelligence (AI) applications has provided a further boost to demand growth for NEXTDC’s infrastructure and services that was already supported by growth from megatrends such as cloud computing, 5G, the Internet of Things and 3D printing. Major cloud service providers and technology suppliers are now scaling up in support of the massive data management challenges that will arise.

While there are plenty of risks related to AI for the technology sector (notably for software companies), we believe that data center companies like NEXTDC look well-placed to benefit. Industry feedback on demand remains very bullish, but there are significant constraints on supply. We believe the supply-demand mismatch is getting more favourable over time due to difficulties bringing on power in a timely manner.

Serving both sellers and consumers

Block is a highly innovative company with market leading designs and user experience offerings for both sellers and consumers. Block is leveraged to sellers through its Square ecosystem. Square grows through acquiring new customers, increasing transaction volumes through its point-of-sale solutions, and upselling software solutions. Block is leveraged to consumers through its Cash App ecosystem. Cash App grows through acquiring new customers, increasing the uptake of its Cash Card and Direct Deposit products, and now also through the uptake of its Afterpay Buy-Now-Pay- Later offering.

Expense discipline has materially changed Block’s profit outlook. They announced a personnel cap in late 2023 that is driving efficiency and operating leverage. We expect Block to maintain its recent pace of earnings guidance upgrades and sustain high growth for a long time. We believe the market is still underestimating the earnings power of the business. Management intends to reach the ‘Rule of 40’ target in 2026. This is a measure of operating performance for technology companies based on achieving revenue growth plus free cash flow growth above 40%. Block achieved 29% in 1Q24.

NEXTDC Revenue Growth History and Forecasts

Block: Revisions to Consensus FY24 Earnings Per Share Forecasts