Undervalued tech stocks could be nearing ‘inflection point’

COST-CUTTING measures by tech companies, including waves of layoffs, are shaking confidence in the sector.

According to estimates, Chinese e-commerce group Alibaba and American semiconductor chip maker Intel have each let go of at least 20,000 employees so far this year due to slow growth.

Mark Zuckerberg’s Meta, Jeff Bezos’ Amazon and Elon Musk’s Tesla have also been among the tech firms with mass layoffs, of over 10,000 staff each.

Closer to home, tech conglomerate Sea and e-commerce subsidiary Shopee shed about 7,000 employees in three rounds of retrenchment this year.

But market watchers say that, in the face of an impending recession, the results of the cost-cutting moves are expected to be varied for these tech firms.

“As we keenly monitor the uncertain macro economy and recessionary risks, we believe that it is down to how much these tech companies can save and deploy cash to the areas that are the most lucrative,” said Maybank analyst Kelvin Tan.

“We think that investors would be looking at the cash balances of these companies and whether capex is deployed to areas of the business where it makes sense,” he added.

For example, Tan noted that two listed tech companies under his coverage – Grab and Sea – showed improved performance in the third quarter ended September as a result of the cost-cutting measures.

Ride-hailing and food delivery firm Grab did not undertake any mass layoffs but has been seen to be “conserving capital” through “very careful and judicious” hiring as well as “specific reorganisations”.

In his latest reports in mid-November, Tan upgraded Grab to “hold”, from “sell” previously, while maintaining his “buy” recommendation on Sea, albeit with a lower target price of US$98.

Another tech firm that has earned an upgrade is GoTo Gojek Tokopedia, Indonesia’s biggest tech company.

GoTo, the ride-hailing, e-commerce and fintech services provider, said in November that it will cut 1,300 employees – around 12 per cent of its workforce – in a bid to curb costs and reach financial self-sufficiency more quickly.

UOB Kay Hian analyst Stevanus Juanda upgraded his call on GoTo to “hold”, from “sell” previously. “GoTo is now embarking on cost-saving initiatives so that it can start delivering better results at the bottom line, and not just at the top line,” he said.

DBS analyst Sachin Mittal suggested that the top three South-east Asian tech firms – Sea, Grab and GoTo – could be seeing an “inflection point”.

“Asean Internet players have gradually raised their take rates to accelerate achieving Ebitda (earnings before interest, taxes, depreciation and amortisation) breakeven instead of focusing on expansion and market share gains,” Mittal said. The take rate refers to fees and commissions collected by the companies on sales and services provided by third parties.

DBS has a “buy” call on Sea with a target price of US$100 and a “hold” recommendation on Grab with a target price of US$2.93.

Lorraine Tan, Morningstar’s director of equity research in Asia, however, is less bullish about Sea’s prospects.

“Much of their fundamental problems still are not solved despite cost cutting, and they still have a long way to go before breakeven,” Tan said.

“For Sea, the layoffs are quite significant. It does help their margins and earnings in their short term as the layoffs tend to come from low-margin or loss-making businesses,” she added. “The caveat is that its original growth and total addressable market forecasts are not as bullish as before.”

That said, Morningstar’s Tan believes that most Internet and tech stocks offer “a reasonable margin of safety” following the recent rundown in stock prices.“Examples include Amazon, Alibaba, Tencent, JD.com, Meta and Intel, which are all trading at a deep discount to our fair value,” she said.

“We take a bottom-up view here, so there are stocks that are more attractive than others. The key is long-term profitability and operating margins, rather than sales growth as a lot of the businesses are loss-making despite increases in sales,” she added.

Richard Clode, co-portfolio manager of the Global Technology Leaders strategy at Janus Henderson Investors, opined that the layoffs must also be put in perspective.

“Mega-cap technology companies (with valuations of over US$200 billion) embarked on a massive hiring spree as they extrapolated the pandemic growth acceleration,” Clode said. “As that growth acceleration normalised post-reopening and as we head into a recession, we are now seeing a right sizing of that headcount with hiring freezes extending into large layoffs.”

“You need to put the announced cuts in the context of the quantum of additions in recent years and the total headcount, so the cuts in percentage terms are not huge,” he added. “What you are seeing are some of the ‘vanity projects’ being reassessed and in many cases shut down.”

However, Clode said some of these companies will continue to invest in strategic areas. These, he said, include Meta pouring capital into artificial intelligence and the metaverse as well as Amazon and Microsoft building on their cloud capabilities.

“These companies are so profitable and have such strong balance sheets that they can continue to invest heavily through any recession,” Clode said.

“Valuations across the technology sector have reset along with interest rate expectations and central banks no longer pumping free money and liquidity into markets,” he added. “Heading into a recession where growth will be scarce, we think investors will come back to the technology sector to find that growth.”