NAC Investment Report NTA February 2022

Market Insight

The month of February saw the NAC investment portfolio decrease by -7.95%, underperforming both the benchmark S&P/ ASX 300 Industrials Accumulation Index (XKIAI) which increased by +0.65% and also its smaller counterpart the S&P/ASX Small Ordinaries Accumulation Index which decreased -0.01% in another extremely volatile month for equity markets. This brings portfolio performance since inception to +13.72% p.a., outperforming the benchmark index which has returned +7.22% p.a. over the same period. The major detractors to performance for the month were Gentrack Group (ASX: GTK), Step One Clothing (ASX: STP) and (ASX: UBN). As expected given half-year reporting, there was a significant amount of news flow in February with the most notable events coming from GTK who provided a trading update at their AGM, STP which released their 1H FY22 results and finally Experience Co. (ASX: EXP), which provided some granularity on the potential earnings power of the business going forward.

It was somewhat surprising that GTK was one of the major detractors for the month, as the company provided a strong trading update at their AGM. GTK’s initial guidance for FY22 was for “revenue growth” though this was amended to revenues of “around $115 million” with EBITDA expected to be in the low single digits ($’m). This guidance implies revenue growth of circa 10% even though management have previously disclosed that there is a $5-10 million headwind from a customer who announced they were leaving GTK some time ago. Taking this into account the true revenue growth of the business is closer to +15-20%. On face value the EBITDA generated could be considered low for a business of GTKs’ scale, but it should be noted that all research & development is expensed. If GTK were to capitalise a majority of this (as most Australian technology companies do) then EBITDA could be closer to $10 million. We continue to believe that GTK remains extremely undervalued and that its growth prospects are more tangible than the wider market appreciates. With an EV/Revenue multiple of just over 1x, in our view GTK has the potential to be valued over 2-3 times higher especially if the current management team’s track record of under promising and overdelivering continues.

STP released their inaugural half-year results as a listed entity and to their credit the quality of the information was excellent. The financial result was in line with the guidance issued in November but in our view, of more interest, was the revenue composition we believe is required for STP to achieve their FY22 guidance, as well as the prospects of marketing spend increasing going forward. Regarding the FY22 guidance, we believe there will need to be a large increase in sales for the recently launched women’s underwear range to offset the slower growth experienced in the UK market. Initial demand for these products has been excellent but we believe there could be a timing risk regarding stock availability considering the volumes required to have a meaningful impact on group revenue. Secondly, the advertising and marketing spend was maintained at ~40% of group revenue. As the group embarks on a global expansion the marketing campaigns that were used successfully in Australia may require significant tailoring to ensure effectiveness across the new geographies. As such, we believe there is potential risk for marketing spend to further increase as a percentage of revenue, despite the projected top-line growth. Given the material impact such an increase would have on the long-term valuation of the STP business, we will be closely watching this metric in future market updates.

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