Welcome to the first edition of Ask the analyst, something that will become a regular feature for Morningstar readers.

This feature was inspired by two of my favourite things about working for Morningstar. Number one, the responses to articles that we get from our readers. And number two, the conversations I get to share most days – usually in the kitchen – with members of our equity research team.

Ask the Analyst combines these by giving you the chance to submit questions about companies under Morningstar Australia’s coverage. I will select questions, talk to the analyst covering that stock and publish their answers here. You can submit a question by email to [email protected].

Today’s question

Today’s article concerns a question I asked Roy Van Keulen after WiseTech Global’s earnings in August. That question went something like this:

“Great results from WiseTech again. How big is the growth opportunity still? The stock looks expensive…”

There are actually two questions there: one on the growth runway ahead of WiseTech (ASX: WTC) and another implied question on valuation. I’ll cover both of those here with a lot of help from Roy. But first, a quick reminder of how WiseTech Global makes money.

How does WiseTech make money?

WiseTech sells software that helps logistics companies digitise their operations. Their main product is the CargoWise suite of software for freight forwarders, who select and co-ordinate the operators of physical assets, such as ships, airplanes, trains, trucks, and warehouses, to move goods worldwide.

WiseTech’s earnings headline in August included a prediction that annual revenue would see another year of strong revenue growth in fiscal 2025 and 2026. The strong growth of WiseTech’s business has been reflected by the performance of its shares which have appreciated by over 30x for investors since the IPO in 2016.

The question today, though, is how much more revenue growth could be ahead. Because at a current market value of $44 billion, WiseTech is right up there with the world’s most expensive companies on a forward price to sales basis. Let alone a price to earnings basis!

The wrong question to ask?

The first thing Roy said to me when I asked him to explain WiseTech’s total addressable market was that it might be the wrong question. Instead, he thinks it makes sense to ask how winnable Wisetech’s current market is, and how good a job WiseTech is doing of winning it.

To show me exactly what WiseTech’s current market is, Roy mapped out a basic freight supply chain on a horizontal axis. All the way from a factory in the country of origin to a distributor’s warehouse or store in the destination country.

wisetech-tam-unshaded

Every time a load of freight moves from one stage to the next, there are tasks that need to be carried out and therefore processes that have the potential to be automated, tracked and actioned using software like WiseTech’s. But WiseTech has not targeted the whole spectrum.

Instead, it has focused very intensely on trying to ‘win’ the management of freight between customs and ports and both ends of the journey – so the middle bit of the freight supply chain chart, shaded in purple below.

wisetech-tam-shaded

 

Roy thinks it is very hard to see anybody but WiseTech winning this part of the market. WiseTech’s software has become the industry standard. 4 out of the world’s top 5 freight forwarders and over half of the world’s top 25 are under contract or have already implemented CargoWise.

That, according to Roy, is quite simply a function of freight forwarding being a commoditised industry focused entirely on lowering costs. CargoWise clients save more money and therefore win more market share. As CargoWise charges on a usage basis, more business for CargoWise clients means more revenue for CargoWise - and it also compels other freight forwarders to join out of fear of being left behind.

In Roy’s view, it is one of the strongest flywheels visible in the software industry today. Not just in Australia but anywhere on Earth.

When do they run out of road?

High adoption rates within the world’s biggest freight forwarders are impressive. But could they also suggest that WiseTech’s growth could be close to plateauing?

Not a problem, says Roy. Implementing CargoWise requires so much groundwork that even if a company is already under contract, it can take several years for them to reach full revenue capacity. For example, a freight forwarder may roll out CargoWise in a small number of countries at a time.

In that sense, WiseTech’s growth runway within existing client accounts is likely just as big as the one with unsigned major forwarders – and that isn’t exactly small.

The complexity of implementing CargoWise also makes WiseTech customers very reluctant to switch providers after the software has been setup and staff have been trained. These sunk costs and the business disruption risk of choosing another vendor underpin Van Keulen’s Narrow Moat rating for WiseTech, which means he thinks WiseTech can earn excess returns on capital for at least a decade.

Van Keulen also thinks that CargoWise benefits from a network effect. As using CargoWise results in significant labor cost savings for freight-forwarders, this incentivizes freight-forwarders, to prefer operators that are integrated with the platform. Hence, asset operators are incentivized to integrate with CargoWise to win business. This in turn increases the pool of potential asset operators that freight-forwarders can work with in a highly efficient manner, thus creating a network effect.

“They used to say nobody got fired for buying IBM. In the freight forwarding business today, you can replace IBM with CargoWise” Roy Van Keulen

Putting a number on it

Roy’s WiseTech valuation assumes that the company can grow its revenues at an average rate of 22% per year for the next decade.

That is a remarkable level of growth – one that would see WiseTech’s sales rise sevenfold from where they are today. For that reason, I asked Roy to break it down. And he mentioned four separate sources of growth in WiseTech’s existing area of focus:

  • Existing clients moving more tasks and shipments to CargoWise

  • More freight forwarders and logistics companies implementing CargoWise

  • Price increases – WiseTech has shown a continued ability to do while maintaining customer retention rates of over 99% for the last decade.

  • CargoWise clients taking more market share

Van Keulen views the last source of growth – client market share gains – as a particularly profitable source because it is funded entirely by the client. WiseTech doesn’t need to pay sales and marketing expenses to get it – nor do they need to invest heavily in product updates or other sweeteners.

Then you have the opportunities for WiseTech to leverage its dominant position in freight forwarding into downstream adjacencies such as customs and compliance, container-based road and rail freight, and, eventually, warehousing.

As we mentioned earlier, there are a huge number of tasks that could be moved to CargoWise beyond the customs and port stage of the freight moving process. Seeing as WiseTech is already embedded in the operations of the freight forwarders involved, it appears to have a huge advantage when it comes to digitizing these parts of the chain too.

This is why Van Keulen was focused first and foremost on the winnability of WiseTech’s initial area of focus.

The elephant in the room: valuation

There is no getting around it – WiseTech shares are eye-poppingly expensive on traditional valuation metrics. As I said earlier, the company’s stock trades at over 40 times forward revenue forecasts for next year and more than 150 times next year’s forecast earnings.

WiseTech shares have also risen to a level where they are over 20% higher than Roy Van Keulen’s current Fair Value estimate. Yet while the share price might not scream value right now, it’s clear that Van Keulen remains bullish on the long-term direction of WiseTech’s business and its moat. One for the watchlist, perhaps.

WiseTech Global

  • Moat rating: Narrow
  • Uncertainty Rating: High
  • Fair Value estimate: $115
  • Star Rating: ★★

Have a question about a company in Morningstar Australia’s coverage? Submit it to [email protected]. I will put selected questions to the analyst covering that stock and publish their answers in a future article.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.