The IMF recently slashed its 2008 global growth forecast to 3.7% (versus 4.9% in 2007), with the US economy stalling at 0.5%. This should end the myth that emerging nations have “decoupled” from the developed world. That’s bad news for overvalued stocks reliant on unsustainable growth in the developing world.
Aveva (AVV), rated a BUY by Numis Securities
Take Aveva. It is a leading provider of computer-aided design (CAD) software for the oil and gas, and power and marine industries. The software helps engineers, increasingly based in Asia (about 50% of turnover), to design and build complex structures, such as offshore oil platforms, petrochemical plants, nuclear-power stations and ships. Revenues and profits are booming as demand has rocketed in line with strong global trade and record oil prices. But with the shares up fivefold in the past three years, and trading on sales and p/e multiples of 5.8 and 25 times, it’s time to bank some profits.
Firstly, assuming America goes into recession, then near-perfect conditions in Aveva’s key markets have now passed. Most of its income is derived from large-scale projects, whose funding has become far more costly owing to the credit crunch. Many developing nations are also suffering from rampant inflation, which means it’s only a matter of time before local interest rates are hiked in order to cool their over-heating economies – again hitting capital investment.
Secondly, Aveva is heavily exposed to the cyclical shipbuilding industry (30% of revenues), which is starting to show its first signs of cracking after a white-hot period. Thirdly, City analysts are pencilling in substantial growth from the company’s new product lifecycle management (PLM) application, which will put it in direct competition with rivals such as Siemens and Dassault Systems. These giants are much larger and better funded, and will respond aggressively if they lose market share. Note too that PLM is often considered a discretionary item, and so vulnerable to cut-backs in tough times. Lastly, the group is substantially exposed to the dollar, which will act as a natural headwind.
Chief executive Richard Longdon is confident that Aveva will ride out an economic slump, pointing out that China “is beginning to build quite a head of steam of its own”, along with the ramping up of the nuclear-power industry. But although the company is performing well, the stock is priced to perfection in an increasingly uncertain world. I would rate the shares on a 17 times 2008 earnings multiple – equating to a fair value of about £8, or 30% less than today. Preliminary results are due out on 27 May.
Recommendation: TAKE PROFITS at £12.11
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments