Sage (LSE: SGE), the FTSE 100 accountancy software group, today released results for its financial year ended 30 September. It said it had addressed the issues that had held back its first-half performance (“inconsistent operational execution”) and, after an improved second-half, exited the year with accelerated momentum in the business.
The shares fell as much as 8.4% in early trading, but moved into positive territory by early afternoon — up 0.7% at 540p, as I’m writing. Nevertheless, they’re 35% below a high of over 820p in January. Is this a great opportunity to buy a stake in the UK’s largest listed technology company?
(Not quite) in line with guidance
At the start of the year, Sage had guided on organic revenue growth of “around 8%.” However, this was reduced to “around 7%” after the aforementioned first-half inconsistent operational execution had produced below-par growth of 6.3%. Q3 saw a pick-up, to 6.8%, but I thought it was a tall order for Sage to deliver 7% growth for the full year, noting that a far more demanding step-up to over 8% was required in Q4.
In today’s results, presented by new chief executive Steve Hare (previously Sage’s finance director), organic revenue growth for the year was given as 6.8%. However, this was only achieved because the company announced today that it is looking to dispose of its Sage Payroll Solutions arm, and is treating it as an asset held for sale. But for this decision, organic revenue growth for the year would have been just 6.6%. Similarly, organic operating margin would have been 27.2%, rather than 27.8%, versus guidance of “around 27.5%.”
Playing catch-up
In addition to my doubts about Sage delivering on its fiscal 2018 guidance, I thought its longer-term targets — annual 10% organic revenue growth and organic operating margins of at least 27% — would very likely have to be lowered. I believe the company has been complacent about the ‘stickiness’ of its customers (leaving it vulnerable to competitors offering lower pricing and superior functionality), and also being slower than its rivals to move to a cloud-based business.
In today’s results, we see that much in the new chief executive’s strategy is about playing catch-up. This includes accelerated investment in innovation, and the capability of Sage Business Cloud. This also includes “focus on the c.£1.5bn of products that are in, or have a pathway to, Sage Business Cloud” and “identifying value creation paths for remaining c.£350m of other products, either under Sage’s ownership, in partnership or through an exit.”
The company said today that, as the business accelerates the pace of transition, the organic revenue growth rate may decrease in the short term. At the same time, it said it expects the required investment will reduce the organic operating margin to between 23% and 25% in fiscal 2019.
Doubts
Sage’s latest underlying earnings of 32.51p a share give a price-to-earnings ratio of 16.6, and its dividend of 16.5p produces a running yield of 3.1%. This valuation is cheap, relative to the company’s historical level.
However, due to what I see as past under-investment in innovation and change, and the inroads made by competitors, I’m doubtful whether Sage’s margin-crushing £60m acceleration investment planned for fiscal 2019 will prove to be a one-off. As such, I’m continuing to avoid the stock for the time being.