Interactive Investor

Surging Sage defies doubters

6th May 2015 13:10

Lee Wild from interactive investor

Sage Group is good at what it does. It sold more payroll and accounting software during the six months to March than it did last year, underpinning confidence in full-year forecasts. It's why the shares are up another 6% to levels not seen since the dotcom boom in 2000. But after a significant rerating in recent years, how much more will investors pay for what the City thinks might only be modest growth over the next few years?

Certainly, there is lots to like about Sage. Organic revenue grew by 6% during the first-half, faster than last year, and recurring revenue - now 73% of all sales - rose by 8%, driven by a 29% surge in software subscriptions. A 70-basis-point increase in margin to 28.1% - just above Sage's year-end target - had organic operating profit up 9% at £192 million.

There are some benefits which beefed up the half-year numbers that will probably not reoccur in the second half, including £3.5 million of sales following new tax rules in Malaysia. But annual results will be unaffected. And, crucially, there is further encouraging progress on Cloud. The number of paying subscriptions for Sage One, the firm's global cloud solution for smaller businesses, doubled to 115,000, and is up from 86,000 since the September year-end.

"We have delivered a good first half performance and remain on track to meet our financial targets this year," said chief executive Stephen Kelly Wednesday, outlining changes being made to underpin longer-term growth plans. "These include organisational and product improvements which will help drive sustainable, profitable growth and build on Sage's existing strengths. We are at the start of this journey which will take a couple of years to fully implement."

We'll get more detail at a Capital Markets Day in June.

Clearly, the arrival of Kelly, the dynamic former government chief operating officer, in November last year created plenty of excitement. Kelly has successfully run US tech firm Chordiant and the UK's Micro Focus, and Sage's full-year results published just a month after his arrival caused a sharp rally in the share price.

Shareholder support

Major shareholders are understandably happy with progress. “It's still early days under Stephen Kelly’s tenure but I am encouraged by the results and more importantly the initiatives he is already introducing,” says Trevor Green, head of UK equities at top six shareholder Aviva Investors.

Green met Kelly at around the time he became CEO and is seeing him again tomorrow. “He’s a breath of fresh air,” Green told Interactive Investor. Kelly hasn’t even had a chance to make his mark yet, and, interestingly, decided against a ‘kitchen-sink job’ at both the full-year and now the interim results.

But Sage is one of the few FTSE 100 companies where more analysts say ‘sell’ than ‘buy’. For now, they’ve been proved wrong, and Green believes it’s time to be “patient” with Sage shares and let Kelly get on with it.

And there is plenty for him to do. Sage One, for instance, is an inferior cloud offering to the opposition, argue bearish analysts.  “Kelly will need to quicken product development,” says Green, although he accepts it will take time. “Discovering why Sage is successful in UK and less so elsewhere will also need investigation.  Sage America needs a new CEO, too.”

However, others believe the valuation is too rich. Since 2008, the company has more than tripled in value, and at 528p the shares trade on about 22 times EPS forecasts for the year to September 2015, and still over 20 for 2016.

Interactive Investor’s own Share Sleuth said in February, with the share price at 480p: "At 20 times adjusted profit the earnings yield is 5%. Investors are paying quite a high price for current earnings, perhaps because they see many years of steady but unspectacular growth ahead." The article is well worth another read.

A month later, broker Panmure Gordon called time on the Sage rally. "While bemoaning historic expenditure on marketing, Sage must increase marketing spend to build mindshare into the entrepreneurial community."

"Our current investment view is that Sage's share price is a neat illustration of the stock market adage of 'Buy the rumour, sell the news'. The risk/reward profile has changed to the negative. Shares trading on a PE of 19.2x and EV/EBITDA 10.9x - a premium to the peers despite its lack of growth. Watch the effect as momentum investors drift away."

Well, they haven't, yet. However, the shares are currently overbought, according to the relative strength index (see chart), and they have strayed far from the 200-day moving average.

Supporters point to Sage's attractive business model - a large customer base, ongoing migration to subscription pricing, and strong recurring cash flows. That’s all good, but it is next month's Capital Markets Day, where Kelly will reveal his strategic vision for Sage, which will likely decide the outcome of this momentum trade, at least in the short-term.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.