ii view: here’s why Sage Group shares just dived

This software maker is denting near-term profits to hopefully benefit the long term. Buy, sell or hold?

Full-year results to 30 September

• Revenue down 1.7% to £1.9 billion
• Adjusted operating profit down 3.7% to £391 million
• Final dividend of 11.32p per share
• Total dividend for the year up 2% to 17.25p per share
• £1.2 billion of cash and available liquidity

Guidance:

• Expects organic recurring revenue growth for FY21 to be in the region of 3% to 5%
• Expects organic operating margin to be up to 3% below full-year 2020

Chief executive Steve Hare said:

"We've delivered a strong performance in FY20, achieving recurring revenue growth in line with the guidance we gave at the beginning of the year, despite the Covid-19 pandemic. I would like to thank all of our colleagues and partners for their continuing commitment to our customers, communities and each other during this period. We've also made good strategic progress, delivering against our customer, colleague and innovation commitments. While the near term remains uncertain, these foundations position us well to support customers as they adopt digital business models, and I am confident that our additional investment in Sage Business Cloud, and in particular cloud native solutions, will deliver stronger growth and drive the future success of the Group."

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ii round-up:

Accounting and business software provider Sage Group (LSE:SGE) has warned of a lower near-term profit margin as it upped investment in both product and marketing, banking on a big benefit for margins over the long term.

Profit margin for 2021 is expected to be up to three percentage points below the 22.1% achieved in 2020, depending on the amount of investment made. But looking beyond 2021, it expects margins to trend upwards over time as the investment drives recurring revenue growth and operating efficiencies.

Broker UBS calculates the potential fall in 2021 earnings to be up to a fifth. Sage shares fell by more than 10% in early UK trading, leaving them down over 15% year-to-date. Shares for industrial software provider AVEVA Group (LSE:AVV) are down around 8% during 2020. 

In recent years, Sage has been focused on growing recurring revenue through the transition of customers from desktop software packages to cloud-based subscription services. Organic growth of 8.2% for 2020 was down on the 10.8% achieved in 2019 and is now expected to grow by up to 5% over 2021.

New customers in April at the height of the pandemic crisis halved compared to prior management forecasts, as businesses deferred spending decisions. A £17 million customer bad debt Covid provision was taken over the period. Lower levels of upsell to existing customers was seen during the second half. 

A final dividend of 11.32p per share was declared, bringing the total dividend for the year to 17.25p per share, a 2% increase over 2019. The balance sheet was summarised by management as resilient, with £1.2billion of cash and available liquidity and a net debt to adjusted profit ratio (EBITDA) of 0.3 times. 

ii view:

Sage employs around 13,000 people and serves customers in over 20 countries. It generates strong cash flows and benefits from sizeable and dependable recurring revenues. Its software products are used daily by businesses of all sizes around the world. 

The accounting software provider has been busy investing in cloud computer connected solutions, launching its Sage Business Cloud back in 2018. The primary operational focus for management is to migrate desktop customers and attract new customers to Sage Business Cloud. During this latest year, recurring revenue increased to 90% of total revenue, up from 86% in 2019, with software subscription penetration now totalling 65% from a previous 56%.

For investors, a progressive dividend policy, which has seen consecutive increases made over more than 15 years, offers a key attraction. A forecast and historic dividend yield of over 2.5% is also not to be overlooked in an era of ultra-low interest rates. But the required investment near term outlined in these results adds to the ongoing uncertainty of the drag from the pandemic. An estimated forward price/earnings (PE) ratio above both the three and 10-year averages continues to suggest that the shares are still not obviously cheap. 

Positives: 

• Recurring revenue now represents 90% of total revenue (FY19: 86%)
• Progressive dividend policy

Negatives:

• Organic operating profit margin of 22.1% (FY19: 23.8%)
• Central & Southern European revenues fell by 2%

The average rating of stock market analysts:

Weak hold