US Edition Sage
427p+14p
Questor says BUY
AN UNEVENTFUL trading statement from an accounting software company is probably about as boring as the stock market gets but investors who overlooked Sage on that basis could be missing out on returns of up to 20pc each year for the next two years, say analysts.
The driving force of those returns for shareholders is that Sage is growing again. “Our performance in the first quarter is in line with our expectations, with good growth maintained across all regions,” chief executive Guy Berruyer said in an update on trading for the first three months ended December.
Sage increased revenue by 4pc on average last year, but the implied growth rate in the second half was 5pc. Mr Berruyer says the software group is on target to deliver revenue growth of 6pc by 2015, which would be double the historic 3pc average rate.
High single-digit growth in revenue doesn’t sound all that exciting, but it is all Sage needs for profits to accelerate. At the same time as quickening sales, the company is looking to increase the pricing on its products.
Sage typically provides an accounting software system for an initial fee and then adds on charges for providing support. That support creates recurring revenue — like a snowball rolling downhill. Analysts from Espirito Santo estimate that up to 85pc of group revenues come from just a quarter of its customer base.
Once a customer has a computer system in place that carries out essential activities such as accounting and payroll, for instance, they are unlikely to go through the expensive and risky process of changing it. Analysts believe this dependency on Sage gives the business the ability to increase prices and boost profits further.
“We conclude that the stock has the potential to deliver up to 20pc annual return,” said Vijay Anand, from Espirito Santo.
For investors, the best thing about Sage is that it generates a lot of cash, and it likes returning that money to shareholders.
Operating cash flow increased by £33m, to £417m last year. Sage returned all of that and more through dividends, special dividends and share buybacks. The company has maintained its commitment to the share buyback programme in the year ahead, and analysts believe that could be worth up to £200m, or 17p per share.
Once the man in charge of the numbers has his feet firmly under the table, there could be more announcements about increasing returns to shareholders. Steve Hare joined Sage as chief financial officer only three weeks ago but he has more than 10 years’ experience in top finance jobs, most recently at Invensys between 2006 and 2009.
The shares, trading on 18 times forecast earnings, do not look cheap. Analysts from Panmure Gordon are even more critical: “Once again, we quibble about the valuation which jars against the incipit growth.”
Questor believes they can’t see the wood for the trees. In a stock market fuelled by quantitative easing, most shares in the FTSE 100 are valued highly. Sage might be one of these but that doesn’t mean the price can’t and won’t rise more. The shares are only marginally above its long-run price-earnings ratio of 16 times, and cheap relative to software sector peers on 21 times.
The consensus earnings estimates for Sage are relatively conservative, so if the company delivers on its growth and profit promise, they will need upgrading.
The balance sheet is strong, the free cash flow and earnings cover the dividend more than twice, and it offers a forecast yield of 3pc.
Questor recommended the shares last year (Buy, 373p, December 3) and regular readers of the column have enjoyed 14pc gains since then. There should be more to come. Buy.