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Sage's cloud evolution is nearly complete

The HR and accounting software company has been investing heavily to speed up its transition to the cloud
Sage's cloud evolution is nearly complete
  • 94 per cent of group revenue now recurring
  • Margin expected to start improving

Labour shortages are perceived by many to be a big economic issue of the moment. However, this could turn out to be a blessing for economies that have been complaining about waning labour productivity for years. If companies can’t find cheap labour, the next best thing is to invest in technology to make their current employees more efficient.

This is where cloud accounting and HR software business Sage (SGE) could be set to prosper. The company, which focuses on selling to small- and mid-sized businesses, is currently going through an evolution. Over the last few years, it has been investing heavily in marketing and innovation to speed up its transition to a cloud business supported primarily by recurring revenues.

The latest half-year release suggests the evolution is nearly complete. Organic recurring revenue rose by 8 per cent, feeding into a an annualised increase of 10 per cent to £1.78bn. Overall, 94 per cent of the group’s revenue is now recurring, up from 91 per cent at the 2021 halfway mark. This represents a solid endorsement of the product offering – current customers are clearly happy with the service they are getting. Sage is also bringing in new business. It added £150mn of annualised recurring revenue through new customer acquisition, up 36 per cent from last year.

Management has invested heavily to achieve this growth, which means the organic operating margin slipped 30 basis points to 19.9 per cent despite the sales growth. Cash conversion also fell from 133 per cent to 120 per cent because of an increase in receivables. This is still an impressive conversion rate, but free cash flow was down 14 per cent to £167mn.

The question is how quickly can it ramp up its cash flow now the business has made the switch to cloud? Management said “organic operating margin is expected to trend upwards in FY 2022 and beyond, as it focuses on scaling up the group”.

Pessimists might think that increasingly unfavourable economic conditions might lead to businesses scaling back investment in software. The opposite is probably true. As labour becomes more expensive, the upside of buying software that streamlines HR, paying suppliers and accounting grows.  

Analyst are confident Sage can keep growing through this turbulent period, with FactSet consensus forecasting 2023 free cash flow of £408mn. This gives a healthy 2023 free cash flow yield of 5.9 per cent.

A scalable company in the fast-growing cloud space with decent free cash flow is a nice mix. There is also a speculative possibility that Sage could also sign a partnership with one of the big cloud providers, like FD Technologies (FDP) just did with Microsoft Azure. Either way, even a forward PE ratio of 24.1 shouldn’t be prohibitive. Buy.

Last IC View: Buy, 770p, 17 Nov 2021

SAGE GROUP (SGE)   
ORD PRICE:667pMARKET VALUE:£6.8bn
TOUCH:666-667p12-MONTH HIGH:862pLOW: 612p
DIVIDEND YIELD:2.7%PE RATIO:24
NET ASSET VALUE:118pNET DEBT:54%
Half-year to 31 MarTurnover (£mn)Pre-tax profit (£mn)Earnings per share (p)Dividend per share (p)
202193719013.36.05
202293418914.86.30
% change-0.3-1+12+4
Ex-div:17 Jun   
Payment:26 May   
*Includes intangible assets of £2.36bn, or 232p a share