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A Sage reminder: software is a mixed bag

What do results from the UK's biggest software company tells us about the state of the domestic sector?
November 20, 2020
  • Even at Sage, the UK’s biggest listed software company, profits wobbled this year 
  • Mixed performances across the sector show digital services are no guarantee of success
IC TIP: Buy at 590p

‘Digital transformation’ has been one of this year's most heavily used buzz-phrases - and rightly so, given how many of us would have struggled to survive 2020 without the more rapid adoption of technology. But among listed UK tech stocks, the picture has been more mixed than their super-charged American counterparts.

Take enterprise software group Sage (SGE), which frequently points out that its market value makes it the London Stock Exchange’s largest software company. The company also has all the hallmarks of a quality software operation. In the 12 months to September, cash conversion came in above 100 per cent, and recurring revenue grew to 90 per cent. As such, Sage is now supported by a huge £1.2bn worth of cash and available liquidity, with a net debt to adjusted cash profits (Ebitda) multiple that sits comfortably at 0.3.

It hasn't entirely escaped the economic impacts of the pandemic, however. Indeed, a £17m bad debt provision connected to Covid-19 contributed to a dip in organic operating profit to £391m. The news was enough for investors to hack off a tenth of the group’s market value on the morning of the results.  

Compare that to US peer Intuit (US:INTU), which reported quarterly results just hours before Sage. The group's top-line grew by 14 per cent to $1.3bn (£0.98bn) in the three months to October, with all of divisions posting growth - including its small business and self-employed group. Meanwhile at Sage, lower levels of upselling to existing customers meant annual recurring revenues to the segment dipped to 99 per cent, from 101 per cent the prior year.

But this is perhaps an unfair comparison, especially as the UK tech sector has never been as strong as its US counterpart. Even then, there are some glimmers of hope. Micro Focus (MCRO), whose value has been depressed since the botched integration of Hewlett-Packard Enterprise’s (US:HPE) software business back in 2017, posted a tentatively upbeat update this week. Although the software and consultancy group said it expected to post a 10 per cent decline in revenue for its October-end financial year, an expected adjusted Ebitda margin of 39 per cent is towards the upper end of forecasts and suggests progress has on a multi-year turnaround plan has been made. That was enough to send its shares flying up by almost a third on the day of the release. 

The sector is no stranger to volatility such as this. Another big fish, Blue Prism (PRSM), also saw its share price jolt this week - albeit in the opposite direction. A note published by short-seller ShadowFall expressed the same concerns in our sell tip, highlighting alarmingly feeble spending on research and development, compared to outlays on sales and marketing. 

This week has provided a further sign that the UK tech sector is a mixed bag, even if several trends across the industry should buoy quality companies in the long-run.

Faster acceleration of cloud-based softwares, for example, should help drive overall revenue growth, even as some hard-pressed customers cut back on their IT spending. Indeed, Sage has committed to additional investment in its business cloud solution, where its penetration rate increased by a tenth to 61 per cent this year. The group may have seen profits waver slightly in 2020, although given that its long term value remains intact, we think the stock is still worth a buy on less than 20 times' FactSet-compiled earnings forecasts for FY2022.

Nevertheless, the fact that a high-quality stock like Sage has not been able to avoid the impact of Covid-19 should remind investors that the broader 2020 tech success story doesn't apply to every company in the industry. 

SAGE (SGE)    
ORD PRICE:590pMARKET VALUE:£5.95bn
TOUCH:590-591p12-MONTH HIGH:795pLOW: 535p
DIVIDEND YIELD:2.9%PE RATIO:21
NET ASSET VALUE:164p*NET DEBT:10%
Year to 30 SepTurnover (£bn)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
20161.4424217.414.20
20171.7234223.915.42
20181.8539827.216.50
20191.9436124.516.91
20201.9037328.417.25
% change-2+3+16+2
Ex-div:14 Jan   
Payment:11 Feb   
*Includes intangible assets of £2.2bn or 215p a share

Last IC View: Buy, 712p, 23 Jul 2020