Join our community of smart investors

Sophos tumble highlights risks of highly-rated sector

Amid high market expectations, the cyber-security group has warned of slower billings growth
July 9, 2018

Things had been looking up for Sophos (SOPH), with the shares rallying in April on news that full-year billings had risen to the top end of management's 20-22 per cent guidance. However, that momentum has not been sustained. Billings grew by around 6 per cent during the first quarter, or a meagre 2 per cent at constant currencies – the worst performance in more than two years. 

IC TIP: Sell at 472p

While Sophos expects to report mid-teens growth in new customer and network security billings over the respective period, the disappointing overall result stems largely from its enduser security business, which had a “particularly challenging comparable”. For the same quarter a year earlier, demand was buoyed by infamous hacking events including so-called ‘WannaCry’ – sending underlying enduser billings growth at constant currencies up more than half. Last year’s first half also saw a maiden contribution from Intercept X, the group’s new endpoint product.

Sophos says these circumstances will continue into the second quarter, although comparisons should become “somewhat easier”. However, it anticipates returning to mid-teens constant-currency billings growth in the second half, while its long-term outlook hasn’t changed. It also highlighted strong revenue and cash flow for first quarter.

Analysts at Shore Capital recommend ignoring quarterly billings volatility, or to see the resulting share sell down as a buying opportunity – pointing to Sophos’s strong competitive and strategic position. It forecasts a free-cash-flow yield of 6.2 per cent for the 2019 calendar year – a decent premium to the 4.3 per cent average for US-listed peers including Qualys, Palo Alto and Checkpoint among others. The brokerage reckons the shares’ decline has “created better value” – despite there being more uncertainty around billings growth.

On the latter point, Shore Capital now expected billings to rise 9 per cent for the year to March 2019, while cash profit margins should remain broadly flat against a previously forecast one percentage point improvement. Still, for 2020, it predicts a 1.5 percentage point margin lift, and mid-teens billings growth.