Shares of FTSE 100 accountancy software firm The Sage Group (LSE: SGE) were down by 10% this morning, after the company warned that full-year sales would be lower than expected.
It’s the second disappointing update this year from the firm. Investors rushing for the exit have now pushed the Sage share price down by nearly 30% from January’s high of 825p.
What’s gone wrong?
In January Sage blamed its French business for a slow start to the year. Today the company said that “inconsistent operational execution” meant that organic revenue growth was “below management’s expectations” during the six months to 31 March.
Organic revenue growth, which excludes acquisitions, is now expected to be 7% this year, rather than 8% as previously guided.
Sage is trying to shift its customers onto a subscription-based model that generates recurring revenue. Unfortunately some customers appear reluctant to make the shift. Today’s figures show that recurring revenue grew by just 6.4% during the first half of this year, compared to 11.1% during the same period last year.
A good business at the wrong price?
One attraction of this business is that many customers pay up front for their services. This means that cash generation is quite strong.
Profit margins are also high — Sage had an operating margin of 20% last year.
Overall, I believe this business could be a good income investment. But adjusted earnings are only expected to grow by 1.2% this year and by 9.6% in 2018/19. And today’s news makes me think that even these forecasts could be in doubt.
Despite the risks, Sage stock still trades on a forecast P/E of 17 with a prospective yield of 2.9%. That’s too expensive for me. I’ll start to get interested if the share price falls below 500p.
Much stronger growth
FTSE 250 network security specialist Sophos Group (LSE: SOPH) is enjoying much stronger growth. The company said recently that it expects to report billing growth of 20%-22% for the year ended 31 March. Management says the business remains on target for annual billings of $1bn by 2020.
Strong growth in billings is encouraging, but what about profit? Since floating in 2015, Sophos hasn’t made a profit. However, analysts expect the group to move into the black this year with an adjusted net profit of $21.7m. Profits are then expected to rise by 59% to $46m in 2018/19.
A cash machine?
Like Sage, Sophos benefits from customers paying upfront for its services. This is why the company generated an operating loss of $23.8m during the first half of the year, but also generated free cash flow of $61.7m.
These upfront payments are initially booked as deferred revenue, which is classed as a liability. They should generate accounting revenue and (hopefully) profit as they’re delivered over the next year and beyond.
Should you buy?
One of the risks of taking cash upfront is that if future sales growth slows, a company can experience a cash crunch. Although this might not be a problem for Sophos, I am concerned that a lot of future growth is already reflected in the share price.
With the stock trading on 65 times 2019 forecast earnings, I think there’s a high risk that the shares’ recent decline could continue. I think there’s better value elsewhere for income and growth investors.
