For as far back as I can remember, the FTSE 100’s Sage (LSE: SGE) has run a growing and defensive business with a trail of impressive trading and financial figures stretching back years.
But the integrated accounting, payroll, and payments solutions provider has been changing its business model and changing it for the better. Chief financial officer Jonathan Howell explained in today’s first-quarter report that the firm is now focusing on building up recurring revenue by moving customers to cloud-based subscription services, “in line with our vision to become a great SaaS company.”
I reckon the strategy shows that Sage is adapting for the times and evolving its business. And recurring subscriptions are like manna from heaven when it comes to generating the kind of consistent and growing cash flow that drives a progressive dividend policy.
Overall, I like the noises Sage is making and see the little stumbles in earnings we saw in 2018 and 2019 as an opportunity to pick up shares in a great company while they’ve been temporarily knocked back. But the reduction in the valuation is disappearing fast. The stock is up almost 6% as I write on today’s update, and has been broadly rising since last October.
Howell said in the report that first-quarter trading was ‘’strong… as expected.” Last year’s growth momentum carried forward into the start of the current year, which suggests to me the earnings hiccup could be behind the firm. Indeed, City analysts following the company expect a low-single-digit percentage increase during the current trading year and a high-single-digit advance the year after.
Consistent and growing cash flow
Despite the earlier setback with earnings, the dividend didn’t miss a beat and has risen a bit each year, fed by cash flow that has been storming higher over the past couple of years – the very period that earnings dipped. “Follow the cash” is a well-used nugget of advice often passed between investors, and in this case, the cash performance of the company could have encouraged us to buy the earlier dip in the share price.
Today’s figures reveal that around 78% of recurring revenues now represent a future Sage business cloud opportunity with a clear path to migration. And recurring revenue accounts for about 88% of total revenue. It seems to me that the firm is making great progress, and an advance of almost 11% in recurring revenue in the period adds to my conviction.
With the shares at 771p, the forward-looking earnings multiple for the trading year to September 2021 is around 24 and the anticipated dividend yield is just over 2.3%. It’s true to say that the valuation reflects the quality of the enterprise, but it has done for a long time. On balance, I’d buy the shares today and hold for the long-term opportunity.
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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has recommended Sage Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.