Sage Group PLC (LON: SGE) – Significant value creation through sustainable profit & cash generation.

Sage Group PLC (LON: SGE) is an FTSE 100-listed Company engaged in providing business software and solution across North America, North Europe, Central Europe, Africa, the Middle East, Asia, and Latin America. The primary focus of the Company is to provide accounting service for mid-scale and small-scale companies. SGE’s products can be bifurcated into two broader categories – Cloud-connected & hybrid solutions and Cloud-native solutions. Moreover, SGE’s cloud portfolio includes Sage X3, Sage 200 Cloud, Sage Accounting, Sage Intacct, Sage People, Sage 50 Cloud, Sage 50 Payroll, etc. SGE is serving millions of small and medium customers around the world. Furthermore, the Company has a strong digital and direct sales presence well-supported by a global network of partners.

On 14 May 2021, SGE will release the FY21 interim results.

(Source: Company presentation)

Technological Initiatives

The Company believes in resolving customer problems through the integration of emerging technology and accelerated progress of Sage Business Cloud solutions. Moreover, SGE has developed new technology platforms enabling cloud-connected customers to shift to a cloud-native solution. Furthermore, the Company had taken the initiative to start Sage FutureMakers aiming to inspire people in AI (Artificial Intelligence) and educating them on the benefits of technology. Meanwhile, the acquisition of Ocrex and AutoEntry would enable the Company to accelerate its vision to become SaaS (software-as-a-service) Company. SGE has demonstrated the new technology of Einstein Analytics to produce more granular SaaS metrics used within the Finance and business teams.

(Source: Company presentation)

Furthermore, the Company is making significant investments to accelerate its growth trajectory with R&D (Research & Development) investments in AI (Artificial Intelligence) and the cloud.  SGE has increased the R&D expenditure by approximately £60 million since 2018. The R&D expenditure represented around 15% of total recurring revenue during FY20. 

Recent Trend of Dividend Payments

(Source: Company website)

SGE has adopted a progressive dividend policy with consistent dividend payments at the end of each financial period. Moreover, the Company had paid a final FY20 dividend of 11.32 pence per share on 11 February 2021 and an interim FY20 dividend of 5.93 pence per share on 12 June 2020. The ex-dividend date for the final dividend was 14 January 2021. The total FY20 dividend remained at 17.25 pence per share, which is approximately 2% more than the total dividend paid during FY19.

Growth Prospects and Risk Assessment

SGE would continue to invest heavily in cloud-based platforms as most of the industries are seeking digital transformation during these challenging business conditions. SGE already witnessed a substantial shift as it focuses more on software as a service for the last two years with a strategic objective of becoming a SaaS company. The total addressable market for the Company would be around USD 33 billion in 2021, and the market for cloud software would be expected to be more than that of on-premise software. Moreover, the total addressable market comprised 69 million small and medium businesses. The benefits of cloud applications became more visible with the emergence of the Covid-19 pandemic. Meanwhile, Cloud adoption rates are estimated to reach 51% in 2021 and 54% in 2022 on a global level. The U.S. would be the most cloud adoptive region, with the cloud adoption rate expected to reach 57% during 2021.

(Source: Company presentation)

The cloud services market can be bifurcated into various business segments like infrastructure as a service (IaaS), software as a service (SaaS), platform as a service (PaaS), business process as a service (BPaaS), cloud advertisement services, and cloud management & security services.

However, there are certain potential risks that can impact the business, such as cybersecurity & data privacy, third-party reliance, leveraging disruptive technology, inability to understand customer needs, execution of product strategy, failure to identify the value of data and live services management. Moreover, considering the technology industry, SGE needs to invest heavily in innovation & system maintenance, and failure to do so would impact the Company’s financial performance.

Industry Outlook Dynamics

According to Grand View Research’s latest report, the market size of the global cloud computing industry was USD 266.00 billion during 2019. Furthermore, the industry is expected to grow at a CAGR of 14.9% from 2020 to 2027. Moreover, the cloud computing industry would be boosted by growing digital transformation and rising penetration of the internet worldwide.

After understanding the industry dynamics, we will analyse some key fundamental and shareholders statistics of Sage Group Plc.

Recent Developments

On 18 March 2021: The Company has appointed Andy Duff, as a Chair of the Sage Board. Andy will join as a Non-executive Director on 1 May 2021. Andy Duff has succeeded Sir Donald Brydon. He will join as a Chairman at the end of September 2021.

On 4 March 2021: Sage announced a share buyback programme of around £300 million. The buyback programme will kickstart from 4 March 2021 and is expected to end around 4 September 2021.

On 2 March 2021: The Company has appointed Derek Harding, as an independent Non-executive Director.

On 1 March 2021: Sage Group has confirmed that it has completed the Polish business's disposal.

On 18 February 2021: It has launched and successfully priced a debut bond offering of £350 million 1.625% notes.

A Glimpse of Business Segments (FY20)

Trading Update (for the three months ended 31 December 2020, as on 21 January 2021)

(Source: Company Website)

• Led by successful strategic execution, the trading update was in line with expectations.
• The recurring revenue surged by 4.7% year-on-year, with an increase in software subscription of 11.3% YoY.
• As per region-wise, North America recurring revenue increased by 6.4% YoY, and Northern Europe recurring revenue surged by 3.3% YoY. In other regions, the performance was largely in line with expectations.
• Total Group revenue for Q1 FY21 increased by 1.4% YoY to £447 million.
• The Company has shown a strong balance sheet, with £1.2 billion of cash and available liquidity and £129 million of net debt.
• In Q1 FY21, the Company saw a good demand for Sage Business Cloud solutions, driven by recurring revenue growth.
• It also saw strong growth in cloud-native revenue, with new customer acquisition.
• The Company has mentioned that there is a limited impact on the Group’s business on account of COVID-19.
• Overall, the sustained investment in Sage Business Cloud throughout the economic cycle will form a robust base for the long-term success of the Group.

Financial and Operational Highlights (for the year ended 30 September 2020 (FY20), as on 20 November 2020)

(Source: Company Website)

• The Company delivered a strong financial performance in FY20, with continued strategic execution.
• Excluding assets held for sale, the organic recurring revenue surged by 8.5% YoY, supported by software subscription revenue growth. Moreover, the recurring revenue (including assets held for sale) rose by 8.2% YoY, reflecting the continued focus on attracting new customers and migrating existing customers to subscription and Sage Business Cloud.
• It has a resilient balance sheet, with cash and available liquidity of around £1.2 billion and net debt to EBITDA of 0.3x as at 30 September 2020.
• The Board declared a final dividend per share of 11.32 pence, bringing a total dividend per share of 17.25 pence. The increase of 2.0% in full-year dividend was driven by strong business performance, liquidity position and cash generation.
• For the last two consecutive years, the cash conversion was above 100%, underpinned by sustained working capital improvements and continued software subscription growth.
• Despite the uncertain economic backdrop, Sage expects FY21 organic recurring revenue growth to be in the region of 3% to 5%, weighing towards H2 FY21.
• Meanwhile, the organic operating margin is expected to be up to three percentage points below FY20, which might vary depending on the additional investment level.

Financial Ratios (FY20)

Share Price Performance Analysis

On 19 March 2021, at the time of writing (before the market close, at 8:02 AM GMT), Sage Group PLC shares were trading at GBX 575.80, down by 0.66% against the previous day closing price. Stock 52-week High was GBX 774.40, and Low was GBX 515.60, respectively.

From a technical standpoint, 14-day RSI (42.44) supports an upside potential. In the last ten years, Sage Group PLC’s stock price has delivered a return of ~207.60% as compared to ~71.52% return of the FTSE 100 index and a ~190.97% return of the FTSE All Technology index, which shows that the stock has outperformed the benchmark sector and the benchmark index.

Valuation Methodology: Price/Earnings Approach (NTM) (Illustrative)

Business Outlook Scenario

SGE witnessed robust demand for Sage Business Cloud solutions, which resulted in higher recurring revenue during the first quarter of the financial year 2021. Moreover, SGE demonstrated robust growth in cloud-native revenue through the acquisition of new customers. Sage Group witnessed a negligible impact on business performance due to the Covid-19 pandemic.

The Company would continue to focus on accelerating the progress of cloud-native solutions in the largest markets, such as Northern Europe and North America. It would also focus on embedding SaaS capability and culture throughout the Company. SGE had provided financial guidance as it projected FY21 recurring revenue to show growth ranging from 3% to 5%. The FY21 organic operating margin would be expected to drop by three percentage points from the levels of FY20. Overall, the delivery of strategic objectives would bring recurring revenue growth, new customer acquisition, operational efficiencies, and SGE is well-positioned to capture future growth opportunities.

(Source: Company presentation) 

Considering a high-quality recurring revenue growth, strong cash conversion rate, robust balance sheet position,  solid FY20 financial results, decent FY21 guidance, operational conditions improving towards normal levels, robust financial & liquidity position, higher profitability margins, and support from the valuation as done using the above method, we have given a “BUY” recommendation on Sage Group at the current price of GBX 575.80 (as on 19 March 2021, before the market close at 8:02 AM GMT), with lower-double digit upside potential based on 29.78 Price/NTM Earnings (approx.) on FY21E earnings per share (approx.). 

*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.

* The dividend yield is subject to change as per the stock price movement.

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