UK Edition
Investor sentiment has deteriorated dramatically since the start of the year. Double-digit inflation, rapid interest rate rises and political uncertainty are just some of the factors that have prompted many investors to adopt an increasingly downbeat outlook regarding the stock market’s future.
Some companies have followed suit, with a slowing global economy prompting them to assert that they are now more cautious about their financial outlook. However, other businesses, such as the FTSE 100’s Sage, are far more sanguine about their future prospects. In fact, the company stated in its recent full-year results that it expects to deliver a rising operating margin in 2023 and in future years.
The provider of integrated payroll and accounting systems has good form when it comes to improving profitability. Its organic operating margin increased by 40 basis points to reach 19.9pc in the 2022 financial year. Further margin growth is expected to be delivered via plans to scale the business and benefit from resulting operating efficiencies.
In the previous financial year, acquisitions sped-up this process. They were made possible by the company’s sound financial position. Indeed, the company’s net debt-to-equity ratio stands at just 52pc, while net interest costs were covered 12 times by operating profit last year. Alongside strong cash flow, this shows it is well placed to further broaden and expand its range of services.
The company’s business model means that it has excellent revenue visibility. In fact, a fear of high switching costs means that many of the small and medium-sized firms that make up its customers have significant inertia when it comes to moving to a different provider. This provides Sage with substantial pricing power that bodes well for its prospects in a period of rampant inflation.
In addition, its successful transition to a subscription-based offer means 95pc of its revenue is recurring rather than one-off. This provides relative stability during a period of economic uncertainty that could prove to be highly desirable to today’s cautious investors. With annual recurring revenue increasing by 12pc last year and a renewal rate by value of 101pc, the company’s new customer acquisition, cross-selling and up-selling strategies seem to be working well.
Of course, Sage is not immune from the challenging global economic outlook. With about 99pc of OECD firms being classed as small and medium-sized, tough operating conditions almost inevitably mean that some of them will fold in the current environment of stagflation. However, with the company’s total addressable market forecast to grow at an annualised rate of 10pc over the next two years and structural trends such as digitalisation expected to remain, it has a clear path to growth.
Moreover, its products could help make small and medium-sized businesses more efficient in an era where profitability comes under relentless pressure across many industries. And with a global reach, it is not reliant on one region for its sales.
Since first being tipped as a “buy” in this column in September 2016, Sage has delivered a 9pc capital gain that is marginally below the FTSE 100’s 10pc return over the same period. While index underperformance is disappointing, the company has successfully transitioned from selling its software as a one-time purchase to an overwhelmingly subscription-based business over recent years.
In Questor’s view, it now has a solid platform from which to deliver strong profit growth as it increases in size over the coming years. Its capacity to raise margins brings scarcity value, while a high proportion of recurring revenue that is relatively sticky, alongside a solid balance sheet, means it offers less risk than many stocks in the current period of uncertainty.
As ever, investors are required to pay a premium given the stock’s attractive risk/reward ratio. It trades on a forward price-to-earnings ratio of 27. Although this is significantly higher than for many large-cap shares, we remain upbeat about the stock on a long-term view.
Questor says: buy
Ticker: SGE
Share price at close: 793.4p
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