Sage punters puzzled by accounting change

Valuation has been a sticking point for many potential investors in Sage. Shares in the payroll and accounting software giant have steadily recovered from the financial crisis lows, and now trade at levels last seen before the technology sector imploded 15 years ago. But forecasts imply double-digit earnings growth both this year and next, and forward valuation multiples are bang in line with peers.

Admittedly, results for the 12 months ended 30 September were mixed, with organic revenue growth of 6% matching forecasts and company targets. But operating profit of £380 million and earnings per share (EPS) of 24.9p seem a little light.

An accounting change also caused confusion and is suspected of triggering an early 6% slump in the share price Wednesday. Deciding to treat payments made for referrals by US business partners as costs, rather than as deductions to revenue, increased the top line by over £46 million.   

But it means extra revenue with no associated profit as costs rise, too. That put revenue at £1,436 million, which, as JP Morgan points out, is technically 3% above consensus estimates.

"We believe it would have been in line if consensus had also made the adjustment," explained the broker.

(click to enlarge)

Organic recurring revenue on the old reporting basis grew by 9% over the year to more than £1 billion, driven by a 29% increase in software subscriptions. SSRS (software & software-related services) revenue rose by 2%. A tight grip on costs meant group operating profit margin improved by 70 basis points (bp) in old money to 28.2%, or 27.1% under the new reporting regime.

JP Morgan forecasts an increase in revenue to £1.5 billion in the year ending September 2016, driving adjusted pre-tax profit up to £401 million and EPS to 27.8p. On those numbers, Sage trades on a forward price-to-earnings (PE) ratio of 20 times for the calendar year, in line with the global software sector.

And that's certainly not going to put investors off, in the short-term at least. Chief executive Stephen Kelly has been in the job just over a year now, and in June spelled out his strategic vision. Unfortunately, struggling equity markets were in no mood for it, and Sage shares limped along until the end of September. 

There was also little in Kelly's masterpiece to convince analysts to upgrade guidance on revenue growth from 6%, or improve the outlook for margins. Previously-bearish Investec, however, did shift Sage shares up from 'sell' to 'hold' and its price target to 535p.

"Our basic view is that the next 12-18 months is full of low hanging fruit, but thereafter the transition becomes tougher," the broker said. That's something hinted at by Kelly today, admitting: "Transformation is rarely linear and it is clear we have much to do as we manage the operational risks."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.