The Sage (LSE: SGE) share price is down by 13%, as I write, after the company reported a 4% fall in organic operating profit, which fell to £391m.
The accounting software firm’s results also showed a sharp 26% drop in sales of its older, non-subscription products. Although management says this reduction is in line with the firm’s strategy, the market appears to be taking a cautious view on the news.
Why profits are falling
Sage’s accounts for the year ending 30 September show that £1,197m of the group’s revenue came from subscription revenue, a 20% increase on last year.
Just £192m of revenue came from older, non-subscription services. However, this figure has fallen by 26% over the last year. That’s a much faster decline than expected. The company says this is due to the impact of Covid-19.
Profits also came under pressure due to a £17m provision for expected bad debts in connection with the pandemic. The end results is that organic operating profit fell by 3.7% to £391m last year. This figure excludes profits from assets to be sold, to provide a picture of continuing performance.
Sage’s profits seem likely to remain under pressure next year. CEO Steve Hare says profit margins are now expected to fall by up to 3% during the coming year. Although margins are expected “to trend upwards over time,” this guidance may explain why Sage’s share price has fallen today.
Sage shareholders: here’s the big picture
In recent years, Sage has been working hard to shift its customers from older software products to online subscription services. The process has been challenging at times. This is reflected in Sage’s share price, which is largely unchanged from five years ago. However, highly-regarded fund managers including Nick Train have stayed loyal, supporting this transition.
Online services are paid for by regular recurring payments, rather than one-off purchases. Over time, the shift to subscription services is expected to make Sage’s revenue more predictable. However, in the short term, it may be slowing profit growth.
The good news is that renewal rates are extremely high. Today’s figures show 99% of subscription revenue was renewed last year, with 65% of the firm’s customers now choosing this option. In total, about 84% of the group’s revenue came from subscription payments last year.
Will the Sage share price keep falling?
There’s no way of knowing whether Sage shares will continue to fall. But today’s results don’t appear to suggest any serious concerns for shareholders.
The group’s operating profit margin of 21% is in line with historic averages. Borrowings are also low and Sage’s cash generation comfortably covers the dividend. Typically, this suggests a dividend cut is very unlikely.
Based on today’s results, Sage shares trade on 21 times earnings with a dividend yield of 2.9%. That’s a slightly cheaper rating than I’ve seen in recent months, reflecting the weaker outlook for 2021 profits.
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Roland Head has no position in any of the shares 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.
Motley Fool UK 2020