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Sophos - momentum weaker, but CEO still confident longer-term

George Salmon | 26 July 2018 | A A A
Sophos - momentum weaker, but CEO still confident longer-term

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Sophos Group plc Ordinary 3p

Sell: 572.30 | Buy: 572.30 | Change 0.30 (0.05%)
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IT security firm Sophos' first quarter trading statement confirms, as expected, that the rate of billings growth has slowed.

The shares dipped 2.6% lower on the morning of the release.

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Our view

Sophos provides IT security services for small and medium sized businesses, with over 100m users in 150 countries.

It has market-leading products, and offers a high standard of both network and end user protection. Customers benefit from a joined up service under a centralised system, with sales conducted through a network of 39,000 independent partners.

Contracts usually run for up to 3 years. Sophos has delivered impressive results when renewal times have come around by consistently increasing the value of its existing contracts through upselling and tacking on additional products.

All this comes with low capital requirements. That means cash flows are significant. Although there's a yield on offer, it's negligible at present, with spare cash being ploughed back into growth.

Given the increasing demand for cyber-security, and high profile attacks on companies and governments, Sophos has long term potential. Its shares command a premium rating as a result - with a PE ratio of 45.9.

Unfortunately, growth, which has been spectacular in the past, has proven unpredictable of late. And when your shares are expensive, failing to deliver growth can be costly. A series of mixed results in recent quarters has seen the price bounce around.

We don't think that's too much of a problem. We'd expect product launches and cyber security flitting in and out of the news to impact momentum.

While we can get onside with management's argument that slower growth so far this year is a short term blip in the long term trend, we're a bit concerned that their guidance hasn't been completely accurate.

For example, full year results, which came just seven weeks before the disappointing first quarter numbers, contained little hint of the slowdown the group must already have been seeing. Management have some work to do rebuilding credibility.

We still think Sophos has a strong position, selling attractive products to a growing market. In the long-term, that's the most important thing.

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Q1 trading details

Group billings rose to 6%, or 2% at constant currency, to $175m. That's behind the rate of growth the group has previously reported.

While unlevered free cash flow rose 31%, higher R&D and marketing expenses saw earnings before interest, tax, depreciation and amortisation drop from $27.3m to $20.3m.

The slowdown in billings growth is due to Enduser security billings dropping 1% (5% at constant currency). Sophos says weaker momentum is due to a tough prior year comparable, where billings rose over 50%, boosted by the WannaCry attack. Network security billings rose 12% (7% constant currency).

The group's renewal rate has fallen from 141% to 114%, impacted by a product transition within Networks and the timing of the WannaCry attack.

Sophos has previously said investors should also expect a relatively modest rate of growth in Q2. However, looking forward to the second half, group CEO Kris Hagerman expects renewal rates to improve back towards a 'more normal' range, and is confident Sophos can deliver constant currency billings growth.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.