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Micro Focus is a quality stock going cheap
We believe there is a clear investment opportunity at Micro Focus (MCRO), the UK’s largest listed software company.
The share price is drifting around the £20 mark, down 25% on November’s record highs and down 21% since half year results at the start of January.
The shares look oversold following weak figures in January. There is a clear path to turning round the operational and share price performance.
WHAT DOES IT DO?
Micro Focus provides software modernisation products and functionality to legacy IT systems. Many large organisations have years of investment stacked up in their IT systems, so ripping them out and starting again is out of the question.
Micro Focus uses its years of expertise in core computing languages, such as COBOL, Linux and the open source SUSE suite. This is applied to creaking client IT infrastructure to make it fit for the modern age of cloud computing, e-commerce, and mobile applications.
Management have years of experience in squeezing maximum value from older infrastructure, making 40%-plus operating profit margins in the process. Extracting this sort of performance from its $8.8bn HPES acquisition is the key to future returns.
HPES has now been fully integrated into the Micro Focus family for five or six months and has been firmly focused on core functions, such as IT security, application delivery, modernisation and connectivity.
The recent half year results were the first to include a contribution from the HPES. The contribution from the acquired assets and performance from older products was disappointing, hence the share price decline. Micro Focus needs to prove that was a one-off setback.
Standardising systems, functions and office locations are the next step in value extraction, plus a new combined go-to-market model. We expect underperforming parts of its business to face the axe.
Longer-term, the company has exciting operational leverage potential, essentially meaning it should be able to grow sales faster than costs. This helps underpin the investment attractions if revenue trends stabilise and profit quality improves.
These positive drivers translate into targeted annual returns of around 15% to 20%, impressive for such a large and mature business. This ambition which is backed by a strong historic track record.
It is forecast to pay $1.05 in dividends for the year to 31 October 2018, implying a 3.7% income yield. Expect double-digit payout growth in the future.
This trade is not without risk for shareholders but a full year 2019 price to earnings multiple of 11.8 means the balance between risk and reward looks very attractive. (SF)