2018 was a rough year for the FTSE 100’s largest tech stock Microfocus(LSE: MCRO). In March, the stock slumped by more than 50% after management issued a dire trading update and investors fled.
The stock has recovered slightly since, but it’s still down 35%, excluding dividends, over the past 12 months. However, despite this poor performance, I think Microfocus has the potential to double in 2019. Here’s why.
Steadying the ship
Microfocus has run into problems integrating Hewlett Packard Enterprise’s software division, which it acquired for £6.6bn in 2017. After issuing a revenue warning in March, in July, management admitted that the merger is a year behind schedule. This did little to improve the group’s reputation.
Since then, the business has repaired some damage by announcing the sale of one of its legacy divisions, Suse, for $2.5bn. A large chunk of the sale proceeds are being returned to investors via a special dividend in a few weeks, and Microfocus is also buying back shares.
I think this could be just the start of Microfocus’ recovery. There haven’t been any further profit or revenue warnings since the beginning of last year, and management’s decision to return cash, rather than pay down debt, tells me it’s confident the business is heading in the right direction.
Management has more at stake than most. Executive chairman Kevin Loosemore has more than £10m invested and management bonuses are tied to total shareholder return.
If Microfocus has managed to put most of the bad news behind it, I think the stock could rise substantially over the next 12 months.
Right now the shares are trading at a forward P/E of 9.7, compared to the IT sector median of 18. If investor confidence returns, I see no reason why the shares can’t trade up to this level, implying an upside of 83% from current levels. Throw in the 5.6% dividend yield as well as the special payout, and it’s not unreasonable to suggest that Microfocus could double investors’ money in 2019.
If Microfocus is too speculative for you, you might be interested in Softcat(LSE: SCT).
Unlike Microfocus, this company has gone from strength to strength over the past year. City analysts have consistently revised their earnings projections for the group higher since the beginning of 2018 and are now expecting year-on-year growth of 7.8%. And, according to a trading update issued by the firm today, it looks as if the software business is now on track to exceed these forecasts.
In particular, the update notes: “As we approach the end of our first half, we are now materially ahead of where we expected to be at this stage of the year.“
It seems the cybersecurity business has seen a surge in demand for its services over the past six months, which is likely to be a result of the uptick in high profile cyber attacks in 2018. As the world becomes increasingly connected, the trend is only expected to continue and, as long as Softcat continues to meet customer demands, its revenue and income should feel the benefits.
Unfortunately, the stock isn’t particularly cheap. It’s currently trading at a forward P/E of 19.2, although considering today’s update, this multiple is now out of date. Still, I think it’s worth paying a premium valuation for such a high-quality business.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Micro Focus. 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.