Why shares in Micro Focus International plc could bounce back
Micro Focus's(LSE: MCRO) share price has taken a battering since last week's trading update showed revenues at the enterprise software company falling faster than expected due to problems with integrating its reverse-takeover of HP Enterprise's legacy software assets.
SUSE
Looking ahead, however, it's important to realise that there's more to Micro Focus than its HPE business. One key reason why I think there's significant upside to its shares is its SUSE product portfolio, which has been delivering sustainable and profitable growth. SUSE is a developer of open source software, providing software-defined infrastructure and application delivery solutions.
I believe the potential of this fast growing business is being overlooked due to the uncertainty surrounding its integration of HPE. Considering SUSE is seeing robust double-digit revenue growth, if things go to plan the division could become a major driver of growth for the company.
Meanwhile, management insists that the fundamental thesis of the HPE software acquisition remains intact. And in a sign of confidence towards the firm's turnaround prospects, five board members have bought nearly £700,000 worth of shares in the week following its trading update. It's always reassuring to see the board show faith in the company's outlook, especially since executives and directors are intimately acquainted with the health of the company.
Valuations
Shares in Micro Focus have now lost just over two-thirds of their value since peaking in November last year, while valuations have fallen to historic lows. The company is now trading at just 7.9 times its adjusted earnings last year, which implies the stock is in deep-value territory.
Although nothing is guaranteed, I'd be surprised if it was still trading at these levels in a year from now. Sure, investor sentiment won't bounce back straight away and there may be further disruption from its HPE integration, but in the long run markets are value-driven.
Another turnaround play?
Looking elsewhere, public transport operator FirstGroup(LSE: FGP) could be another turnaround play. Shares in the bus and rail operator have lost nearly 40% of their value over the past 12 months and currently trade at a mere 6.6 times its forecast earnings this year.
While it still faces some serious challenges, most notably the continued demand weakness in its UK and US bus markets, it is making good progress in a number of areas too. A serious effort is being made to fix its UK bus division, with a strategy to increase efficiencies and maximise patronage expected to result in improved margins and bottom-line growth.
The financial performance of its UK rail business has also been better than expected, leading to a substantial improvement in cash flow generation for the group. Looking ahead, things look sanguine for its rail division, as FirstGroup seems set to keep its lucrative Great Western rail franchise until 2024.
High debt pile
On the downside, dividends are still elusive as the firm grapples with its high debt pile. Although net debt fell by 21% in the six months to 30 September 2017, it stood at £1.18bn, or around 1.7 times EBITDA.
There's also a lot of uncertainty surrounding its near-term earnings outlook. A 1% decline in adjusted earnings for the 12 months to March 2018 is currently anticipated by City analysts, following intensifying airline competition on its long-haul Greyhound routes and extremely challenging weather conditions this past winter.
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Jack Tang has no position in any shares 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.
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