ANSS - ANSYS: Innovating A Sim Future But Currently Overvalued

2023-04-03 09:12:55 ET

Summary

• ANSYS' physics-based simulations are crucial for product development across industries, including automotive, aviation, and green energy.
• The company's growth strategy focuses on expanding user base, monetizing complex computations, and broadening its physics portfolio.
• Despite a strong growth profile and attractive business model, ANSYS' current valuation warrants caution for potential investors.

ANSYS ( ANSS ) has come a long way since its inception 50 years ago, becoming an indispensable partner for businesses looking to revolutionize their products and processes. From its early days in nuclear power to today's innovations in electric vehicles, space exploration, and green energy, ANSYS has consistently demonstrated its ability to deliver significant value. As the demand for accurate physics-based simulations continues to grow, our research indicates that ANSYS' unique position, comprehensive solutions, and customer-centric approach will enable it to thrive in the evolving market landscape. However, we do not believe the stock's historically high valuation is justified given the lack of corresponding improvement in the outlook of the business. Therefore, we would wait for a better entry to establish an investment.

ANSYS: A Brief Introduction

Over the past 50 years, ANSYS has established itself as a trusted partner for companies seeking to create transformative products, ranging from its early work in the nuclear power industry to today's innovations in electric vehicles, space exploration, and green energy. Our research suggests that ANSYS' unique position in the market, stemming from its extensive experience, comprehensive suite of solutions, and customer-centric go-to-market model, allows it to deliver significant value to clients.

Physics-based simulation, ANSYS' core business, is crucial for companies aiming to understand how their products will perform in the real world. These simulations save time and money, providing critical insights into product functionality and business operations. Unlike video game simulations, physics-based simulations are highly accurate, multi-physic solvers that have been developed over decades. This has allowed ANSYS to become an indispensable partner for companies across various industries, even during challenging times like the recent pandemic.

One notable example of the impact of ANSYS' simulations is in the automotive industry, where virtual crash testing has replaced traditional physical tests. A single physical crash test can cost over $1 million and take months to perform and analyze, making it unsustainable for most automakers. However, virtual crash testing using ANSYS' high-fidelity solvers can be conducted at any stage of development, significantly reducing R&D costs and time, while improving safety.

Our analysis indicates that the use of ANSYS simulations has become pervasive across numerous industries, from mobile devices to aviation and even the food we consume. As the reliance on simulation continues to grow, we forecast that its impact will become even more pronounced, with users encountering simulation-driven products and processes more frequently in their daily lives. This pervasive use of simulation will provide differentiated insights, helping businesses transform not only their product design and development processes but also their overall operations.

Our analysis of ANSYS' growth strategy reveals that the company is focusing on three vectors of growth: more users using more products, monetizing customers' workloads that run large and complex computations, and expanding the portfolio physics from the component all the way to the mission level. This approach is backed by ANSYS' commitment to continuous innovation in High-Performance Computing ((HPC)), AI, digital mission engineering, model-based engineering, and the cloud. These innovations are crucial in helping customers solve complex R&D challenges that involve multiple physics working together.

One of the key drivers of ANSYS' growth is the increasing complexity of product development. This complexity demands more computation, creating a need for multi-physics solutions and expanding simulation use cases. The company has successfully widened its user base by making its products more intuitive and easier to use, even for non-expert users. ANSYS has also invested in propagating simulation in academia, which has the potential to significantly extend its addressable use cases and user base.

We are impressed that the core market for ANSYS has delivered consistent growth, even during the pandemic, and we expect it to accelerate going forward. As a leader in the $8 billion simulation market, ANSYS has consistently outgrown its core market since 2017, and we expect it to continue to outpace market growth in the future as new use cases emerge and mature.

Recent Developments Increases Confidence

Our analysis suggests that ANSYS remains a best-of-breed defensive growth story. During Autodesk's ( ADSK ) recent Investor Day , Autodesk's management highlighted extended potential for partnership with ANSYS, and emerging trends like High-Performance Computing ((HPC)) and AI/ML are poised to create paradigm shifts in the industry, driving inflection in markets.

We believe that the game-changer for simulation technology growth lies in democratizing its use for engineers beyond the validation and analysis phase of the product life cycle. ANSYS' PyAnsys and cloud strategy are aimed at tapping into this broader white space. The company's core market addresses hundreds of thousands of potential end users, while future use cases could extend the impact to tens of millions of potential end users across millions of use cases. AI/ML and advances in GPUs are key enablers that could accelerate this process.

Our analysis indicates that Ansys' CTO, Dr. Prith Banerjee , believes that AI/ML as crucial in reengineering the user experience and democratizing technology. The company could leverage ChatGPT-like technology to lower the learning curve for highly technical disciplines like Finite Element Analysis (FEA). ANSYS' AI/ML methods accelerate core solvers while improving accuracy, enable rapid optimization, calibration, and validation with their solvers, and enhance physics-based, data-informed applications.

We believe that GPU acceleration has the potential to enable inflection in ANSYS Discovery and other technologies. The most significant barrier to running more simulations is compute power and capacity, and emerging technology accelerates simulation speed at a lower cost, unlocking more capability. The recent ANSYS R1 introduction featured the Fluent multi-GPU solver, which significantly increases performance and cost savings. Tests run on Dell and NVIDIA hardware demonstrated the tremendous potential of this technology.

We believe the company's robust Q4 2022 results, which reported a 14% ACV growth and above-consensus guidance for 2023, gives us increased confidence in the company's future. The company's shares appreciated by 10% post earning, suggesting that the market shared our view of ANSYS' results.

The Q4 2022 results exceeded expectations, with non-GAAP revenue reaching $694.7 million (+5% YoY, +10% on constant currency), and non-GAAP EPS at $3.09, which outperformed the consensus by 10%. Our forecast for Q1 2023 remains positive, with a projected 17% YoY increase in non-GAAP revenue and a 16% rise in non-GAAP EPS. Furthermore, our outlook for FY23 is optimistic, with a 12% YoY increase in non-GAAP revenue and a 4% increase in non-GAAP EPS compared to the consensus.

We believe that ANSYS' 2025 cash flow target appears less risky due to three key factors. First, the 14% ACV growth in constant currency was driven by enterprise and SMB customers, despite trade restriction headwinds. With a rising mix of subscription leases and ACV growth outpacing revenue, we believe ANSYS could potentially surpass its guidance. Second, strong unlevered operating cash flow growth of 14% in 2022 and guidance for 13.5% growth in 2023 indicate a high likelihood of meeting the cumulative long-term target of $3.0 billion.

Financial & Valuation Analysis

Our financial analysis of ANSYS reveals a strong track record of consistent revenue and EPS growth. Over the years, the company has demonstrated impressive performance with revenue growth of 8.1% in 2009 and double-digit growth in the following three years. This trend is expected to continue with a 10.1% growth in 2023 and an estimated CAGR of 10% through 2025.

Similarly, EPS growth has been consistent, with only one year of decline (by a single penny) in 2015. The company is projected to maintain a similar CAGR for EPS as its revenue through 2025, again at around 10% per year. The high gross and operating margins of around 90% and 40%, respectively, over the past decade indicate the high-quality nature of ANSYS' business.

The software-based nature of the business ensures low capital intensity and high margins, as evidenced by capital expenses as a percentage of revenue remaining around 1 to 2% over the last decade. Ansys boasts a strong balance sheet with approximately zero net debt, a trend that is expected to continue.

However, investors should be aware of the current valuation of the company. ANSYS is trading at 38x forward 12-month EPS, which, although below the 45-50x range seen in the 2020-2021 tech bubble era, still remains at the high end of its 10-year range. In comparison, the company's shares could be acquired at a 20-25x EPS multiple between 2013 and 2016. Currently, ANSYS trades at a 112% P/E premium to the S&P 500, and over the past decade, this premium has ranged between 60% and 150%.

Given the current valuation, we believe that ANSYS shares are not a bargain at today's prices. We would be more constructive on the stock if the P/E premium relative to the S&P 500 were to decrease to around 80%. In conclusion, while ANSYS presents a strong growth profile and an attractive business model, investors should exercise caution and wait for a more favorable valuation before considering an investment.

Risks

There are several risks associated with owning ANSYS stock that investors should consider. One such risk is the potential impact of an economic downturn, such as the one triggered by COVID-19, on ANSYS' growth. Revenue streams related to discretionary areas like Internet of Things and digital twins could be negatively affected, and margins may suffer due to significant fixed costs in the short term.

Another risk factor is the dependency of ANSYS' operations and performance on global macroeconomic conditions, specific foreign country conditions, and U.S. domestic economic conditions. The recent increase in global inflation and interest rates could lead to reduced demand for ANSYS' products and services, constrained credit, reduced government spending, and market volatility. The recent banking crisis in the US and Europe could lead to a contraction in lending, making it difficult for ANSYS customers to fund projects.

Furthermore, deteriorating diplomatic and political relationships between the United States and other countries where ANSYS conducts business, such as China, as well as ongoing conflicts like the Russia-Ukraine crisis, may adversely affect the company's large international operations. International revenue constitutes a significant portion of ANSYS' total revenue, with 54.9%, 54.5%, and 53.8% reported for the years ended December 31, 2022, 2021, and 2020, respectively.

In addition, ANSYS faces competition from both independent specialist vendors and big CAD/PLM vendors. The entrance of Cadence Design Systems into the simulation space could pose a threat to ANSYS' market share. The highly competitive nature of the industry may result in downward pressure on prices, and some competitors may offer lower pricing or more favorable terms.

Conclusion

ANSYS has proven its mettle as a leader in the simulation market with its consistent growth and innovative solutions. The increasing complexity of product development and expanding use cases for simulation technology indicate that ANSYS is poised to continue its success. However, investors should be mindful of the current valuation and associated risks, such as the impact of economic downturns, global macroeconomic conditions, and geopolitical tensions. While ANSYS presents an enticing growth opportunity, investors should exercise caution and wait for a more favorable valuation before taking the plunge. As a result, we remain underweight the shares until a more attractive opportunity to acquire it presents itself.

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