ADSK - Autodesk: What I Will Be Looking For In The Fourth Quarter

Summary

• Third quarter results were mixed as billings were softer than expected as a result of headwinds from foreign exchange and shorter duration.
• Management highlighted macro headwinds in the previous quarter results, reducing guidance for the last quarter, which might have resulted in a more de-risked guidance.
• Channel checks that have been done show that channel partners of Autodesk are highlighting higher promotion activity in the fourth quarter.
• This higher promotional activity and the de-risked guidance could result in a likely beat for the fourth quarter.
• My 1-year target price for Autodesk is $276, implying 26% upside potential from the current stock price.

Investment thesis

Autodesk ( ADSK ) is expected to report on February 23 and this article aims to provide a review of its previous quarter, how the landscape and business conditions have changed and lastly, I hope to provide a preview for the coming fourth quarter.

In the long-term, I think that Autodesk is a top player in the design software industry that will continue to lead. It will likely generate best-in-class revenue and margin profiles in the industry.

However, there are short-term headwinds that continue to persist. This includes a weak macroeconomic environment, which is causing some weakness to the business.

I think that Autodesk could beat expectations for the fourth quarter results as the company has been bringing higher levels of promotion to customers, as well as providing a de-risked guide for the current quarter. I continue to look towards management commentary on the company's outlook and macro conditions as the near-term remains uncertain for Autodesk.

I have written an earlier article on Autodesk on how it is a leading design software player with resilient growth and sustainable profitability, which can be found here .

Third quarter review

Looking back to the third quarter, the results were somewhat mixed for Autodesk. While the revenue generated was meeting expectations, the lower-than-expected billings missed analyst expectations, which came in four percentage points lower than the street. This was largely due to lower duration and foreign exchange headwinds. That said, other leading indicators came in rather strong, including the cRPO numbers which grew at 13% year on year on a constant currency basis compared to the 10% growth we saw in the previous quarter. Also, short term billings did accelerate in the quarter. Despite the weaker billings, profitability met management's guidance and free cash flows even did better than guidance.

In terms of management commentary on macro, this trended downwards from last quarter. In my view, Americas was a region that performed well in the quarter as a result of solid new business growth and expansions. EMEA and APAC, on the other hand, saw some moderation in new business growth. In addition, I thought it was positive that Autodesk's product subscription renewal rates remain strong, and its net revenue retention rate was within its range of 100% to 110%.

Forward guidance

As a result of the shift in mix of annual billings as well as slight macro headwinds, guidance for annual billings was reduced by two percentage points. In turn, this affected the free cash flow guidance for the full year which was driven down by seven percentage points for the FY2023 fiscal year. Other profitability guidance like earnings per share and operating profit margin were all in line with market expectations. the outlook for revenue was also reduced slightly on a constant currency basis, by about 0.3%. This reflects the weaker market conditions seen in EMEA and APAC.

While management was hesitant in giving FY2024 guidance, they did reiterate that they were expecting FY2024 revenue growth to be in the double-digit range and margins to be between 38% to 40%- and double-digit free cash flow growth on a compounded annual basis. Other things to note that management did provide for the next financial year of 2024 was that they expect to have headwinds from foreign exchange and Russia of about six percentage points. This, in my view, was higher than expected, but at least that headwind has already been incorporated into the share price.

While I do not think that the third quarter results were a thesis changer, they did highlight that Autodesk's business was getting impacted by the macro conditions. As a result, while the long-term thesis for Autodesk remains intact, I do think that we will see investors remain on the sidelines for the company. I continue to see that Autodesk can deliver strong and sustainable growth amongst peers as it continues to grow its product portfolio and improve on pricing and monetization.

Thoughts on the fourth quarter

I think that the macro environment continues to hurt Autodesk. In the coming quarter, I would be looking to see if there are any signs of stabilization for the business, given that the third quarter continued to show the weakness in macro conditions seen in the prior second quarter. I think that the market continues to debate about what the FY2024 guidance could look like, and whether we will see the free cash flow trough. For me, I think that in FY2024, we will see a trough for growth and free cash flows and the company can then accelerate from here.

Channel checks done

My chat with one of the sell side analysts for Autodesk highlights that channel partners are telling them that they are seeing more promotions and early renewals in the fourth quarter. These early renewals coupled with the promotions could provide tailwinds for the annual billings' growth for the fourth quarter, in my view.

Furthermore, based on reseller surveys done, the outlook for resellers remains intact as there was no deterioration in the quarter as the macro conditions and sentiment seems to have stabilized or even improved.

Expectations for guidance

I expect that there could be upside to the fourth quarter numbers for Autodesk, although management could incorporate conservatism in its FY2024 guidance. I think that the fourth quarter's billings could come in higher than what the market expects. This is due to the higher levels of promotion we saw in the fourth quarter for the company, as well as the de-risked guidance provided by management last quarter.

For FY2024 guidance, I think management will be prudent and manage expectations. I expect that revenue growth will be guided at the high single digit range while free cash flow growth could also be in the similar range.

Valuation

To derive a valuation for Autodesk, I used a DCF model. My model incorporates a time period until FY2026, with a terminal EV/FCF multiple of 26x and discount rate of 10%. The multiple for Autodesk is justified in my view as I think that the company remains a leader in the design software industry and will continue to bring strong and sustainable revenue and profit growth in the future.

As a result, my 1-year target price for Autodesk is $276, implying 26% upside potential from the current stock price.

Risks

Macroeconomic environment

I think that Autodesk's business is clearly sensitive to changes in the macroeconomic environment. If the macro environment were to worsen, this would bring downside revisions to the company's guidance and estimates, even if they are conservative for the FY2024 fiscal year.

Profitability and cash flow risks

I incorporated expansion in margin in my forecasts for Autodesk. As a result, if management's ability to expand margins is limited by reasons like potential mergers and acquisition deals, this could lead to lower than expected margin expansion for the company.

Conclusion

I think that in the long-term Autodesk remains a solid player in the design software space. It is likely one of the best players in the industry, with solid and sustainable top line growth, while still expanding margins and improving its free cash flow profile. However, in the near-term, the company continues to be hindered by the weak macro environment, which is causing some weakness in the stock.

For the fourth quarter results, I think that the company could beat expectations as a result of the higher promotion activity and the relatively de-risked guidance by management. That said, I will continue to look out for commentary on outlook and macro conditions as the near-term continues to look hazy for Autodesk.

My 1-year target price for Autodesk is $276, implying 26% upside potential from the current stock price.

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