DASTY - Dassault Systemes: China Recovery Should Not Be An Issue

2023-05-19 15:45:33 ET

Summary

• Despite concerns about China, I believe the growth outlook remains robust with gradual improvement throughout the year, supported by a strong deal pipeline and better performance.
• Solidworks exhibited significant momentum in March, and I expect it to contribute to growth in Europe throughout the year.
• Despite short-term growth risks and a weak macro environment, DASTY's strong business profile, cash generation, and potential for M&A justify its relatively high valuation, in my view.

Thesis

I continue to believe Dassault Systemes SE's ( DASTY ) PLM category is rising in importance as a key enabler of digitalization across multiple industries, ranging from Industrials to Life Sciences. I reiterate my Buy rating following the 1Q23 results, and while there are concerns about China, I am maintaining my Buy rating because I do not think China's situation is as dire as it may seem. Moreover, I think there is high visibility into China's deal pipeline, which reduces the uncertainty surrounding FY23 estimates. With the increased funding for R&D in China, I have no doubt that DASTY will be able to close the deals in its pipeline and deliver on its promises. In contrast to the bears, I expect DASTY to grow in 2H23 thanks to an improving pipeline that will fuel expansion in all regions. In addition, Solidworks' current momentum can't be ignored, and I anticipate it to remain high through FY23. All in all, I continue to see DASTY as fundamentally well positioned within PLM and expect it to be a share gainer through the deployment of its 3DXPERIENCE platform via large standardization contracts. Even though the stock trades at an expensive PE in both relative and absolute terms, I believe this is justified by a superior business profile, cash generation, and M&A optionality.

Growth Outlook

I anticipate robust growth across all regions and sectors, with the European market continuing to shine across a wide range of industries and the Americas reaccelerating expansion after a weaker 1Q23. This is especially true in the United States, where the pipeline is expected to be back-end loaded. For China, a critical factor in future results, the weak performance in 1Q23 was largely attributable to the high bar set by the stronger growth seen in 1Q22. So, I don't take the drop as a major warning sign today, especially since management has said they are seeing better trends in China through the end of the quarter and a strong pipeline ahead. I anticipate a slow but steady recovery for China this year, with growth rates slowly improving through the year as performance improves. In addition, the fact that Solidworks saw a surge in momentum in March, resulting in low-single-digit growth in 1Q despite tough comparisons, is also indicative of underlying demand and growth. I anticipate it will continue to grow for the remainder of the year, which should contribute positively to Europe's performance.

License Headwinds

While I do think the company and stock have good long-term potential, I do worry that short-term growth risks could hurt the equity value. A weak macro environment, especially with worsening manufacturing PMIs , lends credence to the bear case that DASTY may not be able to grow licenses as quickly as it should. The 2Q license outlook is conditional on growth in North America, continuous momentum in Europe, and a turnaround in China. China is the deciding factor. Even though the 1Q slowdown in China was largely attributable to a tough base from the previous year, management did note that about 300-400bps of the decline was due to organic weakness. The slowdown was caused by China's decision to reinvest less in innovation (i.e., DASTY demand) and more in servicing the domestic consumer market by relaunching its own manufacturing capabilities. However, management also acknowledged that the March election had an impact on the ability of some organizations to make substantial commitments. In my opinion, the latter is an issue of yesteryear, and the pipeline should now be pumping deals through - which is a positive thing. Given the size of the deals that are known to be in the works in China (management has visibility into it), I believe DASTY will be able to print the short-term growth target despite the weak China manufacturing PMI . By the time these massive transactions are finalized, the macro environment will hopefully have improved, allowing DASTY to begin printing robust organic growth. This would make a nice positive narrative as the China business would carry the headline thesis of "not being affected by the weak macro, and growth is now expected to accelerate".

Conclusion

I maintain my Buy rating on DASTY. Despite concerns about China, I believe the situation is manageable, and management's visibility into the pipeline and expected large deals in China instill confidence. China's performance is likely to improve gradually throughout the year, supported by a strong pipeline. The momentum of Solidworks, despite tough comparisons, bodes well for growth in Europe. Overall, I believe DASTY continues to be well positioned in the PLM industry, and I anticipate it to be a share gainer through standardized contracts. Despite a relatively high valuation, justified by its business profile, cash generation, and M&A prospects, I maintain a positive outlook on DASTY.

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