DASTF - Dassault Systemes: Strong Backdrop Uncertain Future As Value Add Remains In Question

2023-10-11 07:18:41 ET

Summary

• Despite a projected ~7% FY23 revenue increase from expansions into emerging markets and CAD industry growth, Dassault faces stark growth limitations in the long run.
• A shift in consumer preferences and new features could support demand for AutoDesk, hurting Dassault unless they define their specific platforms value add and hold R&D spending to match.
• With a FY23 price target of $40.35 and an upside of roughly 8%, we rate Dassault Systemes a HOLD for growth-oriented investors.

With the 3DCAD industry growing at record pace, investors have started to ask themselves how Dassault Systèmes (DASTY) will design their own future, with the answer not quite clear yet.

While Dassault carries a diversified revenue model providing software solutions to various industries, its growth prospects are limited compared to competitors who have already integrated newer features and AI-CAD systems. While growth in the 3DCAD industry and strategic plans to expand into emerging markets will drive revenue in the short run, they can soon expect to lose market share if they do not improve their platform's value add. With a price target of $40.35 and an upside of roughly 8%, we rate Dassault Systemes a HOLD for growth-oriented investors.

Summary

Dassault Systèmes is a global software solutions provider operating across a wide range of industries, from manufacturing to aerospace, with a diversified revenue model following their business. Although working across many countries, the company has centralized its suite of products containing hundreds of apps to one main platform, Dassault's 3DEXPIERENCE.

The primary use of CapEx has been to improve the 3DEXPIERENCE (Page 30) business platform by expanding the industries targeted, specifically with ventures into healthcare technology following the $5.8B acquisition of MediData Solutions. While the company has integrated other minor improvements, including AR Technology and Business Lifecycle programs, it has shied away from more extensive improvements to its 3D Modeling programs, especially with integrations of AI and other new features.

This lack of improvement could ultimately prove catastrophic in the long run, although effects may take a while to show, as Dassault remains a preferred choice to maintain legacy systems. Despite a robust subscription-based revenue model , they also face headwinds financially, as R&D spending is holding steady with an increasing COGS and a slowdown in operating income growth, the latter dipping -9.89% and -13.4%YoY respectively over the last two quarters. Normalized EPS has followed suit (-3.11%YoY), but retained earnings continue to build steadily, indicating that the cash situation is not dire.

In the 3D-modeling market, Dassault's products (Solidworks + CATIA) hold around 17% of the market share , whereas Autodesk's products control a share closer to 80%. The market is an oligopoly concentrated among a few significant players with relatively high barriers to entry, which will challenge Dassault's market influence in the long run.

Catalysts

There's a consensus in the market that Dassault's software lacks the cutting-edge features in Autodesk's offerings. Their primary competitor, Autodesk, has recently acquired Innoyze and Upchain to enhance its product portfolio, particularly with standout performer Fusion 360. Recent financial reports show a dip in annual sales growth for Dassault's flagship products (9% YoY), while Autodesk's sales (14% YoY) remain robust, similarly indicating a shift in customer preferences.

Despite consisting of 53% of their revenue share , this need for more attention to their 3D Modeling programs threatens to leave it out of a rapidly expanding industry with great forward growth potential. With a forward CGAR of 6.9% and a diversified development in almost all G3 countries, this will mark a critical inflection point for Dassault.

In the short run, the company will continue its growth trajectory trend and maintain its current market share with a solid legacy base and subscription model.

In the long run, however, Dassault faces two options: Either it continues with its focus on medical technology with uncertain prospects, or it capitalizes on the growth of CAD to secure and grow its current market share.

On the plus side, expansions in emerging markets could provide a cushion, especially in India and China. With markets in Asia accounting for ~24% of revenue, a 5% rebound in China , as well as "double digit" revenue growth in India (to be safe- we will use the conservative estimate of an 8.2% increase in revenue in line with the local CAD market) could further drive revenue up by another 3.2%.

Valuation

With a steady market share for the 3D CAD Industry in the short run, we project revenue will increase by roughly 3.5% in line with CGAR estimates. An anticipated expansion and rebound of Asian markets will increase revenue by another 3.2%, bringing total revenue growth to approximately ~6.7% FY2023.

Although such growth projections lie below the $6.5B guidance management set in February, it might be well justified considering the current interest rate environment and the unanticipated high cost of borrowing.

With a basic EPS of 0.713, and a forward P/E ratio of 56 (Software Application forward P/E from NYU research ) we give DASTY a price target of $40.35, with an upside of roughly ~8% based on the Oct 4 quoted price of $37.18. This would make Dassault Systemes a HOLD for growth oriented investors, as it's long term valuation remains in the dark following a re-evaluation of its competitive offerings and products.

Risk

The risks associated with holding Dassault Systemes stock are few but significant, including market liquidity and, as discussed previously, rapid product obsolescence.

First and foremost is market liquidity, where a lower trading volume compared to competitors (60K vs. industry average: 1.2-1.9M) and a far wider bid-ask spread make Dassault subject to pricing shocks. This is evident by its higher pricing volatility compared to industry competitors, although a generally decreasing trend will mitigate some of this liquidity risk in the short run. It has also helped that the company has generally kept its disclosures up-to-date despite being traded as an OTC ADR.

With regards to technology, as discussed previously, rapid technological advancements including Autodesk's recent acquisitions and rapid integration of CAD-AI, can lead to the obsolescence of Dassault's existing products and cause the need for constant innovation. To this end, Dassault similarly carries an industry dependence risk, where most of their revenue comes from the rapidly developing manufacturing and aerospace industries, which puts heightened pressure on increasing R&D funds. As these companies switch to more feature-heavy AutoCAD products in their work, the influence of their software will trickle down to lower levels of engineering companies, also carrying to potential to thwart Dassault in the long run.

Although not as major, it is also key to mention that while we talked about growth in the Asia markets, China in particular carries geopolitical risk following the Evergrande crisis and adjustments in the official growth rate. While this is worth a mention, Chinese manufacturing has historically been a strong business, which is unlikely to affect revenue in the short run.

Conclusion

With a strong subscription based revenue model, expansions into emerging markets, but uncertain prospects of the future in a rapidly growing industry, we rate Dassault Systemes a HOLD for growth oriented investors. With a projected revenue growth of 6.7% and an upside of roughly 8% FY23, we recommend investors wait for more certain growth prospects before going long on DASTY, paying attention to both rapid advancements in CAD technology and a more certain macro environment with a lower cost of borrowing. While market liquidity remains a concern, Dassault Systemes carries a large potential for growth if it turns around its current trajectory and refocuses on established CAD markets, securing a future in the long-run.

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