PTC - Decoding Autodesk's Future Growth

2023-05-19 14:23:37 ET

Summary

• Autodesk's growth strategy hinges on next-generation technology, end-to-end digital transformation, and unique growth enablers, promising to create value for its clients and shareholders.
• Despite some financial concerns, Autodesk’s solid operational efficiency, low leverage, and reasonable valuation present a moderate investment opportunity.
• Risks tied to intense competition, industry cloud cyclicality, currency fluctuations, and dependency on key distributors are significant factors that investors need to consider while assessing Autodesk.

Autodesk's (ADSK) recent Analyst Day offered a tantalizing glimpse into the company's future growth strategy, centering on three core areas - next-generation technology and services, a relentless push for end-to-end digital transformation, and unique growth enablers. From our vantage point, this strategy paints a compelling picture of Autodesk's pathway to continued growth, capitalizing on its technological prowess and the momentum of industry-wide digitization. In this article, we aim to break down the company's strategic focus areas, dissect recent financials, and weigh the inherent risks, to offer a comprehensive view of Autodesk's potential as an investment opportunity.

Conceptualizing Autodesk's Path Forward

Autodesk's recent Analyst Day, which we attended, offers a glimpse into its future growth strategy, hinging on three critical areas: next-generation technology and services, end-to-end digital transformation within and between industries, and unique growth enablers. We believe that this strategy outlines a potent and well-targeted growth path for Autodesk, potentially positioning the company for a promising future.

In our assessment, Autodesk's foremost identity is as a technology company, and we believe it fully intends to leverage this in its growth plan. The company is focusing on next-generation technology and services like common data, teams and workflows, real-time and immersive experiences, and shared extensible and trusted platform services. By connecting data from various products, third-party products, and proprietary sources into a single view, Autodesk aims to provide a seamless and granular data experience in the cloud for its customers. We are of the opinion that this approach, if executed well, could address one of the most pressing problems facing its customers, fostering increased loyalty and client retention.

Moreover, Autodesk is also aiming to transform the design and manufacturing process by integrating real-time and immersive experiences. We believe the company's partnership with Epic Games is a significant step in this direction. This could shift traditionally downstream or asynchronous processes upstream and in sync, thereby making more processes nearly real-time. In our view, this could vastly improve efficiency and turnaround times, driving higher value for customers.

Underpinning these efforts are shared, extensible and trusted platform services, including data APIs and a suite of technologies and services deployed across Autodesk's products and industry clouds. The company's intention to let customers and third parties use its core capabilities to extend and expand solutions in the cloud is an innovative strategy that we feel could significantly increase the value proposition of Autodesk's offerings.

The strategic focus on end-to-end digital transformation, powered by AI and machine learning, is another crucial aspect. The company's aim to create live digital twins used during the design process can give project owners a real-time view of project status and evolution, which we believe is a game-changer. The use of AI and ML to assist these interactions, providing real-time insights early in the design process, could greatly improve the cost, predictability, sustainability, and performance of projects.

In our view, Autodesk's growth enablers, including its business model, broad go-to-market opportunity, and ability to converge multiple industries, are particularly noteworthy. The company's subscription model, tiered plans, and consumption models are well-positioned to increase access to Autodesk's ecosystem, tailoring to a diverse range of customer needs. We also believe Autodesk's next-generation technology will allow it to better serve customers within and between industries, connecting design and make in AEC, and moving upstream to conceptual design and downstream to the operations phase of the asset cycle.

Overall, Autodesk's shift from products to capabilities, with an eye on expanding its total addressable market ((TAM)) towards $100 billion, demonstrates its ambitions to capitalize on the growing digital ecosystem and build a flywheel of compounding growth. From our perspective, if Autodesk executes these strategies effectively, the company could be poised for significant long-term growth.

Financial & Valuation

Note: All historical data in this section comes from the company's 10-K filings, and all consensus numbers come from FactSet.

Autodesk announced its FY Q4 earnings, which were followed by a 12.9% fall in the company's stock price. Despite reporting an 8.8% y/y revenue growth, reaching $1,318 million, the reaction to the announcement was less than favorable due to what we perceive as underwhelming FY24 guidance, particularly regarding margins. Though the Q4 results were solid, with gross margin at 92.2% and operating margin improving to 36.3% from 34.8% a year ago, the company's guidance of no margin expansion for FY24 fell short of expectations.

Looking at financial trends, ADSK's revenue growth of 15.2% CAGR over the past three fiscal years is commendable, but sell-side consensus forecasts a slowdown to 8.2% this fiscal year, reaching $5.4 billion, before picking up again to 11.6% growth in the following fiscal year, reaching $6.0 billion. We are concerned that this anticipated slowdown might impact the overall growth trajectory of the company. The increase in EBIT margin from 24.5% to 35.7% over the past three years is a positive sign of improving operational efficiency.

Interestingly, despite the company spending 12.3% of its revenue on share-based compensation, the number of diluted outstanding common shares decreased by 2.0%. This suggests that management is leveraging share repurchases to counterbalance shareholder dilution. The impact of these moves is clear in the EPS, which grew at a CAGR of 33.4% over the past 3 fiscal years, outperforming its revenue growth.

A critical element that requires our attention is the forecasted free cash flow ((FCF)) margin. It's expected to be 22.5% this fiscal year, a significant decrease from 41.5% four fiscal years ago. We attribute this decline largely to ADSK's transition from collecting upfront payments for multi-year contracts to billing annually. The FCF margin and the reduced capex, which averaged 1.6% of revenue over the past four years, hint at a capital-light business model. However, the declining FCF margin might indicate potential challenges in maintaining healthy cash flow.

ADSK is currently burdened with a net debt of $175 million, but it's just 0.1 times levered to its projected current-year EBITDA of $2.1 billion. It's a robust position for the company, but we must not ignore the fact that ADSK doesn't pay a dividend, which may not sit well with income-focused investors, especially when the S&P 500 offers a dividend yield of 1.6%.

In terms of stock performance, ADSK has not been a star. Over the past year, it returned 4% points less than the S&P 500, achieving only 0.3% in absolute return. The stock is currently trading 5% below its 200-day moving average and 18% below its 52-week high, but is 18% above its 52-week low. Despite this negative sentiment, short interest is still low at 1.1%.

In terms of valuation, ADSK is trading at a premium compared to the S&P 500 across multiple measures, including EV/Sales, EV/EBIT, P/E, and FCF multiples. However, the company's PEG ratio of 1.4 is at a slight discount to the S&P 500's PEG ratio of 1.5.

ADSK is trading at a forward 12-month P/E of 25.5, which is considerably below its 5-year mean of 45.6. This current valuation is on the low end of its 5-year, 2-standard deviation range of 20.0 to 71.2.

Lastly, when we compare ADSK's valuation with its peers, the picture becomes clearer. ADSK's forward 12-month P/E of 25.5 compares favorably with Intuit's (INTU) 27.8 and Salesforce's (CRM) 26.7, but it's higher than Adobe's (ADBE) 21.0. This suggests that ADSK is moderately valued in relation to its peer group.

ADSK has demonstrated solid revenue growth and has successfully improved its operating margin over the past few years. However, the forecasted slowdown in revenue growth, coupled with the decreasing FCF margin, are points of concern. Its current valuation indicates a moderate investment opportunity, especially when compared to its peers. Nonetheless, given the company's robust return on invested capital and relatively low leverage, we believe ADSK could still make for a worthwhile investment for those with a tolerance for potential near-term volatility and a longer-term outlook.

Risks

In the ever-evolving landscape of technology vendors, Autodesk is confronted by formidable competition across its industry cloud solutions. Competing with big names like Procore, Oracle ( ORCL ), Trimble, and Bentley Systems in the Architecture, Engineering, and Construction segment, Autodesk is facing a serious threat. In the media and entertainment industry, Autodesk is pitted against powerful players such as Adobe, Sony Corporation (SONY), Unity ( U ), and Epic Games. Furthermore, the manufacturing sector sees Autodesk rivaling design and simulation titans like PTC ( PTC ), Dassault Systèmes (DASTY), Siemens, and MSC Software Corporation.

Investors should also consider the risk of end market adoption of ADSK's solutions. The construction industry, despite being one of the largest global industries, has been sluggish in adopting digital tools. This, coupled with the challenges of managing remote teams due to COVID-19 and a persisting labor shortage, has emphasized the need for digitization to improve project insights and operational efficiency. In this context, Autodesk's solutions could be critical for the industry's leap towards digitization, however, rising interest rates and increasing macro concerns has damped the near-term prospects of the construction end market.

The cyclical nature of industry clouds is another crucial factor impacting Autodesk. While the macroeconomic instability could have a bearing on Autodesk's growth projections, the resilient nature of the construction industry and the early-stage digitization efforts in both manufacturing and construction sectors could somewhat insulate Autodesk from these trends. Moreover, Autodesk's transition to a subscription-based revenue model should help shield it from market cyclicality given the platform's vital role for end-users.

Autodesk's international operations introduce currency risk to the company's profitability and reported growth. However, Autodesk's costs, partially denominated in foreign currencies, act as a natural hedge against currency fluctuations. Additionally, the company uses currency hedging contracts to offset potential forex exposure, adding a layer of protection to its international revenues.

Lastly, Autodesk's reliance on its key distributors, including Tech Data Corporation and Ingram Micro Inc., which collectively accounted for a sizable chunk of its net revenue in fiscal 2023, cannot be ignored. Although the company is shifting towards direct sales, any disruption in relationships with these distributors could adversely affect Autodesk's revenue. Nevertheless, Autodesk's expansive distribution network and a loyal user base could mitigate the impact of any potential loss of a major distributor.

Conclusion

Autodesk's strategy seems meticulously planned, with a clear vision of harnessing next-generation technology to drive end-to-end digital transformation and exploiting unique growth enablers. Although financial trends and some valuation metrics may raise eyebrows, Autodesk's robust return on invested capital, relatively low leverage, and an ambitious growth strategy signal potential for long-term returns, especially for investors with a tolerance for near-term volatility and a longer-term horizon.

However, navigating through formidable competition, digital adoption hurdles in targeted industries, and the cyclical nature of industry clouds presents challenges. Furthermore, Autodesk's significant exposure to foreign markets and reliance on key distributors adds to the risks that need close monitoring.

Autodesk's journey to realize its full potential will not be without challenges. Nonetheless, its well-articulated growth strategy, backed by solid operational efficiency, may provide investors a rewarding journey, granted they remain cognizant of the inherent risks. As always, a well-informed decision grounded in comprehensive analysis is the best approach to investment.

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