2023-09-28 07:45:48 ET
Summary
- Altair Engineering's software and cloud-based solutions enable businesses to make informed decisions in computational science and AI.
- The company reported strong revenue in 2Q23, but operating expenses have grown faster than revenue, resulting in a decline in EBIT.
- Altair is positioned to profit from the long-term growth in digital transformation, but further evidence of growth acceleration is needed before investing.
Summary
I am recommending a hold rating for Altair Engineering (ALTR) as I await further proof that growth can accelerate back to the mid-teens level (same as pre-covid). Until then, based on the current growth rate of high single-digits, I believe the stock is fairly valued.
Business
In today's globally interconnected world, Altair is at the forefront of computational science and artificial intelligence, enabling businesses across a wide range of industries to make more informed decisions. The software and cloud-based solutions offered by Altair cover a wide range of fields, from simulation to HPC to data analytics to AI. An extensive library of high-quality physics solvers, market-leading optimization and HPC technology, and a comprehensive platform for developing AI and digital twin solutions all contribute to their simulation- and AI-based approach to innovation. About half of the firm's operations are located in the United States, with the remaining quarter split evenly between Asia-Pacific and Europe-Middle East-Africa.
Financials/Valuation
Strong revenue of $141 million in 2Q23 was reported by ALTR, the company's highest 2Q revenue in recent history. As a result of the impressive top-line performance, gross profit increased from $103 million to $110.8 million, a growth of 70 bps. However, operating expenses have grown faster than revenue, resulting in a decline in EBIT from $18.2 million to $14 million (a 380bps margin decline). Net income, however, grew by 21.6% year-over-year to $13.2 million, with help from interest income and a lower effective tax rate.
My model suggests that ALTR is fairly valued at $61. Based on my conservative view of the business in the near term, I modeled ALTR to grow 7.7% in FY24 as well, following the same guided growth rate for FY23. This is also to reflect my reason for a hold rating until I see signs of ALTR growth acceleration (back to the >10% growth level pre-covid). With my expected growth rate, I expect ALTR to continue trading at a modest discount to peers such as Cadence Design (CDNS), Bentley Systems (BSY), Synopsys (SNPS), Procore Tech (PCOR), Autodesk (ADSK), Matterport (MTTR), etc. These peers are expected to grow low-to-mid-teens over the next 2 years and are trading at 8x forward revenue.
Comments
I believe that ALTR is positioned to profit from the long-term growth in digital transformation. ALTR, as a pioneer in the realm of Product Lifecycle Management [PLM] software development, is at the forefront of the ongoing digital revolution in the industrial and design sectors. The company is well-positioned to reap the rewards of the ever-growing Simulations and Analysis subsegment of the PLM market, as well as HPC, thanks to its innovative simulation, solver, and optimization software.
ALTR's portfolio of simulation, HPC, and AI/data analytics products is also converging, coinciding with its transition to the Units model. As a result of this shift, deal sizes are growing and renewal rates are skyrocketing. Moreover, as engineers and designers become more comfortable with emerging technologies like the Internet of Things and electric vehicles, I believe there will be a greater need for ALTR's offerings.
We see great momentum in the convergence of simulation with AI. A major automotive manufacturer in APAC has licensed additional Altair Units, specifically for using data science to design antennas. Source: 2Q23 earnings
In the short term, I remain conservatively positive about ALTR's business and market position because it has shown relative resilience in the face of a weaker macro backdrop. The fact that the FY23 software product revenue guidance of 10% fx-neutral was reiterated is, in my opinion, a sign of confidence by the management that things are not as bad as they seem. I take this as an indication of demand (based on ALTR feedback and ongoing deal discussions with customers), where customers are returning to investment mode towards the ALTR mission-critical unit application portfolio. Recall that previously during COVID, a lot of customers pulled back on spending. My opinion is that these customers can only delay investment for a certain period of time as they ultimately need to deliver on product innovation, for which ALTR products serve a mission-critical function. That said, I would rather be one step late by investing when the actual earnings show signs of growth acceleration than one step too early (i.e., now).
We are fortunate to have a very broad and diverse industry base, but as the macro economy is hit with extreme reductions in consumer spending, we believe some companies that consider new product development to be mission critical may be forced to reduce R&D spending. Source: 1Q23 earnings
Furthermore, I also noticed that the exceptional performance in software product revenue and billings during 2Q23 was a result of strong renewals within prominent accounts across crucial customer sectors. I would expect this upbeat renewal trend to continue for the foreseeable future as ALTR introduces new products like Altair SLC and RapidMiner . In particular, cross-promotion of ALTR's products for data and analytics ought to become easier as the company expands its product range. Recent Go-To-Market [GTM] initiatives have greatly aided this by promoting the entire Units portfolio and adapting sales tactics to different industries.
"but I do have a lot of experience. And I think that our products that we're developing right are really going to position us. And not just the products but our go-to-market approach, we've much more meaningfully organized towards specific verticals. All that's really coming together in a very nice way for us as well. A lot of work going on this year to sort of reorient the company and we're just seeing -- the results of that I think is going to continue to grow" Source: 2Q23 earnings
Key among these is management's continued optimism regarding the budget reset cycle in 2024, when they anticipate growing confidence that the spending environment will begin to normalize. To further emphasize this point, the CEO mentioned that the current downturn has been milder than expected and that they may be nearing the end of the cycle.
Despite my optimism regarding ALTR's underlying performance, I am keeping a close eye on the stock until it demonstrates accelerating growth, at which point the downcycle will have ended and growth will be easily visible in the near and medium term.
Risk & Conclusion
In my investment case, the risk I am worried about is that management is over optimistic about the near term, which is still heavily impacted by the macroeconomic environment. Suppose things get worse, we could see a delay in recovery, and management revising their FY23 estimate downwards. Neither of which is positive for the business and stock.
ALTR's convergence of simulation, HPC, and AI/data analytics products, along with their transition to the Units model, is driving larger deals and higher renewal rates. While I am conservatively optimistic in the short term, I'm closely monitoring ALTR until it demonstrates clear signs of accelerating growth, considering potential risks associated with macroeconomic uncertainties. Therefore, I recommend a hold rating for ALTR while awaiting stronger evidence of a growth acceleration back to pre-COVID levels in the mid-teens. Currently, with growth at a high single-digit rate, I believe the stock is fairly valued.
For further details see:
Altair Engineering: Awaiting Evidence Of Growth Acceleration