2023-11-11 06:36:14 ET
Summary
- Ansys' third quarter results were poor due to sales restrictions in China. This will cause headwinds through 2024 but its impact is expected to be largely transitory.
- Challenging macro conditions and economic weakness in Europe and China also present risks to Ansys' growth.
- Ansys' valuation still looks elevated, despite the drop in share price over the past few months. If growth softens or Ansys can't improve its margins, it could face further declines.
Ansys' ( ANSS ) third quarter results were poor, although this was in large part due to a restriction on sales in China. Recent weakness has not been surprising though, based on demand trends I highlighted in July . While there is excitement around AI, end market weakness is likely to continue into 2024. Ansys' operating profit margins are also still depressed, despite the company's business model transformation maturing. Despite the fall in Ansys' share price over the past few months, the company's high valuation still means there is elevated downside risk with limited upside.
Market
Challenging macro conditions have persisted in 2023 and this has been weighing on Ansys’ growth. High-interest rates are impacting economic activity in a number of areas, and the manufacturing sector is still adjusting to the post-pandemic norm. In addition, Europe and China are both facing economic weakness and rising geopolitical tension has contributed to uncertainty.
Ansys is somewhat protected from this by the fact that 80% of its revenue is recurring. High exposure to the automotive and aerospace industries have also helped to support Ansys' business in recent quarters. This could change in 2024 though, as automotive demand appears to be softening and the UAW strike could also cause issues. While automotive is one potential area of weakness, Ansys has suggested that it is tied to the R&D cycle, and that customer development efforts around autonomy and electrification are ongoing.
China Restrictions
Third quarter weakness was largely attributed to restrictions placed on sales by the US Department of Commerce due to Ansys’ prospect vetting process not meeting requirements. Incremental approval processes are also delaying sales. Ansys believes that this created a 20 million USD headwind in the third quarter, and it is expected to have a 25 million USD negative impact on ACV and revenue for the full year. Ansys expects that some business will be permanently lost (approximately two thirds), while other business is just deferred. China currently represents around 5% of Ansys’ ACV, indicating that the China business has been severely impaired.
Export restrictions and incremental processes are also expected to dampen growth in China in 2024, after which the China business is expected to return to steady state growth. The 2024 impact is expected to be roughly 10-30 million USD on both ACV and revenue, with most of that lost business.
Ansys
Ansys has a leading portfolio of solutions, and is supporting future growth by investing in areas like:
- High Performance Computing
- Artificial Intelligence
- Cloud Computing
- Digital Engineering
ANSYSGPT is a virtual assistant that aims to help democratize access to simulation. A beta version of the tool was released in the second quarter. ANSYSGPT is based on GPT-4, although has been trained on Ansys data, and can answer technical questions from customers. This likely provides utility to users but it is an incremental product introduction that isn’t particularly important.
AI+ extends AI enhancements to existing product capabilities and includes ANSYS Granta AI+ and optiSLang AI+. SimAI is a cloud native AI platform that enhances Ansys’ 3D physics simulation capabilities. It supports design optimization by using simulation results to train an AI model, which can then be used to predict the results of different design configurations. This allows a broader range of designs to be assessed faster and more efficiently. While Ansys SimAI is expected to launch in early 2024 , AI+ product capabilities will be available on a rolling basis beginning this Fall, first with the release of Ansys optiSLang AI+ and then Ansys Granta MI AI+.
Automotive and ground transportation is Ansys' third largest industry, making the health of this industry important to the company's performance. While automotive sales are generally still reasonably robust, there are growing signs of consumer weakness and inventory levels are rising rapidly, albeit from very low levels.
Ansys doesn't seem to believe that this will be an issue at this stage, and instead highlighted the growth potential from the increased adoption of EVs, autonomous vehicles and software in vehicles.
Ansys offers a range of simulation solutions that support the development of EVs. For example, multiphysics battery simulation solutions as well as system simulation, model-based development and functional safety analysis for electric powertrains. Ansys' solutions for Lidar, radar and cameras also help customers to improve drive assistance systems. Ansys also offers model-based, certified embedded software and code generation, electronics reliability and connectivity systems which support the development of software-defined vehicles. This is a market that is expected to grow from 35 billion USD now to over 200 billion USD early in the next decade.
Financial Analysis
Third quarter revenue was 458.8 million USD, a 3% decline YoY which Ansys attributed to ASC 606 dynamics given the quarterly mix of license types. Restrictions in China also undermined growth and absent this impact growth would have been around 1.4% YoY. ACV increased 12% YoY in the third quarter and ACV from recurring sources grew 13% on a trailing 12-month basis, representing 83% of total ACV. From a vertical perspective, High-tech and semiconductors, aerospace and defense, and automotive and ground transportation were strong contributors.
Ansys is now guiding to 2.234-2.284 billion USD revenue for the full year 2023, which implies approximately 14% YoY growth in the fourth quarter. Fourth quarter ACV is expected to be 898-943 million USD, roughly a 12% YoY increase.
While Ansys' performance in coming quarters will be dependent on whether the manufacturing sector continues to deteriorate, there have been recent signs that demand may be stabilizing. Job opening data points towards this, and Altair's ( ALTR ) third quarter results and forward guidance were solid.
In addition to recent weak growth, Ansys is yet to show the improvement in profitability that was expected as its business model transition matures. Third quarter margins were certainly hit by the revenue miss though. Conversely, Ansys' third quarter operating margin was boosted by lower expenses and the timing of some investments.
Valuation
Ansys continues to command a premium valuation, which is a reflection of the company's strong competitive position, solid growth and cash flow generation potential. Despite the recent share price decline, Ansys' PE ratio is well above its historical norm, implying an expectation of margins returning to historic levels. Even assuming operating profit margins return to around 35%, Ansys' stock is still expensive given elevated near-term risks. I think Ansys provides better value at around 200 USD per share.
For further details see:
ANSYS: May Still Have Further To Fall