2023-07-19 07:10:41 ET
Summary
- ANSYS, a leader in advanced numerical simulation methods, is leveraging AI to enhance its technology and accelerate product development for customers, contributing to its target of 12% ACV growth rate from 2022 to 2025.
- The company is extending its leadership in advanced numeric simulation to high-performance computing, and shifting its financial model towards a subscription lease model, which has driven growth and improved resilience.
- Despite high margins and exposure in the energy market, ANSS is well-positioned for growth due to increasing demands from electrification, autonomy, connectivity, and the industrial Internet of things.
ANSYS ( ANSS ) is a leader in advanced numerical simulation methods for a broad spectrum of industries, including high-tech, aerospace and defense, automotive, energy, and industrial equipment. Electrification, autonomy, connectivity, and the industrial Internet of Things are key growth drivers, as they drive the increasing need for simulation among customers. AI can enhance ANSYS's existing technology and help customers achieve fast-speed simulations, accelerating their product development and time to market. I believe this is attractive for ANSYS's annual contract value ((ACV)) annual compound growth rate target of 12% from 2022 to 2025. Additionally, ANSYS's business exhibits high recurring revenue with 81% of ACV mix.
Investment Thesis
Extend their leadership in advanced numeric capabilities to high-performance computing: ANSYS is the leader in advanced numerical simulation methods that accurately predict the multi-physics behavior of engineered products. Accurately predicting physical phenomena in the real world, is intrinsically complicated. The numeric pillar encompasses the latest advances in science, mathematics and analytics, which help them gain a deeper understanding of the physical world.
For the numerical simulation, only Dassault Systèmes (DASTY) can compete against ANSYS. Dassault Systèmes is a more life cycle management solution provider, and simulation is just part of their business. ANSYS has been dedicated for the advanced numerical simulation for decades. I think ANSYS is really a niche player in the simulation space.
ANSYS is trying to extend their leadership in advanced numeric simulation to high-performance computing ((HPC)). ANSYS has close partnerships with hyperscale computer partners like Nvidia ( NVDA ), and has long taken advantage of distributed memory, multiprocessing and multiple cores to accelerate their customers' products to market, and in the process drive more computations. ANSYS can run Fluent natively on multiple GPUs, which could bring their customers 7 times less expensive in hardware costs and 4 times less power consumption than an equivalent CPU solution.
Leverage AI to accelerate the time required to complete simulation : In the past, a single large complex simulation could run for days, causing a longer product-to-market cycle. ANSYS is now incorporating AI techniques directly into multiple products to increase the speed and scale of a single simulation. For example, their optimization engine, ANSYS optiSLang, uses AI techniques to significantly reduce the time it takes to intuitively run thousands of simulations for products across the portfolio. In my opinion, these AI functionalities could help ANSYS gain a larger market share, charge higher prices, and improve customer satisfaction.
F inancial model has shifted towards subscription lease licenses : ANSYS has gradually shifted its financial model towards a subscription lease model, and lease licenses have been driving their growth over the past few years. The subscription lease annual contract value mix has already improved from 35% in FY17 to 53% in FY21. I believe this financial model shift makes ANSYS's business more resilient, especially during economic downturns.
Growing demands from e lectrification, autonomy, connectivity, and industrial internet of things : ANSYS has a wide range of exposures in various end markets. Among these industries, I believe electrification, autonomy, connectivity, and the industrial internet of things are experiencing an increasing demand for frequent solutions.
For instance, electric vehicle companies require simulation solutions for electrified powertrain system simulation, battery management systems, electromagnetic interference/compatibility, and electric motors to expedite and enhance the design process. These simulations are more intricate compared to those for internal combustion engines. ANSYS offers comprehensive simulation solutions for EV performance, battery structures, and electric powertrains, among others. Therefore, I believe that as the world moves towards electrification, there will be a greater need for ANSYS's simulation technologies in the design and manufacturing phases.
Investment Risks
High margin business already : I believe one of the primary concerns for ANSYS is their industry-leading margins. Their adjusted gross margin exceeds 90%, and their adjusted operating margin hovers around 42%. The question arises: how much higher can they expand? Their current margin is considerably high even among software companies. I anticipate that the majority of margin expansion will come from operating leverage, meaning that the growth rate of operating expenses will be slower than the growth rate of revenue.
Energy Exposure : ANSYS has approximately 9% of its revenue exposure in the energy market. Their products are utilized for optimizing oil and gas production and processing, covering activities from drilling to production and refining. While there is a potential impact on ANSYS's sales if traditional oil and gas customers face economic challenges in the future, it's worth noting that ANSYS's products are also employed in renewable energy sectors, including wind, solar, and tidal power. Consequently, I believe ANSYS has the capacity to navigate through the transformation towards renewable energy.
Outlook and Valuation
ANSYS is scheduled to report their Q2 earnings on August 3rd. They are guiding for 0%-5.3% constant currency sales growth and an operating margin of 31.9% - 34.1% in Q2. The weak growth guidance is attributed to the seasonality of their renewal base. However, for the entire year, ANSYS anticipates 7.7% - 11.6% constant currency sales growth, indicating that this year's growth will be weighted towards the second half.
Considering ANSYS's increasing subscription lease model, I believe they have good visibility on their quarterly results, and I don't expect a significant surprise for their Q2 results. Additionally, I don't anticipate a revision of their full-year guidance.
In my discounted cash flow model, I assume 11% organic sales growth and 3.6% acquisition growth. I project their reported operating margin to reach 32.7% in FY32, which is a reasonable figure compared to other software players, in my view. The model utilizes a 4% terminal growth rate and a 10% weighted average cost of capital.
ANSYS DCF Model - Author's Calculation
With all these assumptions above, the present values of FCFF over the next 10 years and terminal are calculated to be $2.98 billion and $16.7 billion. Adjusting the debt and cash, the fair value is $233 per share, as per my estimate.
ANSYS DCF Model - Author's Calculation
End Note
I believe ANSYS is the leading player in the software simulation space, boasting a highly recurring franchise. Their investments in AI have the potential to create tremendous value for their customers. Electrification, autonomy, connectivity, and the industrial internet of things are key drivers of structural growth for ANSYS. However, in my view, the current stock price is overvalued, and I would encourage investors to consider buying the stock when it drops below $240.
For further details see:
ANSYS: Unique Simulation Leader, High Stock Valuation