2023-03-28 11:17:38 ET
Summary
- ANSS had impressive 4Q22 results and 1Q23 guidance, with growth in every region and industry, but the outlook for the remainder of the year is somewhat conservative.
- I believe AI/ML and GPU advancements will help with the adoption of ANSS simulation solutions.
- Despite the quality of the business, ANSS's valuation is currently too high, and the stock's price needs to drop significantly before it becomes an attractive investment.
Investment thesis
Ansys ( ANSS ) remains one of my favorite defensive growth stories in the market. For engineers who aren't involved in the product life cycle's validation and analysis, ANSS's ease of use is where I think its true power lies. PyAnsys's cloud strategy is meant to fill this larger unfilled market niche. The size of the opportunity that ANSS's core market addresses was laid out in more detail during the company's August 2022 Investor Update. Additionally, management has mentioned that the future use cases may greatly increase the addressable use cases. I believe that the capabilities of AI/ML and advancements in GPUs will underpin and accelerate all of these use cases. And I think ANSS is set up to take advantage of this. One supporting evidence is that the management of Autodesk (ADSK) also highlighted the potential of the partnership with ANSS in their recent March 22 Investor Day.
Overall, I think ANSS has the most comprehensive set of simulation-related solutions and is well position to continue taking market share. The company should be well-positioned to increase ACV organically while maintaining extremely healthy margins (40+% EBITDA margins). That said, as a stock investor, I agree with the bears that the valuation is too high. ANSS is trading at 35x forward earnings, which is expensive given the slower growth rate vs the past (20%). While I have no doubt about the quality of the business itself, I do think the stock's valuation needs to drop significantly before it becomes an attractive investment. I recommend a holding rating.
4Q22 results
Given the challenging market conditions for software companies, ANSS's 4Q22 results and 1Q23 guidance were particularly impressive. Even more surprisingly, given that they are unaffected by the SMB space's weakness, ANSS saw growth in every single region and industry it operates in. The 1Q guide indicates that the Q4 beat was not just a matter of timing, and underlying demand continues to be strong. However, I find the outlook for the rest of the year to be somewhat conservative, as it predicts a drop in margins beginning in the remaining quarter. It's interesting to note that despite FY22 being a year of reinvestments, ANSS drove margin expansion.
Margin could be better
More on margins, management-guided EBIT margins for FY23 would be in the 41-42% range. Combining this with the expected 160bps margin expansion in 1Q23 would suggest a decline in margin of roughly 100 basis points for the remainder of the year. Considering the outlook for FY22, I believe this to be overly conservative. Another reason I have faith is that management has a proven track record of success in executing on the cost side. For instance, non-operational headwinds, such as foreign exchange and the loss of the Russia and Belarus business, cost the company $82 million in 4Q22, but they managed to generate $94 million in positive operational momentum, which more than compensated for it. With the major headwinds and adjustments out of the way and a near 90% gross margin, I believe margins can continue to grow along with revenue.
AI/ML helps with adoption
ChatGPT's release, in my opinion, will have far-reaching consequences for the market in which ANSS competes. I think ChatGPT has the potential to make learning easier and more accessible, which will help spread this technology to more people and hasten its democratization. To give an example, when someone was to use ANSS simulation tools, one would need to set up a lot of different parameters which require strong technical knowledge to make sure it is set up right. However, with ChatGPT's assistance, one can easily inquire as to which parameters and settings are necessary. The hurdles to adoption may not be eliminated entirely, but they are significantly lowered. I also believe that the time and money needed to solve a complex simulation would be a barrier to widespread use. It stands to reason that solving an equation with a larger number of variables will take more time and require more processing power. With the help of artificial intelligence and machine learning, however, this procedure may be shortened, as customers will be able to skip over unnecessary simulations and instead concentrate on the critical boundaries.
GPU advancement also helps with adoption
It should come as no surprise that the faster the computing power, the faster the simulation calculation. As a result, the GPU is another limiting factor in this case. The need for more computing power and capacity, I believe, is one of the most significant barriers to adoption (or running more simulations). This would have been a problem in the past because technological advancement was not as strong. However, as large innovative companies like Nvidia (NVDA) continue to innovate much better technology, I believe the cost of one unit of computing power will continue to fall.
Valuation
In order to illustrate how expensive the valuation is for ANSS, I modelled very generous growth and improvement in margins over the coming 3 years and laid out multiple scenarios at different exit multiples to showcase the undiscounted share price in FY24. As you can see, even if we assume ANSS trades down back to somewhere around its average of 30x forward earnings, there is only a 7% upside. If we were to discount by 10% for 2 years, that would suggest a downside of ~30% today.
Conclusion
I believe ANSS is a high-quality defensive growth company with a comprehensive set of simulation-related solutions that is well-positioned to continue taking market share. While the company's 4Q22 results and 1Q23 guidance were impressive, the stock's valuation is currently too high, trading at 35x forward earnings. I recommend a holding rating for now and suggest waiting for a significant drop in valuation before considering an investment.
For further details see:
ANSYS: Valuation Is Too Expensive For This Growth