2023-07-21 09:34:10 ET
Summary
- I maintain a hold rating on BSY due to uncertainties surrounding the upcoming earnings report and a high valuation multiple of 57x forward earnings.
- Despite strong 1Q23 performance, I note that growth was influenced by one-time items and there are potential headwinds in China and the Commercial sector.
- I believe any miss in consensus estimates could cause a sharp rerating due to the company's high valuation.
Summary
Following my coverage of Bentley Systems ( BSY ), which, I recommended a hold rating due to my view that the valuation was extremely demanding at high forward earnings multiples. This post is to provide an update on my thoughts on the business and stock. I reiterate my hold rating as I see many uncertainties in the upcoming earnings report. BSY is also trading at a very high valuation multiple that I believe is at risk of sharp rerating if it misses consensus estimates.
Investment thesis
BSY is set to report in about 3 weeks, and I think it is worth visiting management guidance to see how the upcoming results might look like.
Touching on the 1Q23 strong performance , I would say that BSY has done very well in 1Q23 where ARR, revenue, and adj. EBIT came in strong. However, I note that one-time items largely propelled the upside to 1Q subscription revenue growth of 18% ex-FX, benefiting from one additional month from the PLS acquisition in 1Q23 vs. 1Q22 and some portion of revenue pull-forward from coming quarters that would have reduced the strength of subscription revenue growth. As such, I do not expect the same degree of strength anytime soon.
Management reiterates FY guidance, exiting 1Q. Despite solid business momentum both from a geographic and sector perspective, namely Resources and Public Works/Utilities, the company opted to maintain its FY guide for 9.5% to 12.5% revenue growth. I believe the higher degree of prudence on the FY guide reflects management's continued caution around China and the Commercial sector. Regarding China, I do not see any easing in geopolitical headwinds, which is impacting foreign companies from operating effectively in China. Even if things start to think for the better, I also find it hard to BSY to be confident in deploying all its resources, as things could turn south anytime. Notably, this headwind is also impeding the company's ability to sell into state-owned enterprises. As for the Commercial sector, I see potential for more pronounced weakness. I note that the Commercial sector has trended flat since 4Q22, and I think it is likely to come under increasing pressure due to higher interest rate sensitivity.
In addition, management restated its goal of 12.5% ARR growth in F23, excluding FX. It is true that management has built in a 1pt headwind to ARR guidance in F23 to account for the more challenging selling environment, but I see the volatility in China as a major risk to hitting the guide. This is especially true considering the low probability of significant annual contributions from recent JV initiatives. In addition, BSY's Commercial growth was flat again in 1Q despite widespread strength across most end-markets, including Public Works and Resources.
While I acknowledge that investors are likely to view the guide as increasingly conservative through the remainder of the year due to still elevated customer backlogs and solid pipeline trends, I now see a limited catalyst path ahead for the shares. In our view, Bentley's valuation now fully reflects the resilience of its top-line growth, trading at 12x EV/S (CY24). We anticipate the need for meaningful upside to expectations through the remainder of the year to warrant further outperformance, which could prove challenging due to the ongoing volatility in China and a softening commercial market
Balance sheet weakness
In my opinion, BSY balance sheet is quite weak given the high net debt level. BSY currently has a net debt of ~$1.6 billion, or net debt to EBITDA ratio of 5.24. While this ratio is expected to reach 3.6x by FYE, this is dependent on EBITDA increasing - which is at risk given the uncertainties I mentioned above. A high leverage ratio is likely to put a lid on how much BSY valuation could potentially re-rate upwards, especially with the current high valuation of 57x forward earnings.
Valuation
I believe the fair value for BSY based on my model is ~$50. My model assumptions are that: BSY will continue to grow at 10% until FY24, as the underlying tailwind remains strong. However, it is unlikely to see further inflection beyond these levels until the uncertainties are cleared. Margins should increase gradually as well, given the high incremental gross margin (~78+%) flowing through the fixed cost base. The key question is what BSY should be trading at. Looking at the past 2 years, BSY seems to trade at an average 35% premium against other Design and Engineering Peers like Altair Engineering (ALTR), Synopsys (SNPS), Ansys (ANSS), Autodesk (ADSK), and others. Using the same premium, I think the current 57x forward earnings multiple is too high, as it should trade at 51x (37 x 1.39). Note that even at 51x earnings, it is very high on an absolute level. At such a high valuation, any miss in consensus estimates can send the stock diving.
Risk
Commercial and Facilities is a cyclical industry that accounts for about 10% of BSY's revenue. The rise of telecommuting and other forms of flexible work arrangement may have an adverse effect on this revenue stream as customers reevaluate their need for a fixed workplace in the wake of COVID. Additionally, most of Commercial's funding comes from private investors. When interest rates increase, their ability to borrow money decreases.
Conclusion
I maintain my hold rating on the stock due to several uncertainties surrounding the upcoming earnings report. BSY's high valuation multiple of 57x forward earnings could be at risk of sharp rerating if it fails to meet consensus estimates. The company has performed well in 1Q23, but the growth was influenced by one-time items, making it unlikely to maintain the same level of strength going forward. While management reiterates its guidance, there are potential headwinds in China and the Commercial sector that may hinder achieving growth above the stated range.
For further details see:
Bentley Systems: A Lot Of Uncertainties With The Upcoming Earnings, Reiterate Hold