2023-06-19 21:45:00 ET
Summary
- BSY boasts a long growth runway considering its $29.8 billion TAM, and it has the potential to expand its profit margin.
- But Bentley Systems' EV/EBITDA and P/E valuations are very rich, considering the expected EBITDA and EPS CAGRs for BSY.
- I am assigning a Hold rating to Bentley Systems, as I believe investors should be patient and consider the stock again when it is trading at more attractive valuations.
Elevator Pitch
I rate Bentley Systems, Incorporated ( BSY ) stock as a Hold. BSY's prospects in terms of profitability improvement and top line growth are good. However, investors should wait for a better buying opportunity to accumulate BSY's shares. In my opinion, when Bentley Systems' earnings multiple comes down to a level equivalent to 1.5 to 2.0 times its earnings CAGR, this will be the time to reconsider the stock as a potential investment candidate. As it stands now, BSY is deserving of a Neutral or Hold rating.
Business Profile
In its press releases , BSY describes itself as an "infrastructure engineering software company" whose solutions are utilized in the "design, construction, and operations" of infrastructure assets.
Bentley Systems' Annualized Recurring Revenue Split By Infrastructure Asset Category
Bentley Systems' Revenue Model
Bentley Systems' Top Line Breakdown By Revenue Stream
In terms of geographic exposure, Bentley Systems derived 53%, 29%, and 18% of its FY 2022 revenue from the Americas, EMEA (Europe, Middle East and Africa), and APAC (Asia-Pacific) markets, respectively as per its 10-K filing .
Long Growth Runway
BSY has a long growth runway taking into account both its current sales with its Total Addressable Market or TAM. Bentley Systems' trailing twelve months' revenue of $1,138 million (source: S&P Capital IQ ) represents a mere 3.8% of the company's estimated TAM of $29.8 billion.
Bentley Systems' TAM Estimate
At the Nasdaq London Investor Conference (event transcript sourced from S&P Capital IQ ) on June 14, 2023, Bentley Systems stressed that the "$30 billion (or $29.8 billion to be accurate) would be the expenditure by infrastructure engineers throughout the world if they spent as much as already do the product engineers." In other words, the degree of digitalization for infrastructure engineering is way lower than that of product engineering, and the $29.8 billion TAM is pretty realistic assuming that the gap closes over time.
Specifically, the Small And Medium-Sized Businesses or SMB client segment is the one that boasts the greatest growth potential. BSY had indicated in its 2023 corporate presentation that its SMB segment has been "adding hundreds of new logos quarterly" and contributing an average Annualized Revenue Growth of around +3%. Despite the strong growth momentum, Bentley Systems' SMB segment "is not quite yet a quarter of our business" as per company management's comments at Baird's Global Consumer, Technology & Services Conference on June 6, 2023. It is reasonable to assume that the level of digitalization for infrastructure engineering is lower at SMBs as compared to large enterprises, which makes the former a key area of growth for BSY.
In summary, BSY still has ample room to expand its top line in the future, taking into account its substantial TAM. In particular, Bentley Systems' SMB customer segment is growing rapidly, but this group of clients just accounts for a fraction (less than 25%) of the company's revenue.
Profitability Improvement Potential
Bentley Systems noted at the Nasdaq London Investor Conference on June 14 that it has a goal of "growing our operating margins 100 basis points per year."
BSY's profitability improvement target is consistent with the current sell-side analysts' consensus financial forecasts (source: S&P Capital IQ ), which point to the company's EBIT margin improving from 32.2% in FY 2023 to 33.4% and 35.4% for FY 2024 and FY 2025, respectively. As a comparison, Aspen Technology, Inc. ( AZPN ), one of BSY's peers, is projected by Wall Street to deliver operating margins in excess of 40% for both FY 2024 and FY 2025. Therefore, it isn't a stretch to expect Bentley Systems' operating profit margin to rise further.
In the preceding section, I mentioned that the SMB clients are a key driver of Bentley Systems' revenue growth. With regards to BSY's margin expansion, it is the enterprise customers who play an important role.
Bentley Systems' Client Account Mix
As indicated in the chart presented above, enterprise clients account for the majority of Bentley Systems' customer mix. BSY has achieved Annualized Recurring Revenue growth of +2.5 percentage points, +3.5 percentage points, and +4.5 percentage points for FY 2020, FY 2021, and FY 2022, respectively by up-selling to enterprise customers as highlighted in its 2023 corporate presentation. Enterprise clients are a significant source of positive operating leverage for BSY. The company is able to earn meaningful incremental revenue from these enterprise customers via up-selling initiatives without a lot of additional costs.
Certain categories of fixed operating expenses are also a key source of positive operating leverage for Bentley Systems. At the recent mid-June Nasdaq London Investor Conference, BSY emphasized that "can scale up over time" in terms of revenue without a corresponding increase in "G&A" (General & Administrative) costs.
In a nutshell, BSY is well-positioned to witness a further improvement in the company's profitability thanks to the positive effects of operating leverage.
Valuations Are Unappealing
A comparison of Bentley Systems' key valuation metrics with the company's consensus profit growth rates as per S&P Capital IQ data implies that BSY isn't attractively valued.
BSY stock currently trades at 42.9 times consensus forward next twelve months' EV/EBITDA, while the company's consensus FY 2024-2025 EBITDA CAGR is +13.0%. Similarly, Bentley Systems' FY 2024-2025 normalized EPS CAGR of +18.1% doesn't justify its current consensus forward next twelve months' normalized P/E multiple of 62.1 times. As a rule of thumb, a stock is considered to be undervalued if its earnings multiple is less than its expected earnings growth rate. Even for companies with good prospects like BSY, their earnings multiples shouldn't exceed their expected earnings growth rates by more than two times.
While BSY's expected EBITDA and EPS growth rates are decent, it is clear that these positives have already been adequately priced into the stock's valuations.
Concluding Thoughts
I like Bentley Systems' potential for revenue growth and margin expansion in the medium to long term. However, BSY's valuations are too demanding, and I view a Hold rating for the stock as fair.
For further details see:
Bentley Systems: Wait For A Better Buying Opportunity