Wednesday, August 8, 2012

Autodesk Stock Analysis

Another day and another technology stock is being hammered on slightly weaker guidance. This time it’s the turn of Autodesk $ADSK, which reported broadly in line results and affirmed full year expectations but guided Q2 guidance slightly below estimates. Autodesk also spoke of some variable markets in Europe and underperformance in its smallest business segment. The result? The stock sank nearly 13%. There has been a lot of these sorts of movements in the market of late and it’s interesting to look at Autodesk as an example.

In summary, Autodesk is undoubtedly a cyclical stock that will get hurt by a slowdown in the global economy. However, the current evaluation is cheap and the market's severe reaction to its earnings and guidance is mainly explainable by a very high risk aversion by investors to any kind of negative commentary around Europe. Simply put, investors are looking for reasons to sell in this market and it doesn’t have to be a rational reason.


Autodesk’s main competitors are Adobe Systems $ADBE Parametric Technology $PMTC and Avid Technology $AVID. All of these companies operate in the field of supplying software to enable content creation. Engineers and designers use the software to design anything from apartment blocks and bridges to automobiles and online content.

Avid is more focused on digital media creation, whilst Parametric is probably the most cyclical company due to its exposure to product development enhancement. Adobe is a more diversified company and offers good upside from the growth of digital marketing, whilst Autodesk is seen as the laggard in recent years due to its heavy exposure to the North American architecture and construction markets. Ironically, this is likely to be an area of strength going forward for Autodesk. To a certain extent, all these stocks should be in focus as 3d printing becomes a reality. But so far, this is more about interest rather than revenues.


Turning to Autodesk’s recent results, they were pretty much in line. Non-GAAP EPS came in at 47c and revenues were close to analyst estimates and above the internal guidance. However, two things hurt the stock.

Firstly, the company declared disappointing results in the Media and Entertainment (M & E) segment, which were down 5% annually. However, this is the smallest of the segments and currently makes up only 8.7% of total revenues. In addition, the reasons for this weakness seem plausible to me. Autodesk currently tends to sell its software in ‘flagship’ (57% of revenues) stand-alone products, but is migrating toward selling solutions bundled together in ‘suites’ (28%) based solutions.  Therefore, sales of certain stand-alone products are likely to decline in certain segments. In addition, sales were believed to have been held back by the delayed launch of a third party hardware product. Both of these issues can be resolved.

The second issue was that management mentioned that Europe saw variable performance across the region and only reported 4% growth. This is a concern as Europe (38%) is still the biggest geographic segment for the company. In addition, BRIC revenue was seen as variable with India and Brazil being a bit weak in the quarter. 

Combining these two issues meant that the guidance of $580-600m in revenues for the next quarter was weaker -- at the mid-point -- than analyst estimates of $595m. Moreover at the mid-point it is an annual growth rate of 8.1%, when full year guidance was unchanged for a 10% revenue growth rate. Analysts were right to question the company about the feasibility of hitting the full year target given the implied growth slowdown in Q3.

Autodesk Always Under Guides!

I want to focus on the guidance issue. Here is a chart of how Autodesk guides revenues for the quarter and then what it achieves. Autodesk is currently in fiscal year 2013.

Note that the company tends to beat the mid-point of its internal guidance, with the sole exception of the two quarters in the turbulent calendar year of 2008. It’s worth reminding ourselves that this occurred because of the collapse of the financial system, not because of the broader economy. The knock on effects of Lehman et al then affected the economy. In other words, there was little in the guidance or commentary of Autodesk in 2008 that foresaw the collapse in earnings -- it was the financial sector's troubles that caused the step change in earnings.

Understanding this, I calculated the average revenue ‘beat’ over the mid-point of guidance (excluding those negative and highly economically volatile two quarters) and it comes to 3.2%. To put this into context, Autodesk’s guidance mid-point for the next quarter was $590m. If I assume a similar ‘beat’ then Q2 revenue will be a handsome $608m; however I won’t. I will pencil in the average of the last four quarter’s beats, which gives revenues of $598m.

This would make Autodesk’s recent annualized growth path look like this.

If you combine the revenues for Q1 and my estimate for Q2, it gives an H1 growth rate over 10.5%, which suggests that Autodesk can hit its 10% revenue growth target for 2012.

So What is the Market Worried about?

As noted above, I don’t think these kind of stock-specific dramatic sell-offs are really about the earnings or guidance. Autodesk’s earnings were in line, the guidance was a tad weak. So what gives with a 13% sell-off?

Essentially, the market is running scared of another financial crisis created by a disorderly default in Greece spreading contagion to the rest of the Euro Zone. I understand this fear, but question the rationality of discovering it the day after a stock like Autodesk gives results!

It strikes me that investors are nervous and looking for reasons to sell. This company has generated $533m in free cash flow over the last four quarters, which equates to 9.8% of its Enterprise Value. In other words, even with no growth for the next decade, this company will earn the cash to pay for itself!

What Next for Autodesk?

I think the stock is attractive and for longer term investors now could be a decent entry point. However, I have a few concerns. The business is cyclical and whilst there is upside in North America and potentially upside in Europe, given a successful resolution of the Greek problem, my main concern would be in the BRIC regions. AsiaPac (including Indian & China) was responsible for 41% of the growth in this quarter and management are keen to talk about the growth prospects of the BRICs in general. I think some caution needs to be applied here.

China’s fixed asset investment looks set to slow and indicators like electricity usage and car sales are definitely slowing. The effect isn’t just related to China because a lot of Brazil’s growth is tied to supplying China with commodities. So my concern with Autodesk is actually with where it is reporting strength right now and its exposure to cyclicality. Given the theme in this article -- highlighting the irrationality of a lot of current tech selling -- I would be more inclined to look at the tech stocks that are benefiting from some more secular growth trends with things like cloud computing and mobile, rather than Autodesk for the moment.