Tuesday, June 4, 2013

Time to Buy Autodesk?

There have been two major themes to the first quarter reporting season. The first is that tech spending has been weak across the board, and the second is that--outside of pockets like aerospace and automotive--the industrial sector has been weak too. Cue Autodesk’s latest set of results. It’s a software company and its end markets are industrial. The rest is history--the company's results were disappointing and it guided lower. What's next for Autodesk, and what do its latest results say about the industrial sector?

Autodesk’s first quarter results

I have previously covered the stock, and those wanting to assess the migration of its earnings can get some background information on the company there.

 A brief look at Autodesk's first quarter numbers versus its internal guidance:

  • first quarter revenue of $570 million vs. internal guidance of $570-590 million

  •  first quarter earnings-per-share of $0.42 vs. internal guidance of $0.41 to $0.46

  • second quarter revenue guidance of $550 to $570 million vs. analyst estimates of $583 million

  • second quarter EPS guidance of $0.39 to $0.44 vs. analyst estimates of $0.45

  • Full-year revenue guidance of $2.38 billion vs. analyst estimates of $2.45 billion

The end result is that the company's revenues and earnings for the first quarter came in at the bottom end of guidance, and its future projections were lower than analyst estimates. I appreciate that the lowered guidance may appear to be somewhat easier for the company to hit, but I want to demonstrate how even this might prove tough.

Assuming that the mid-point of the second quarter guidance is hit, the remaining $1.25 billion in revenues that were forecast by Autodesk could be split up in the following manner. I note that the management stated that fourth quarter growth would be stronger than that of the third quarter, so some back-of-the-envelope revenue estimates of $593 million and $658 million for the third and fourth quarters respectively could be implied. I want to graphically demonstrate what this means to the back end of 2014’s revenues.

Looking at it, reaching these goals seems like a fairly big ask. The company was duly forced to spend significant time during its conference call discussing various reasons why targets like these might be feasible.

Can Autodesk hit guidance?

The main reasons that Autodesk gave to indicate that it can hit its (lowered) full year guidance are:

  • Its business is becoming more back-end loaded with its major account business. As this was an area of weakness in the first quarter, the numbers are expected to contribute more in the second half.

  • Autodesk argued that $24 million of growth for the first half of 2014 was pulled into the fourth quarter 2013, resulting in somewhat distorted seasonality for 2014.

  • The comparisons from the second to fourth quarters of last year are a lot easier to beat.

  • The ongoing transition in its business model towards selling software as a service (SaaS) suites (bundled software packages) rather than standalone flagship products should drive growth in the second half. This is similar to he way that Adobe Systems  is shifting its customers to SaaS-based solutions instead of standalone software.

  • Autodesk sees improved strength in certain sectors of the economy that heavily use its software, such as global commercial construction. The company is also making progress in expanding its automotive accounts.

There are notes of caution against this, of course:

  • The company reported that April is weak. With other manufacturing exposed companies like Fastenal and MSC Industrial Direct reporting weak numbers before April, this is not a good sign for the second quarter.

  • Despite the second quarter of last year being relatively weak, the guidance for the second quarter of 2014 is not great.

  • Emerging markets underperformed in the quarter. These markets are supposed to be a long-term growth driver for the company.

  • Suite sales in emerging markets have been a bit disappointing, and piracy remains an issue.

  • The transition to SaaS is making the company's revenues harder to predict, and with companies like Adobe shifting sales models towards SaaS and subscription-based sales it is causing some hesitation in the purchasing habits of customers.

Essentially, the manufacturing sector has been weak as both Fastenal and MSC Industrial confirmed in their earnings reports that are discussed here. Both companies have limited visibility and short sales cycles. MSC saw sequential weakness in the quarter to the end of March, and with Autodesk saying that its April got weaker then this is hardly good news for MSC.

It was a similar story with Fastenal, though interestingly it saw stronger results in its metal work operations. I think this is partly due to having more exposure to aerospace and automotive. Investors in the industrial manufacturing sector should watch the statements of these two companies quite closely while also keeping an eye on the ISM numbers.

As for Adobe, its shift looms large in Autodesk’s thinking because the former has started to regenerate growth in its core product range thanks to the shift to SaaS and subscription-based sales. At some point Autodesk may well emulate Adobe’s model of ending perpetual license sales (which will cause some short-term revenue shortfalls as customers shift), but until then we shouldn’t model too much of these effects onto Autodesk’s numbers. Prospects for Adobe look good in the mid-term but will it hit is (raised) expectations this year, bearing in mind how many other tech companies have warned in the first quarter?

Where next for Autodesk?

In conclusion, I think that it makes sense to wait for more evidence of a pick-up in general industrial conditions before buying into Autodesk. I've no doubt that many will be tempted into buying in after the fall as this has been a good tactic this quarter, but cautious investors may want to wait to avoid buying in while the stock still has room to fall.

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