It's no secret that stocks in the technology sector have been volatile in 2021. While some of this is a consequence of overstretched valuations and overly optimistic growth assumptions, that's not the case with industrial software company PTC (PTC 1.06%). As such, the stock should be looked at closely by investors. Here's how PTC makes money and why investors should favor buying its stock on any significant weakness in 2021.
Introducing PTC: Core products
As a reminder, the investment case for buying PTC is that the growing digitization of the factory will spur demand for its core computer-aided design (CAD) and product lifecycle management (PLM) software.
Image source: Getty Images.
PTC has a growth opportunity through shifting its PLM and CAD solutions to the cloud and selling them on a software as a service (SaaS) basis. Cloud-based collaboration helps the company's CAD and PLM customers as it enables closer cooperation between different functions in a company. For example, sales and marketing can quickly communicate with decision engineers through the cloud collaboration process and positively impact a product's design.
Together, PTC's core products (CAD and PLM) generated around 72% of revenue in 2020, and management expects them to grow at a high-single-digit annual rate over the medium term.
Introducing PTC: Growth products
However, the fascinating part of PTC's portfolio is its Internet of Things (IoT) and augmented reality (AR) solutions. IoT connects physical assets to the digital world. Doing so allows asset owners to run their assets better using digital technologies, including advanced analytics. Think of an automated process digitally modeled so its owners can better predict when a part needs servicing or replaced.
Meanwhile, AR allows technicians to service a product without even being present. Similarly, technicians can easily access digital information to help them service machinery.
Augmented reality in practice. Image source: Getty Images.
Together, the growth products (IoT and AR) generated 14% of revenue in 2020, and management expects them to grow at a 30%-plus annual rate over the medium term.
Now let's turn to why it makes sense to buy PTC on any weakness.
Long-term targets look achievable
First, the company remains on track for its targeted aims, and if it hits them, the company will look like an excellent value. As a reminder, PTC expects its overall annual run rate (or ARR, that's defined as the annual value of its customer contracts at the end of a reporting period), to grow at a mid-teens rate over the medium term.
As the ARR grows, so will free cash flow (FCF) generation. On this note, back in November 2019, management gave a range of FCF outcomes for 2024. The outcome scenarios range from "recession," resulting in FCF of $700 million, to "optimist," resulting in $900 million.
I've plugged in the numbers below for the different scenarios (assuming constant growth rates in FCF) and included the current Wall Street consensus to 2023. As you can see, based on Wall Street analysts, PTC appears on track for something in between "pessimist" and "market." That's not bad, considering there has been a recession since November 2019.
|
PTC Free Cash Flow Given Management Scenarios |
2021 Est. |
2022 |
2023 |
2024 |
|---|---|---|---|---|
|
"Optimist" |
$340 million |
$470 million |
$651 million |
$900 million |
|
"Market" |
$340 million |
$461 million |
$626 million |
$850 million |
|
"Pessimist" |
$340 million |
$443 million |
$576 million |
$750 million |
|
"Recession" |
$340 million |
$432 million |
$549 million |
$700 million |
|
Wall Street consensus |
$343 million |
$469 million |
$601 million |
N/A |
Data source: PTC presentations. Author's analysis. Wall Street consensus from marketscreener.com
Also, the targets to 2024 suggest PTC remains an excellent value. For example, based on the current market cap of $15.2 billion and, say, FCF of $800 million in 2024, PTC would trade on 19 times FCF in 2024. That's incredibly cheap for a software company with such exciting long-term growth prospects.
Current trading looks strong
Based on PTC's statements and the updated guidance of industrial automation giants Siemens and Rockwell Automation (particularly relevant as it's a partner and an equity investor in PTC), there's reason to believe PTC could exceed management's FCF guidance of $340 million in 2021.
Here's a summary of the relevant takeaways from each company's most recent results. For reference, Siemens' digital industries segment encompasses factory and process automation, industrial software, and motion control.
| Company |
Event |
What Management Said |
|---|---|---|
|
Siemens |
First quarter 2021 earnings in February |
"Digital Industries now expects fiscal 2021 comparable revenue to grow year over year instead of modestly." |
|
Rockwell Automation |
First quarter 2021 earnings in January |
"The recovery in manufacturing is happening at a much faster pace than we were anticipating, with our total orders exceeding pre-pandemic levels." |
|
PTC |
First quarter 2021 earnings in January |
"We are updating our fiscal 2021 financial guidance to reflect the effect of Arena Solutions2, the impact of foreign currency, and our Q1'21 performance." |
Data source: Company presentations.
There's good momentum in automation and industrial software spending in 2021, and manufacturers appear to have prioritized it in the aftermath of the pandemic.
A stock to buy
All told, PTC's long-term targets look achievable, and its near-term earnings momentum is strong. If you believe in the digital revolution in the industrial sector, PTC is an attractive stock to pick up given market weakness.
