Determining what is a "want" versus a "need" can be difficult when purchasing software. No company can purchase every software type. During tough times, some must-have software programs get cut. At most businesses, one or two programs are necessary. Identifying the software providers that fit into this recession-proof category can drive success for investors. Autodesk (ADSK -1.18%) and Unity Software (U -5.55%) each provide software critical for their customers.
Go to any construction site and ask the contractors for a structure blueprint or rendering, and chances are it was created using one of Autodesk's offerings. Customers cannot get away from Autodesk's products. An architecture or engineering firm that can't produce blueprints or drawings is useless. TechRadar recently released its best architecture software of 2021 list, and four of the eight programs were Autodesk's. Autodesk simply rules the space.
The maker of industry staples like AutoCAD and Revit used to sell yearly editions of its software that engineers or architects could use forever. Now, Autodesk has switched to a subscription model, which is creating growth for the stalwart. By doing this, Autodesk controls how much the price will increase each year, and customers are required to oblige.
During the second quarter, Autodesk's revenue rose 16% to $1.1 billion. Recurring revenue makes up 98% of that total, making it a predictable business to manage. With a 90% gross margin, Autodesk has plenty of room to make a profit. It generated $148 million in operating income and free cash flow of $186 million. It also maintained a revenue retention rate between 100% to 110%, displaying its stickiness. It is guiding 19% revenue growth for its fiscal year, nearly cracking $5 billion in revenue. Autodesk also projects a 31% free cash flow margin, allowing it to accumulate cash.
Autodesk trades at 46 times forward earnings, the exact same valuation as Adobe, another software company with strong margins and a sticky subscription model. While not cheap, 46 times isn't a terrible price to pay for a company with predictable growth and impressive profitability. Companies as vital as Autodesk don't come around often. Investors wanting a strong performer that isn't burning its profits for growth should have Autodesk on their watch list.
Video game designers are Unity Software's primary customers. It provides the tools necessary to create games as well as methods to monetize and grow the game's user base. Unity is indispensable for smaller creators who cannot afford to develop their own platforms. Without it, the designers would lack the tools necessary to release new games.
Unity's customers are expanding their usage, demonstrated by its 142% net revenue retention rate. It also grew its third-quarter revenue by 43% and projects about 30% fourth-quarter growth. However, investors may expect a revenue beat, as Unity projected 31% Q3 growth when it gave its second-quarter guidance.
Unlike Autodesk, Unity is not profitable. It lost $0.41 a share last quarter, equating to a negative 40% net margin. It is producing free cash flow, so the business will not need additional funding to survive. Because Unity does not have any profits, it must be valued using a price-to-sales ratio. At more than 50 times sales, Unity is one of the more expensive stocks on the market today. Investors can justify this by pointing toward gaming expansion and Unity's growth. A high valuation doesn't make Unity a bad company, just a tricky investment.
For future growth plans, Unity is expanding its 3D prowess into industrial use cases. It allows its customers to use augmented reality (AR) or virtual reality (VR), bringing their designs to a new authenticity level. It competes against Autodesk's 3D animation tools in this space. While this market is smaller than video games, it represents Unity's optionality.
Both Autodesk and Unity are vital for customers. Without the software each provides, businesses could not perform basic day-to-day functions. While both represent great stock ideas, investors need to be aware of each company they are buying. Autodesk will not provide huge growth, but it is reasonably valued and should provide dependable returns. Unity is higher-risk, but could provide monster returns should the investment thesis work out. Finding stocks customers couldn't live without is a smart strategy when picking stocks. Autodesk and Unity are two that fall into this unique designation.