It's no secret that the technology sector has corrected in recent months, particularly with some of the more speculative names. It's partly due to a correction from frothy valuations and a more realistic appraisal of tech stock growth prospects. But where does industrial software company PTC (PTC 0.42%) stand in all of this? First, let's look at the investment proposition in light of the recent earnings.
PTC in 2021
The excitement around the stock centers on its growth product portfolio, namely its Internet of Things (IoT) and augmented reality (AR) software. They are supposed to drive growth toward free cash flow (FCF) in the range of $700 million to $750 million in 2024. But unfortunately, growth in the growth product portfolio hasn't quite been what investors might have hoped for.
PTC's operational performance in its fiscal 2021 was good, but under the circumstances, investors might expect a bit more. The company's organic annual run rate (ARR) growth of 12% in 2021 came in at the high end of the original guidance of 9% to 12%, but there were a couple of slight disappointments in PTC's fiscal 2021. For reference, ARR is simply the annualized value of PTC's portfolio of active subscription software and contracts at the end of the period. It's the key metric management uses to measure performance.
Turning back to the disappointments, growth in the industrial sector in 2021 was better than many forecasters had expected, so it's reasonable to expect spending on PTC's solutions to have been boosted. However, PTC only met the high end of its initial ARR guidance.
As such, PTC is yet to report a "breakout quarter," demonstrating that its growth product portfolio is seeing a dramatic increase in adoption and ARR growth.
Fast forward to the first quarter of 2022
It was more of the same in the recent fiscal first-quarter 2022 results. Overall organic ARR growth in constant currency came in at 11%. Organic core product (computer-aided design, or CAD, a product lifecycle management, or PLM, software) ARR growth in constant currency was 11%. Meanwhile, the growth products organic ARR growth in constant currency was 14%.
These numbers align with management's guidance on its investor day presentation in December.
For a flavor of PTC's growth progression, the following chart breaks out ARR growth at constant currency every quarter since 2019. It's a good performance, but PTC hasn't yet returned to the rates of growth achieved in its growth products before the pandemic struck.
During the earnings call, CEO Jim Heppelmann was asked whether much-documented supply chain issues in the economy might have had some effect. He responded, "We talked about how perhaps COVID had an impact on IoT. Perhaps the supply chain a little bit, although I think muted compared to COVID. So to me, the supply chain thing is [a] fairly small factor in our results."
So, it doesn't appear that there's pent-up demand to be released as supply chain issues in the economy get resolved.
That said, based on strong bookings growth, Heppelmann does expect that the growth products portfolio will see "an acceleration of growth into the twenties as we get into the back half of the year."
All told, it's another quarter of perfectly acceptable, but not great, performance from PTC, and investors are still likely to be in "show me the second-half growth" mode over the stock.
The question then turns to whether investors want to buy a stock that currently trades at just under 29 times management's estimate for free cash flow (FCF) of $450 million in fiscal 2022. It seems like a heady valuation, and it's understandable if investors shy away from it in the current environment.
On the other hand, PTC continues to hit its guidance, and management's modeling for FCF in 2024 continues to be the $700 million to $750 million mentioned earlier. The low end of that range would put PTC on 18.6 times FCF in 2024. That would be an extremely attractive valuation for a company that should be seeing a pickup in its growth rate as its growth products become a more significant part of its revenue (currently only 13%).
On balance, the stock remains attractive, particularly for investors who believe in the growth potential for IoT and AR as part of the fourth industrial revolution.