Industrial software company PTC (PTC 2.60%) gave one of the most exciting earnings I've seen in the recent earnings season. Software companies often command high-valuation multiples to reflect their growth potential. Indeed, PTC did grow in its fiscal third quarter, and its guidance looks conservative. However, the outperformance came from its core products and not its growth-product portfolio. Moreover, the case for the stock rests on its resiliency in a downturn and its growth potential. Here's why PTC is a stock for the long term. 

The investment case for PTC

There are three parts to the argument:

  • PTC's near-term guidance looks conservative.
  • Its business model allows for a certain amount of resiliency in a downturn, and PTC is performing very well on its critical metrics.
  • Its core products are relatively outperforming now, implying that there's more to come on growth when its growth products accelerate growth.

Conservative guidance

PTC's key metric is its annual run rate (ARR), representing the "annualized value of our portfolio of active subscription software, cloud, SaaS, and support contracts as of the end of the reporting period." The excellent news from the third quarter is management raised its full-year ARR guidance (due to an acquisition and better-than-expected performance), and its fourth-quarter guidance looks highly achievable. 

Specifically, management now expects a full-year ARR of $1.66 billion to $1.69 billion, compared to previous guidance of $1.64 billion to $1.665 billion. During the earnings call, CFO Kristian Talvitie pointed out that $16 million of the $23 million increase was due to an acquisition, with the remainder coming from PTC's outperformance. 

Moreover, with ARR currently at $1.625 billion, all PTC needs to do is add $50 million in ARR to hit the midpoint of guidance. Given that ARR increased by $63 million in PTC's fourth quarter in 2021, the $50 million looks achievable.

Earnings resiliency 

CEO Jim Heppelmann challenged market followers to "show me a piece of data that supports" the view that PTC is a cyclical company. In other words, he believes PTC has a significant ability to grow irrespective of where the economy is trending. He has a point. The argument rests on the idea that PTC's software is "98% recurring," according to Heppelmann. He also noted that PTC had the "lowest churn the company has seen in many quarters" in the third quarter and that bookings currently exceeded churn by a ratio of three to one.

The difference between bookings and churn represents what's added to ARR, so based on the ratio above, PTC will have to see a dramatic 67% drop in bookings for ARR to decline.

Core vs. growth products

PTC's core products comprise computer-aided design (CAD) and product lifecycle management (PLM) software, and its growth products are the Internet of Things (IoT) and augmented reality (AR). In a nutshell, investors expect solid growth from the core products and high growth for the growth products, such that the latter takes over the heavy lifting in earnings in the next few years. 

Somewhat surprisingly, the core-products growth has almost been at the level of growth-products growth in 2022. That's partly a function of the former outperforming relative to management's expectations and the latter underperforming. 

Heppelmann put the growth-products underperformance down to factory owners being unwilling to invest at a time of uncertainty around their supply chains and inventory. He doesn't think "the market supports more than [a] 20% growth rate at this point in time" for the growth products. 

While that's disappointing, it's also understandable, and it sets up a scenario in which PTC's growth could receive a kicker when conditions clear up in the manufacturing sector.

ARR Growth in Constant Currency

Third Quarter 2022

Second Quarter 2022

First Quarter 2022

Core products

14%

13%

11%

Growth products

19%

15%

14%

Ending ARR

16%

13%

16%

Data source: PTC presentations. 

A stock to buy

The outperformance of CAD and PLM is a boon and suggests PTC is well placed in its core markets. At some point, the IoT and AR business will see robust growth, as there are powerful secular trends behind them, and PTC remains an excellent option for growth-orientated investors who can tolerate some downside risk from the economy.