PTC Is Great. Here's Why You Shouldn't Buy It

There's little doubt that the manufacturing sector is slowing, but what does that mean for industrial software company PTC (PTC 0.62%)? The company's first-quarter 2024 results showed that it's continuing to grow its crucial metric by a mid-teens rate, and its guidance for the full year suggests it will keep growing and generating value for investors. Still, will PTC hit its guidance? Here's what you need to know before buying the stock.

PTC, ARR, and FCF

There's no way around it. This is an investment article about PTC, so there will be three-letter acronyms! Please stick with me -- it will get easier as I go along. ARR refers to PTC's key metric: Annual run rate. This represents "the annualized value of our portfolio of active subscription software, cloud, SaaS, and support contracts as of the end of the reporting period." As with all software companies focused on a subscription model, this is the critical number to follow as it tends to convert to free cash flow (FCF).

After delivering 13% organic constant currency ARR growth of 13% in 2023, management expects ARR growth of 11% to 14% in 2024 and conservatively models 12% ARR growth to hit its guidance for FCF of $725 million.

That figure makes PTC look fully valued. For example, an FCF of $725 million in 2024 would put it on nearly 30 times FCF. That may seem high, but note that management sees a pathway to $1 billion in FCF in 2026, putting it on 21.6 times 2026 FCF. That's more acceptable, provided PTC hits its numbers.

After all, this is a company that's growing its crucial metric at a mid-teens rate, and its solutions are enabling the digital revolution in manufacturing.

Image source: Getty Images.

Question marks on PTC's guidance

Still, investors should always question the assumptions around guidance, and there are reasons to doubt PTC will hit its ARR guidance for 2024. The following table shows PTC's sequential growth by half years. So, for example, the figure for the first half of 2022 represents the net increase in ARR from the start of the financial full-year 2022 and the first six months of 2022. Adding the two halves gives you the full-year net increase, so you get $215 million ($94 million plus $121 million) for 2022 and a net increase of $214 million for 2023. Management believes its net ARR will grow by $241 million in 2024.

But here's the thing: PTC will have challenges meeting its full-year guidance. The net ARR increase in the first quarter was $38 million, and management forecasts $41 million in the second quarter, which leaves it needing $162 million to meet the full-year guidance of $241 million. Put another way, PTC will need to generate 67% of its net ARR increase in the second half, compared to 60% and 56% in the previous two years.

Data source: PTC presentations, author's analysis.

The subject matter came up on the recent earnings call. The new CEO, Neil Barua, expressed confidence in hitting the target of a net increase of $241 million in 2024 due to PTC's deal pipeline, which "is interesting to us in a manner that gives us confidence around the guidance."

He also noted that "this doesn't assume that anything changes in the selling environment from now to the end of the year." In other words, the increase in the second half doesn't include an assumption that its end markets will improve.

That's fair enough, but PTC still needs to meet its implied guidance for the second half.

Image source: Getty Images.

A stock to buy?

PTC is a great company, and its solutions are the future of the manufacturing industry, but the stock's valuation doesn't leave much room for error. This hasn't been a great earnings season for industrial companies, and PTC is relying on a strong second half to meet its guidance. The risk/reward calculation suggests taking some caution over the stock as things stand now.