The industrial software company's recent results have given investors confidence that the company will meet its full-year plans.
industrial software company PTC's (PTC) The stock price has fallen recently, and investors, at least initially, reacted negatively to the company's second-quarter results in early May. Is this trend likely to continue, or is now the best time to buy shares in exciting growth companies?
Recent big news from PTC
Investors typically make medium-term growth assumptions based on management's goals, and so do PTC shareholders. So when CEO Neil Barua (appointed in mid-February) told investors that the most important metrics for the business would remain at low double-digit growth over the medium term, , investors grew concerned.
Management's previous mid-term annual run rate (ARR) projections were for mid-teens growth, but this contraction is not good news. PTC defines ARR as “the annualized value of the portfolio of active subscription software, cloud, SaaS, and support contracts as of the end of the reporting period.” Increasing ARR is the key to creating long-term value and increasing free cash flow (FCF).
Wall Street quickly picked up on the negative news regarding ARR growth. “We roughly estimate that we will probably generate $100 million from ARR,” Oppenheimer analyst Ken Wong told management on an earnings call. A few days later, Mizuho analysts lowered their price target on the financial company's stock from $210 to $200 (maintaining a buy rating), noting the lower ARR outlook.
Are medium-term ARR guidance changes significant?
The obvious answer is that do Case. Naturally, analysts asked why management thought now was the right time to lower ARR while maintaining its FCF target. Mr. Barua replied, “Given the current state of the market, we felt it was appropriate to aim for a medium-term target in the low double digits.''
However, some context is needed here.
First, Barua is relatively new to the role, so it's understandable if he wants to adjust his expectations towards the goals he believes the company can achieve. One of the worst things an incoming CEO can do is start his term ignoring headline guidelines. It makes more sense to underpromise and overdeliver than the other way around.
Second, management argued that even if ARR growth slowed, PTC could still meet its FCF targets by managing internal spending in line with ARR growth. This isn't great news in itself, but it does show that just because PTC's growth is slowing doesn't mean its cash flow will decline significantly.
Third, like former CEO Jim Heppelman, Barua said the recent sales environment has been weak. He claimed this was due to the difficulty of securing large-scale digital transformation deals in the “seven or eight figure” size. That is understandable in the current environment where industrial growth remains weak and susceptible to interest rate pressures.
That said, there is still a strong long-term growth story here, related to the digital transformation taking place in the industrial sector and PTC's role in it.
Image source: Getty Images.
Why PTC stock is a buy
Moreover, there were far more good than bad results. For example, going back to the first quarter results at the end of January, I argued that PTC's implicit guidance for ARR for the second quarter and the rest of the year meant that it would be facing a sharp increase in ARR in the second half of the fiscal year. It took a year to get there. For reference, according to the implicit guidance, the ARR increase in the first half would be $79 million, and PTC would generate $162 million in the second half, which would be a rate of 33%/67%. Masu.
However, PTC exceeded management's expectations, increasing ARR by $96 million in the first half of the fiscal year and generating $145 million in the second half, a 40%/60% ratio. This is consistent with recent indicators. Overall, the results are a net positive.
The company's performance in the first half of the year gives management more confidence in its full-year outlook. On the other hand, the lower medium-term ARR guidance is understandable and gives investors an opportunity to reset expectations a bit. That's a good thing, and a drop in stock prices looks like a good buying opportunity for long-term investors.
