The industrial software company’s recent results gave investors confidence in meeting full-year guidance.
Industrial software company PTCin (PTC) shares have fallen recently and investors, at least initially, reacted negatively to the company’s fiscal second-quarter earnings, released in early May. Is the trend likely to continue, or is now a great time to buy shares in an exciting growth company?
PTC’s recent big news
Investors typically establish assumptions for medium-term growth based on management objectives, and PTC shareholders are no different. So when CEO Neil Barua (appointed in mid-February) told investors that the business’s most crucial metric would only grow by double digits in the medium term, they were worried.
Management’s previous medium-term guidance for its annual run rate (ARR) was for average growth, and it can’t be good news that the number is declining. PTC defines its ARR as “the annualized value of our portfolio of active subscription software, cloud, SaaS and support contracts at the end of the reporting period.” Increasing ARR is the key to generating long-term value and increasing free cash flow (FCF).
Wall Street immediately received the negative news about ARR growth. Oppenheimer analyst Ken Wong told management, “We roughly estimate that maybe $100 million is coming out of ARR” on the earnings call. A few days later, a Mizuho analyst lowered the financial company’s price target on the stock from $210 to $200 (while maintaining a buy rating) and noted the reduction in ARR guidance.
Is the change in medium-term ARR guidance important?
The obvious answer is that he does matter. Naturally, analysts asked why management felt now was the right time to reduce ARR while still maintaining FCF targets. Barua responded that he “looked at current market conditions and felt it was the appropriate thing to do to achieve the medium-term target toward those low double digits.”
However, some context is needed here.
First, Barua is relatively new to his role and it’s understandable that he would want to adjust expectations around the goals he believes the company can achieve. One of the worst things a new CEO can do is begin his tenure ignoring the guidance in the headlines, and it makes more sense to underpromise and overdeliver rather 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. While this is not good news in and of itself, it does demonstrate that cash flow will not decline significantly just because PTC is experiencing a period of weaker growth.
Third, like previous CEO Jim Heppelmann, Barua described the recent sales environment as slow. He argued this was due to challenges in securing “large digital transformation deals that run into seven, eight” figures. This is understandable in the current environment, where industrial growth remains weak and susceptible to interest rate pressure.
That said, there is still a powerful secular 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
Furthermore, there was much more good than bad in the results. For example, going back to Q1 results from late January, I argued that PTC’s implied guidance for ARR in Q2 and the rest of the year left it facing a sharp rise in ARR in the second half of the fiscal year. year to get there. For reference, the implied guidance suggested that the ARR increase in the first half would be $79 million, leaving PTC generating $162 million in the second half, a 33%/67% split.
However, PTC exceeded management’s expectations by generating a $96 million increase in ARR in the first half of its fiscal year, leaving it to generate $145 million in the second half, a 40%/60% split. This is in line with metrics from recent years. All in all, the results are positive.
The company’s performance in the first half gives me more confidence in management’s outlook for the full year. However, the reduction in medium-term ARR guidance is understandable and gives investors a small reset of expectations. That’s a good thing, and the falling share price looks like a good buying opportunity for long-term investors.
