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We are improving our rating on ANSYS (NASDAQ: ANSS) to “buy” after recently hedging the company and being bearish on stocks. We are upgrading based primarily on valuation, but also on the company’s attractive growth outlook for this year.

Since we published our bearish post, equities have had a total negative return of around -31%, while the S&P 500 has returned -10%. Although we always thought Ansys was a great company, with an attractive business model and well-managed operations, we were put off by what we considered to be an extremely expensive valuation. Now that this has largely been corrected, we can be more bullish on stocks. We’re particularly attracted to Ansys’ strong competitive moat that comes from high switching costs and recurring revenue streams that give the company incredible stability.

Broad Alpha Ansys coverage

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Ansys’ finances

When Ansys released its first quarter 2022 results, it had both earnings and revenue, but what we found more interesting was the increased outlook for fiscal year 2022 on the growth of the annual contract value (ACV). During the earnings call, management summarized the new guidance for fiscal year 2022 as follows:

Let me start with our full-year 2022 forecast. We are updating our full-year ACV outlook to be between $1.960 billion and $2.020 billion. This represents growth of 4.8% to 8% or 9.2% to 12.4% in constant currency. We are raising the midpoint of our ACV forecast by 1 point of growth at constant currency compared to our February forecast. This increase is due to the strong ACV performance we saw in the first quarter and the improved guidance we see for the rest of the year. This underlying improvement resulted in an operational increase in ACV for the full year of $35 million over our February forecast. This operational dynamic was offset by the absorption of $18 million of activities in Russia and Belarus and $47 million of adverse exchange rate effects. […] Accordingly, we expect our EPS for the full year to be between $7.53 and $7.94. Compared to our February guidance, our full-year EPS increased by approximately $0.25 due to better operating performance and lower share count, which was offset by the absorption of $0.14 from Russia and Belarus and $0.24 from currency headwind.

The company also continues to skew its mix more towards rental licenses rather than perpetual licenses, creating recurring ACV growth momentum. As can be seen below, revenues have continued to grow with remarkable consistency. It slowed down somewhat during the Covid crisis, but has since returned to trend.

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Data by YCharts

In fact, revenue growth has averaged around 10% over the past ten years, and we see no reason to believe that won’t continue for many years to come.

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Data by YCharts

The company continues to have enviable margins, in particular its high gross profit margin gives it significant operating leverage as sales increase. Operating margins and net profit margins have deteriorated slightly in recent years, but remain well above average, reflecting the high quality of the business.

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Data by YCharts

Evaluation

Along with the improved forecast, it is the reduced valuation that is driving our upgrade of Ansys to ‘Buy’. As we will see, the valuation has become much more reasonable thanks to the combination of a falling share price and an increase in profits and revenues. Stocks are no longer trading at unrealistic EV/Earnings multiples of 15-20x, but closer to their 10-year average of around 10x.

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Data by YCharts

Likewise, the EV/EBITDA multiple has deflated, and is now approaching the 10-year average around 26x, with a slightly lower forward multiple thanks to the expected increase in earnings.

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Data by YCharts

Looking at analyst estimates compiled by Seeking Alpha, we can see that the forward P/E ratio is around 32x, and over the next two years it is expected to decline to around 26x on the back of earnings growth. These multiples aren’t cheap, but Ansys is a very high-quality company that rarely goes on sale.

Ansys EPS estimates

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DCF model

To get an idea of ​​what kind of return an investor can expect at current prices, we built a simple discounted cash flow model, with a 10% discount rate, using analysts’ EPS estimates to the next three years, and a growth of 11% thereafter for ten years, and a terminal growth of 5%. Despite an optimistic bias, the net present value we obtained was still slightly lower than the current price, but not by much. So we think long-term investors buying at current prices can expect an 8-9% return, which is perfectly fine for a consistently risky, below-average company like Ansys.

PES Discount @ 10%
AF 22E 7.82 7.11
AF 23E 8.68 7.17
AF 24E 9.76 7.33
AF 25E 10.83 7:40 a.m.
AF 26E 12.03 7.47
AF 27E 1:35 p.m. 7.53
AF 28E 14.82 7.60
AF 29E 4:45 p.m. 7.67
AF 30E 18.26 7.74
AF 31E 20.26 7.81
AF 32 E 22.49 7.88
Terminal value @ 5% terminal growth 449.85 143.33
VAN $226.06

Conclusion

We are upgrading Ansys to “Buy” based on an increased FY2022 guidance and a much more reasonable share price. Several valuation ratios are now close to their 10-year average after reaching unrealistic levels. The company remains the same consistent producer it has been for a long time, and with all the promise of new use cases for its simulation software. We believe that long-term investors buying stocks at current prices can expect a return on investment of around 8-9%, which can be considered quite reasonable given the consistency and company quality.