I've been a little surprised by Autodesk's (Nasdaq:ADSK) performance over the past nine months or so. While I've long liked this company and thought it was significantly undervalued on a cash flow basis, I've been surprised that worries about macroeconomic conditions, the switch to a cloud/subscription model, and generally unimpressive top-line growth didn't overshadow that underlying value. With another disappointing quarter in hand and estimates heading lower, though, it may be a little harder for the value trade to support these shares in the short term.

Fiscal 2014 Isn't Off To A Roaring Start

Autodesk reported that revenue fell 3% for the fiscal first quarter (or flat in constant currency), missing the average estimate by around 2%. The miss was led by disappointing license revenue, as this figure fell 9% from last year (missing the average estimate by about 6%). Maintenance and subscription revenue was stronger, though, growing by 6% and surprising expectations by about 3%.

Margins were not impressive and contributed to the miss. Gross margin fell 160bp (though still at a very high relative level of over 90%), as the company saw a mix shift and absorbed costs related to building its cloud business. Operating income fell 6%, with the operating margin decline of 60bp showing some efficiency gains to offset the gross margin loss.

Ample Headwinds For Now

There are plenty of headwinds blowing into Autodesk's face right now. For starters, there's a generally weak IT spending environment to contend with, as companies all across the sector have seen delayed deals and trade-downs to cheaper offerings.

Macro factors are also hurting Autodesk and the sector as a whole. While architecture / engineering / construction (AEC) demand was up 4% and better than expected, it was still down 17% sequentially despite management's mention of improving demand in commercial construction. The company's platform/emerging segment saw sales decline 6%, while demand in the manufacturing vertical fell 5% and weakened from the prior quarter. It doesn't sound like the macro picture is improving very much at this point, and like Ansys (Nasdaq:ANSS) and PTC (Nasdaq:PMTC), Autodesk lowered guidance for the next quarter.

Last and not least, all of this is going on while the company is in the midst of a transition to a subscription/cloud model. As we've seen at Adobe (Nasdaq:ADBE) and Microsoft (Nasdaq:MSFT) this can create some turbulence in revenue as customers adapt to the new terms. While this transition could improve margins over the long term, I do worry that sell-side analysts are too optimistic about the margin contributions from this switch (particularly as most of the large players are all doing it).

The Big Picture Still Basically The Same

For better or worse, I don't see tremendous change coming in this business. As is so often mentioned with Autodesk, the company has essentially created the standard in CAD/CAM and thousands of engineers and other such professionals are trained on their systems in college. At the same time, the company has been working to develop more products like Fusion 360 which help deliver more functionality to small businesses at affordable prices.

The real question is how much this will be worth outside the company's traditional markets. Autodesk's reputation and history is arguably worth less in emerging markets, and it has yet to be proven that the company can establish itself there to the same extent.

The Bottom Line

While Autodesk is suffering from a weak macro climate and the transition to a new model, neither of these will last indefinitely. To that end, I believe Autodesk can still expect to grow its revenue at a long-term rate in the mid-single digits. Likewise, I do believe there is still some incremental margin improvement potential, and that can push free cash flow higher at a mid-to-high single-digit rate. With that sort of growth, Autodesk shares appear to be worth about $45 to $46.

Although that free cash flow-derived target doesn't suggest huge undervaluation, I do believe that Autodesk is likely to be treated as a proxy for the macro and IT demand environments. If the second half recovery still comes through, these shares could head higher through the end of 2013. On the other hand, if global demand stays sluggish these shares may struggle to break out of their current range.

At the time of writing, Stephen Simpson did not own any shares in any of the companies mentioned in this article.

Related Articles
  1. Fundamental Analysis

    How To Decode A Company's Earnings Reports

    Read between the lines to decipher a company's true financial condition.
  2. Mutual Funds & ETFs

    Technology Sector Funds

    Evaluate past performance before investing in these types of gadget funds, as technology investors have been on a wild ride for a few years.
  3. Personal Finance

    6 Things To Look For In Earnings Reports

    Learn how to consider all the known variables when assessing a company's health.
  4. Stock Analysis

    How the Decline of the Personal Computer Market is Affecting HP

    Learn how falling demand for PCs has hurt Hewlett-Packard's revenues and income. Read about how the company is splitting into two separate companies.
  5. Stock Analysis

    Is Now the Right Time to Buy Brazilian Stocks?

    Examine the current state of the economy of Brazil, and learn why there may be some reasons for investors to look for a rally in Brazilian stocks.
  6. Stock Analysis

    Will WYNN Continue to Rally?

    Wynn Resorts has experienced a rally recently. Will it remain a good bet?
  7. Stock Analysis

    Don't Be Fooled by the Market's Recent Rally

    The bulls won for a bit in early October, but will bears have the last laugh?
  8. Stock Analysis

    Will Twitter's Stock Find its Wings Soon?

    Twitter is an enigma to many investors, but its story is pretty straightforward.
  9. Economics

    The 10 Best Tech Jobs

    Discover the 10 best tech jobs, based on job demand and salary.
  10. Investing Basics

    How to Think About Seasonality Trends

    Investors benefit when company research incorporates seasonality trends that predict relative strength and weakness throughout the calendar year.
  1. Can a company's working capital turnover ratio be negative?

    A company's working capital turnover ratio can be negative when a company's current liabilities exceed its current assets. ... Read Full Answer >>
  2. Does working capital measure liquidity?

    Working capital is a commonly used metric, not only for a company’s liquidity but also for its operational efficiency and ... Read Full Answer >>
  3. How do I read and analyze an income statement?

    The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>
  4. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>
  5. How do I use discounted cash flow (DCF) to value stock?

    Discounted cash flow (DCF) analysis can be a very helpful tool for analysts and investors in equity valuation. It provides ... Read Full Answer >>
  6. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!