Autodesk's Growth Problems Go Front-And-Center

By Stephen D. Simpson, CFA | August 27, 2012 AAA

When I last wrote about Autodesk (Nasdaq:ADSK), I cited the company's lack of top-line growth (and the macroeconomic sensitivity of that growth) as key impediments to the stock living up to its apparent value. Based on this quarter and management's guidance, those growth concerns are biting even harder right now. Although management deserves praise for the extent to which it maintained margins, margin preservation and cash flow just aren't going to make much headway against the negative sentiment around revenue growth.

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Macro Bites in the Second Quarter
It looks like the broad-based macroeconomic issues that companies like Caterpillar (NYSE:CAT) and Illinois Tool Works (NYSE:ITW) have been citing are taking their toll on this leading CAD/CAM software company, as Autodesk not only posted a miss but also took down guidance for the next quarter. Revenue rose just 4% this quarter, as license revenue improved only 2%, while maintenance billings increased 7%. There was weak performance across the board, as suites and 3D underperformed, and end markets like manufacturing and construction continue to soften. All of that said, Autodesk missed the average Wall Street guess by about 4%, so we're not talking about a full-on disaster.

While revenue clearly disappointed, management did a surprisingly good job of pulling in expenses. Gross margin weakened a point from the first quarter, but held steady with the prior year. Operating income did fall 2%, as the company maintained its operating margin on a sequential basis, but saw a point of erosion from last year.

SEE: Can Earnings Guidance Accurately Predict The Future?

Growth Drivers Not Driving
It doesn't look like there's a lot that went particularly right for Autodesk, particularly as it pertains to initiatives that ought to be driving the company's growth. Suites, for instance, saw just 5% growth from last year. Now while the year-ago comp number was a tough one (45% growth), the flat sequential performance moots that excuse. What's more, the suggestion that there was customer confusion regarding pricing and what was included in suites is not encouraging. At the same time, the emerging markets are wobbling. The company did see 9% sequential constant currency growth from emerging markets on strength in Russia and China, but Brazil and India were both soft. Given the recent PMI numbers out of China, though, I'm not sure if investors can rely on ongoing strength there in the short term.

SEE: The Risks Of Investing In Emerging Markets

How Much Spillover Will There Be?
If conditions are weak at Autodesk, and more to the point, if that weakness is due to macroeconomic factors and not sales force execution, this is not good news for others like Parametric (Nasdaq:PMTC), Dassault (OTC:DASTY), Stratasys (Nasdaq:SSYS) or 3D Systems (NYSE:DDD). More to the point, with Autodesk taking down third quarter revenue guidance by about 7% (relative to pre-existing estimates) and many large industrial companies seemingly throwing in the towel on 2012 growth estimates, there's not much optimism in the space right now.

Longer term, there are still all of the usual positive arguments to make. Cloud offerings offer new revenue possibilities, emerging economies are increasingly adopting advanced methods like CAD/CAM, and demand from commercial construction/engineering is due for a rebound. None of that is going to matter, though, so long as estimates are heading down.

SEE: An Evaluation Of Emerging Markets

The Bottom Line
Autodesk still looks undervalued on the basis of its long-term free cash flow generation potential, and it still doesn't matter. Tech investors don't embrace low-growth stories, and they like cyclical stories tied to manufacturing growth even less. Consequently, unless management can figure out a way to create legitimate and meaningful organic growth, the stock is not going to get the full valuation benefit of its cash flow production potential.

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

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