After enjoying a seemingly uninterruptible rally throughout the year, shares of Autodesk (NASDAQ:ADSK) have experienced their first real reckoning alongside the release of its Q1 results. Though investors have long praised Autodesk's growth - both organic and acquisition-driven - as it continues to convert the majority of its revenue base onto subscriptions, Autodesk suffered a substantial disappointment this quarter as revenues came in below Wall Street's expectations. Reality has come to bear on Autodesk - at its ~$3 billion annual run rate, Autodesk's ~30% y/y growth rate isn't safe forever.
Unsurprisingly, shares of Autodesk shed nearly 10% in after-hours trading as the results were published:
The question for investors now, however: has Autodesk fallen far enough? Judging by its ~12x forward revenue valuation (which puts Autodesk in the echelon of highest-valued software stocks, alongside other perennial high-flyers like Adobe (ADBE) and New Relic (NEWR)), I'd say there's plenty more risk on the downside for this stock.
Autodesk's tepid guidance is the first indicator that 2019 may not be Autodesk's year. Here's a look at the company's latest guidance update below:
Figure 1. Autodesk guidanceSource: Autodesk 1Q20 earnings presentation
Autodesk failed to raise its FY20 outlook this quarter, sticking to its original forecast of $3.25-$3.30 billion in revenues, representing a growth range fo 26-28% y/y (six points weaker at the midpoint versus 33% y/y growth this quarter). This disrupts the "beat-and-raise" cadence that investors have come to expect of growth stocks like Autodesk (and in fact, Autodesk didn't manage to beat nor raise this quarter). Wall Street had expected $3.29 billion in revenues, higher than the $3.275 billion midpoint of Autodesk's range.
There are real risks to be wary of as we digest Autodesk's poor growth forecast. The major red flag here is China. Widespread sentiment has it that China, and particularly its construction sector, is expected to see a substantial economic slowdown. The recent noise around tariffs and the escalating tensions between the White House and China certainly aren't helping, either. Autodesk is a well-globalized company, with Asia-Pacific revenues comprising a substantial 20% of total revenues. Any material slowdown in China will pose a serious headwind to top-line results.
Common wisdom has it that software companies are among the least exposed to trade tensions. After all, tariffs only affect hard imports like farm goods and semiconductor chips - but in this case, Autodesk's reliance on the construction industry does produce a correlation. Construction, in fact, has been one of Autodesk's key strategic priorities, and the company doubled down on construction with its ~$1 billion purchase of PlanGrid.
Figure 2. Autodesk construction strategySource: Autodesk 1Q20 earnings presentation
Construction isn't just facing headwinds in China; it's a global risk. U.S. residential construction, in particular, is another sore spot. The U.S. Census Bureau just reported that new-home sales fell in April, due in part to a shortage of inventory and insufficient new construction.
The key point here: Autodesk's disappointing guidance ranges isn't just a reflection of management's conservatism, but bona fide macro risks in the global economy. As a software vendor that derives a good portion of its revenues from infrastructure and construction companies, it wouldn't be surprising to see Autodesk's billings pull back. Note also that Autodesk has a fairly aggressive billings growth target of 50-53% y/y this year (the nominal range is $4.05-$4.15 billion), which the company may be hard-pressed to meet.
Let's now parse Autodesk's Q1 earnings results in greater detail. The earnings summary is shown below:
Figure 3. Autodesk 1Q19 resultsSource: Autodesk 1Q19 earnings release
Revenues grew 33% y/y to $707.8 million, missing Wall Street's expectations of $703.2 million (+32% y/y) by a point. billings, fortunately, painted a stronger picture - up 40% y/y to $798 million, clocking in a first-quarter record:
Figure 4. Autodesk billings trendsSource: Autodesk 1Q20 earnings presentation
Scott Herren, Autodesk's CFO, additionally noted that Autodesk performed well on renewals. He reported that the company's net retention rate stayed within the target range of 110-120%, driven by better-than-expected renewals from a cohort of customers that bought into Autodesk at a promotional rate three years back. Per his prepared remarks on the Q1 earnings call:
In Q1, some of the deeply discounted subscriptions from a global field promotion we ran three years ago came up for renewal. We were very pleased with the renewal rates of this group of customers as they renewed closer to list price, and the total value from the entire cohort grew."
What is disappointing, however, is the rate of deceleration in Autodesk's ARR growth - which, for a company whose narrative focuses almost entirely on subscriptions now, is a huge blow. Total ARR grew 33% y/y to $2.83 billion, as shown in the chart below:
Figure 5. Autodesk ARR trendsSource: Autodesk 1Q20 earnings presentation
This represents one point of deceleration from 34% y/y growth in Q4. However, when we account for the fact that organic ARR growth was only 29%, the story becomes much worse. Autodesk completed its purchase of PlanGrid in December, and expects the acquisition to contribute three points of ARR growth in FY20. It contributed four in Q1 - so on a net basis, organic ARR slowed down by five points this quarter.
On the margin side, though Autodesk managed to drive substantial improvements to both gross and operating margins, the company still missed Wall Street's earnings targets. Pro forma gross margins rose two points to 91% (a sky-high number) from 89% in the year-ago quarter, while pro forma operating margins saw a 13-point jump from 5% in 1Q19 to 18% this quarter. You'll recall that Autodesk incurred heavy expenses last year in laying off 13% of its workforce, and has begun to reap the cost benefits of its slim-down this year.
In spite of these margin gains, Autodesk's pro forma EPS of $0.45 still missed Wall Street's mark of $0.47. The double whammy of a revenue and EPS shortfall - alongside a disappointing guidance outlook - put a huge damper on Autodesk shares.
I remain fundamentally positive on Autodesk and its positioning in the software landscape - Autodesk is without a doubt the best-in-breed vendor for CAD tools, and the gold standard by which all engineers are trained in college. That being said, the company is facing substantial macro headwinds in the coming year, with twin risks of a slowing construction sector and economic chaos in China.
In light of these risks, Autodesk's 12x forward revenue valuation appears rich, especially at a time when the market is pulling back from frothy growth stocks. Even after we account for Autodesk's post-earnings pullback, the stock is still up nearly 25% year-to-date, nearly doubling the performance of the S&P500. I'm inclined to stay on the sidelines until a better price avails itself.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.