The future of the manufacturing industry lies in the adoption of digital technology, that is, industrial software, especially software that connects the digital and physical worlds. That is PTC‘S (NASDAQ: PTC) raison d’être and the company appears poised for solid growth for many years to come. Moreover, despite a valuation of 57%, the share’s valuation remains very attractive for growth investors.
PTC is not yet firing on all cylinders
Increasing adoption of digital technology is a powerful driver of long-term growth, but does not fully offset cyclical weakness in some of PTC’s end markets. Management defines its five key end markets as industrial products, federal aerospace and defense, electronics and advanced technology, automotive, medical technology and life sciences.
It’s no secret that the industrial, automotive and electronics/technology sectors have been under pressure this year. CEO Neil Barua has previously spoken about a slow sales environment impacting PTC’s ability to convert sales leads into larger deals.
But PTC continues to grow its key metric, annual run rate (ARR), in low double digits. Management defines its ARR as “the annual value of our portfolio of active subscription software, SaaS, hosting and support contracts as of the end of the reporting period.”
As such, the ARR is consistent with what PTC bills customers annually, and management believes it is the best way to assess the progress of its subscription business. It may be a conservative measure for a number of reasons:
Image source: Getty Images.
Given that PTC offers a range of software solutions that operate in a so-called digital thread-closed loop, it is likely that many of its customers will purchase more of its software solutions after using its core product lifecycle management (PLM) solution. As such, contract values are likely to increase as customers increase their orders. Similarly, with digital technology adoption likely to increase, PTC is expected to have a high retention rate, implying contracts are billed over several years.
What is closed loop digital wire?
The digital wire closed loop concept is simply the continuous and iterative flow of data between the physical and digital worlds. For example, PTC’s computer-aided design (CAD) software helps digitally design a product. PLM, on the other hand, helps in managing the product, automating and monitoring its production. And service lifecycle management (SLM) software helps support and maintain a product (for example, an elevator).
Image source: Getty Images.
Data feedback from SLM and PLM in the physical world could lead to a redesign using CAD. Additionally, a CAD redesign will result in changes to the SLM and PLM data. Ultimately, the solutions will work together to iteratively improve and accelerate the design and development process for a customer – an essential requirement in a world of increasingly complex products.
PTC has a bright future, and that also applies to its revenues
The secular growth engines discussed above are powerful enough to drive 12% constant currency ARR growth in fiscal 2024 ending September 30, and management expects constant ARR growth of 9% to 10% by 2025.
As you can see below, ARR growth is accompanied by greater conversion to free cash flow (FCF), driven by subscription growth and increased software-as-a-service (SaaS) revenue generation through the increase sales of cloud-based software and cross-pollination. -Selling solutions to existing customers.
Data source: Business presentations. The 2025 estimates are the centerpiece of management’s guidance. Chart by author.
PTC Valuation: A Stock to Buy?
Management forecasts free cash flow of $835 million to $850 million in 2025. This includes a $20 million outflow related to the restructuring of the go-to-market structure, hiring a Chief Revenue Officer and easing sales efforts. regrouped around the five critical industrial sectors discussed. above.
Wall Street analysts expect $990 million in free cash flow by 2026. These numbers place PTC at an expected price-to-FCF multiple of 27 times free cash flow in 2025 and 23.2 times free cash flow in 2026. While these multiples seem high, keep in mind that PTC is increasing its ARR with growing double digits and the FCF by mid-teens.
Furthermore, it is achieving these growth rates in a challenging trading environment, so it is reasonable to assume that it could increase its growth rate given an overall improvement in the industrial, automotive and technology sectors. This is very likely to happen as the industrial sector is still in the early stages of adopting digital technology, and the improvements that PTC brings are tangible and will increase in value as customers become accustomed to using the digital thread in their activities.
All of this makes PTC a growth stock worth buying now.
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Lee Samaha has no positions in the stocks mentioned. The Motley Fool recommends PTC. The Motley Fool has a disclosure policy.
