Archive: November, 2007

LSTR: Landstar Should Shine Again

This column originally appeared at RealMoney on November 19, 2007

Along with most of the rest of the trucking industry, the news on Friday from FedEx (FDX - Annual Report) and YRC Worldwide (YRCW) sent shares of Landstar (LSTR - Annual Report) down sharply, briefly causing it to breach the 52-week low. Landstar has long been one of my favorite names, and I took the opportunity to buy some shares because I think the current valuation will be tough to beat.

Don’t get me wrong – I’m not arguing that trucking revenues are about to ramp up across the board. As the chart below shows, the industry has been slowing since early 2006 and despite the little uptick in September the year/year change was a decline of 2.3%. Demand for trucking services is bad, and the slowing U.S. consumer suggests that it will probably get worse before it gets better.


Source: American Trucking Associations

No, the main reason I like Landstar for the long haul (har!) is their business model. Rather than own their own trucks, they outsource the loads to owner operators who provide their own rigs. The business capacity owners (BCOs in Landstar terminology) get the lion’s share of the revenue for the load, which encourages them to haul as many as they can. This is a virtuous cycle that benefits both Landstar and their BCOs. More than 30,000 rigs are in the Landstar network, though some are much more active than others.

But the benefit isn’t just incentives to work harder. The revenue sharing process means that most of Landstar’s expenses are variable rather than fixed. When business is slowing for the trucking industry as a whole, Landstar’s expenses fall in proportion to any decline in revenues and the company is able to remain profitable.

For regular trucking companies like YRC, each unassigned truck is a drag on profitability. The truck certainly represents a depreciation expense and could also represent an economic expense if it is leased or purchased on credit. Every truck without a driver hurts the company.

At Landstar, an empty truck hurts the driver, who then has that much more incentive to haul some merchandise, earn some money and make the truck payment.

Industry Slowdown?

Although Landstar reported a 3% decline in total revenue during the first nine months of 2007, the decline was mostly due to a fall-off in one contract. The company provides disaster-relief services for FEMA and the milder hurricane season in 2006 led to lower revenue in early 2007 than was experienced post Katrina and Rita for 2005/2006.

According to Landstar’s latest 10Q, revenue would have been up 5% excluding FEMA business in both years. Contrast that with the decline in overall industry revenues, and I smell market share gains. The industry may be slowing down, but I don’t think Landstar is.

Cheap Growth

Over the last 12 months, Landstar generated $167 million in free cash flow. Nearly all of its operating cash goes to share repurchases and dividends since the company isn’t buying trucks. On a $2.1 billion enterprise value, that amounts to an 8% free cash flow yield – more than twice the yield on Treasury bonds and a healthy risk premium in today’s market.

What’s more, Landstar’s 5% apples-to-apples growth in a bad year suggests the longer-term growth rate could be significantly higher. With today’s price justified even without any growth, the prospect of an eventual return to double-digit growth rates gets my mouth watering.

Sure, the P/E of 17x is significantly higher than YRC’s 6x. But the lack of capital requirements, the absence of YRC’s $1.5 billion in debt and the variable cost nature more than justify the higher P/E in my opinion.

Disclosure: William Trent owns shares of Landstar (LSTR - Annual Report)

Topics: Air Courier, FedEx (FDX), Landstar Systems (LSTR), Miscellaneous Transportation, Transportation, Trucking, United Parcel Service (UPS) | 2 Comments

ANSS: Market Pullback Presents Buying Opportunity in Ansys

This article was originally published at RealMoney on November 19, 2007.

With shares of Ansys (ANSS) up 100% over the last two years and more than 1,200% over the last seven, it hardly qualifies as undiscovered. However, with only four analysts covering the stock – and none from bulge bracket investment firms, the stock may remain under-appreciated.

Earnings have exceeded estimates by a wide margin for several consecutive quarters (including a significant earnings beat just two weeks ago), which is further evidence that the current consensus may not fully reflect the company’s earnings power. The shares soared on that news but have since come back down to their prior levels due to the overall stock market weakness. I think this baby is wrongfully being thrown out with the market’s bath water.

Ansys (ANSS) designs engineering simulation software used in such industries as aerospace, automotive, manufacturing, electronics, biomedical and defense. Simulation software reduces the time it takes to move products from the design stage into manufacturing because it allows for much of the necessary product testing to be simulated rather than tested on prototypes. Ansys licenses its technology to businesses, educational institutions, and governmental agencies.

On May 1, 2006 Ansys acquired one of its largest competitors, Fluent. The acquisition depressed trailing earnings and elevated trailing valuation multiples, possibly keeping Ansys off the radar screen of some investors.

Despite a fairly hefty multiple of 28x next year’s earnings, the company generates a strong free cash flow yield of 3.5%, which is nearly as high as the current yield on five-year treasuries. Unlike Treasuries, Ansys also offers significant growth that should more than compensate for accepting the related risk. Based on my calculations, the stock has an intrinsic value of $46 per share based on that ability to generate excess cash.

An Eye on the Risks

With the possibility of a recession rising, it is worth considering a possible demand slowdown. The company’s largest end markets are aerospace and autos. Aerospace is booming but major projects like the A-380 and Boeing Dreamliner are past the design stage, so arguably demand could slow until the next major product cycle is under way. Autos face the opposite risk – slowing demand due to the overall industry’s distress.

The long sales cycle and potential for large license sales can lead to lumpy sales patterns, a risk reduced by the Fluent acquisition since Fluent sells a higher proportion of lease-based licenses rather than perpetual licenses. Ansys has been a leader for many years, and even if it were to fall behind technologically its customers would be unwilling to migrate to a new platform immediately. This lag could allow them to catch up or buy the necessary technology.

The company could fail to successfully integrate a future acquisition. However, its acquisition of Fluent, and Dassault’s (DASTY) purchase of ABAQUS, has reduced the pool of potentially large acquisition candidates significantly.

Valuation

Ansys has generated more than $103 million of free cash flow in the last 12 months. Based on its current enterprise value of $2.9 billion, Ansys is generating a free cash flow yield of 3.5%, slightly less than the yield on five-year treasury securities.

According to Zacks Investment Research, the consensus five-year earnings growth estimate is 18% per year, which compares to 11% actual historic market growth and a 13% theoretical sustainable growth rate (equal to the average ROE since there is no dividend.)

I think sales can grow 15.7% in 2008 and 15% in 2009, which should generate nearly $130 million of free cash flow in 2008 ($1.60 per share) and $160 million in 2009 ($2.00 per share). At that time, assuming a 100% required return premium to treasuries and a 4% terminal growth rate the company could be worth $3.7 billion, or approximately $46 per share. I further believe they would have $4 per share in net cash by that time for a total potential value of $50 per share and total potential cash on cash return over the 2+ years of 30%. Discounting the cash flows to the present at a required return of 8.5% generates an estimated current intrinsic value of $46.00 per share, from which the current price represents a 20% discount.

Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

Topics: ANSYS (ANSS), Dassault Systemes (DASTY) | 1 Comment

CTSH: Don’t Fall into Cognizant’s Value Trap

This article was originally published at RealMoney on November 7, 2007

Don’t Fall Into Cognizant’s Value Trap

Cognizant Technology Solutions (CTSH) is trading down more than 16% after issuing revenue guidance slightly below expectations. Although buying a stock posting 50% earnings growth for a multiple in the 30’s may appear appealing, I think doing so would catch you in a value trap.

As I have noted elsewhere, Cognizant’s labor-intensive business requires adding people in order to add revenue. In fact, the growth in one year’s headcount has generally closely predicted the following year’s growth in revenue. Historically that has not been a problem.

In 2007, however, Cognizant is adding the same absolute number of employees as it did in 2006 – about 15,000. But while last years increase amounted to 60% growth in employees, this year’s only amounts to 37.5%. Don’t get me wrong – that is still a very impressive number and the employees have historically been underutilized. Increased utilization can be a good thing.

But what if the 15,000 employees per year is an upward limit? Next year that would make for just 27% growth and the year after it would be just 21%. You can see that within a few years the growth rate would look “normal,” and the P/E would have to decline. Then getting a really good return starts to become tough.

PEGging Down the Value

I am no fan of the PEG ratio, which wrongly assumes that growth and valuation have a linear relationship. But many Cognizant investors seem to put some faith in it, arguing that the P/E multiple is low given how much Cognizant is growing. Looking back, Cognizant’s PEG has consistently ranged around 1.0 – which suggests that investors may truly be using it as a gauge. Whatever my own feelings about the PEG’s merits, if it drives the stock price I will pay attention to it.

ctsh-peg.jpg

Sources: Zacks Research Wizard, William A. Trent

So if a PEG of about 1.0 is where the shares will trade, what are the implications of a 15,000 employee per year growth in headcount?

For simplicity’s sake, I am assuming that the employee growth will predict the following year’s revenue growth and that margins will be constant. Increased utilization could make those estimates conservative, while a rising rupee and ongoing wage inflation could make them appear aggressive. For this illustration I’m implicitly assuming those factors will cancel each other out. If you disagree, it is a fairly simple matter to adjust my assumptions to fit your forecast.

Here’s how things would trend using those assumptions for the next five years:

ctshforecasts.jpg

All of the increase in earnings is offset by an equal or greater reduction in the growth rate. Today’s buyer at $33 on the basis of a low PEG ratio should be prepared to sell in five years for a whole $35.

Another Perspective

As I said, I don’t put much faith in the PEG ratio. Therefore I don’t want to draw all my conclusions from it despite its past usefulness in explaining the stock price. For another perspective I turn to my favorite tool, free cash flow yield.

In the last 12 months, Cognizant generated about $138 million in free cash flow (cash from operations less capital expenditures.) With a $9.5 billion market cap after today’s shellacking, the yield is still less than 1.5% – far lower than I could earn on a risk free treasury bond.

On the other hand, Cognizant’s cash flow could grow while the treasury interest payment will not. In the past, cash flow has risen in line with earnings. However, in the last 12 months it has not grown even though EPS have. Still, I will assume that the free cash flow will match the earnings growth over the next five years to reach $326 million in 2012.

By then, the growth will have sufficiently normalized that I would expect at least a treasury-like yield. At 20x the free cash flow, I would only be willing to assign a $6.5 billion valuation in five years. That is nearly a third less than the current valuation.

Either way I cut it, Cognizant is looking to me like a high-growth value trap.

Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

Topics: Cognizant Technology Solutions (CTSH) | 1 Comment

PMTC: Parametric Cheap For a Reason

This article was originally published at RealMoney on November 6, 2007.

Parametric Technology (PMTC) develops software used for Product Lifecycle Management (PLM) and Enterprise Content Management (ECM). At a P/E of approximately 15x and a 5.3% free cash flow yield, Parametric appears cheap relative to other technical software developers. However, its earnings quality has historically been low and it faces more severe competition than some of its peers. With earnings quality improving and the valuation favorable, PMTC certainly bears watching. But for now I think Dassault Systemes (DASTY) and Ansys (ANSS) have sufficiently better prospects to justify their higher valuations.

Compared to companies like Ansys, which develops highly technical products and has relatively few competitors, Parametric has significant competition in each of its business segments.

PLM competitors include Dassault Systemes SA, Siemens (SI) subsidiary UGS, Autodesk (ADSK) and Agile Software (AGIL). They also compete with larger enterprise-solution companies such as SAP (SAP - Annual Report) that have entered the PLM market and offer solutions integrated with their other enterprise software applications.

ECM competitors include EMC (EMC - Annual Report) Documentum, IBM’s (IBM - Annual Report) FileNet, OpenText, Adobe (ADBE) Framemaker, and the Microsoft (MSFT - Annual Report) Office suite.

Parametric suffered mightily during the tech downturn, but since 2004 the company has been engineering a turnaround based on improved profitability and a return to growth. Current consensus growth estimates for the next five years are just 7%, or half the rate expected for the industry. The lower growth estimates are part of the reason for the cheaper valuation. However, they also make for a lower bar to clear, and the recent reversals of its deferred tax valuation allowance are a signal that the company is now “more likely than not” to earn sufficient income in future years to utilize tax losses from prior periods.

There are a few other issues that cause me to think Parametric’s low valuation is justified. For example, 58% of revenues are derived in North America, which faces an uncertain near-term economic outlook.

Another issue is earnings quality. Gross margins have been declining due to a higher percentage of revenue being derived from consulting and training rather than license and maintenance revenue. A bad debt charge-off in 2006 and increased customer financing activity are other signals that earnings quality may be low.

To get a feel for overall earnings quality, I calculated the accrual ratio, or the change in net operating assets divided by average net operating assets. This ratio describes the percentage of earnings contributed by discretionary accounting items rather than actual cash flows. An ideal accrual ratio would fluctuate around zero. Parametric’s has been all over the map, though it has been improving for several quarters.

parametricsaccruals.jpg

Sources: Zacks Research Wizard, William A. Trent

If Parametric continues to improve its earnings quality, or if it gives back some of the stock gains it enjoyed post-earnings (or preferably both!) it could become an attractive buy candidate.  In the meantime, interested investors may find an option play worthwhile.

The January 17.50 puts were trading recently at $0.50/$0.75. If you could write the option for $0.60 it would offer a 3.1% 2.5-month return on the money at risk, which annualizes to nearly 15%. You’d be forced to pay $17.50 for the shares if they drop between now and then, but the option premium would give you an effective price of just $16.90. At that price, the 6.0% free cash flow yield would probably be enticing enough to justify a buy anyway.

Disclosure: Short naked put options on Ansys (ANSS)

William Trent currently has a short position in put options related to Office Depot (ODP).

Topics: ANSYS (ANSS), Adobe Systems (ADBE), Agile (AGIL), Autodesk (ADSK), Dassault Systemes (DASTY), EMC Corp. (EMC), IBM, Microsoft (MSFT), Parametric (PMTC), SAP (SAP), Siemens (SI) | No Comments

DASTY: Dig in to Dassault After Dip

This article was originally published at RealMoney on November 5, 2007.

Dassault Systemes (DASTY) is trading down nearly 6% after the company trimmed its earnings outlook by five Eurocents last week. The company now expects to earn between €1.96 and €2.00 in 2007, compared with earlier guidance of €2.00 – €2.05. With a solid overall business and a valuation that I believe looks reasonable, I think investors will ultimately find today’s price to have been an excellent entry point.

Dassault designs engineering software used for Product Lifecycle Management (PLM) (81% of 2006 revenue) and Mainstream 3-D design (19%). It has grown through organic growth and a series of acquisitions, including Abaqus in 2005 and MatrixOne in 2006 – each of which was in the order of $500 million consideration. It is 44.5% owned and effectively controlled by France’s Groupe Industriel Marcel Dassault.

Dassault offers software under several brands, including Solidworks for Mainstream 3D design and CATIA, DELMIA, SIMULIA and ENOVIA for PLM. However, a key aspect of its growth strategy is to combine the strengths of its various programs and allow customers to customize solutions using the company’s V5 platform.

The company generates 47% of its revenue in Europe, 31% in the Americas and the remainder in Asia. Although it blamed the lowered outlook on the weak dollar, the company’s latest annual report said its greatest currency exposures are between the Euro (its reporting currency) and the Yen, Pound and Korean Won.

More than half of the company’s sales are on a recurring (software rental or maintenance contract) basis rather than through perpetual license fees. With a largely industrial customer base, revenue growth drivers include business investment and industrial production in its end markets.

Competition

Dassault lists its primary PLM competitors as Parametric (PMTC) and Unigraphics, which was recently acquired by Siemens (SI). Its main competitor in Mainstream 3D is Autodesk (ADSK). The company also competes with Ansys (ANSS), Agile (AGIL), MSC Software (a href="http://stockmarketbeat.com/blog1/category/msc-software-mscs/">MSCS - Annual Report) and to a lesser extent Oracle (ORCL - Annual Report) and SAP (SAP - Annual Report).

The combined revenue of the nearest competitors and comparables, which I believe to be Dassault, Ansys, MSC and Parametric, has been approximately 11% annually over the last decade. Dassault has used its acquisitions and the opportunities provided by the V5 platform to grow at a faster rate than its peers.

In 2006 Dassault grew 24%, much of which was contributed by the Abaqus and MatrixOne acquisitions. On an organic basis sales grew 10% (12% assuming constant currency exchange rates.)

Risks

As I see it, the greatest risk Dassault faces is loss of a major customer. Although the company cites a customer base of 100,000 just 20 of those account for 25% of sales, with the largest customer accounting for 5%.

A potentially greater, though probably less likely risk is the company’s long-standing relationship with International Business Machines (IBM - Annual Report). IBM has a non-exclusive distribution relationship with Dassault and accounted for 45% of sales in 2006, so a rift between the companies could have a serious impact. The companies renegotiated the partnership earlier this year such that Dassault is taking responsibility for mid-market customers and IBM will serve enterprise customers. However, this adds a new risk related to maintaining a larger sales force.

Valuation

Dassault current market cap is approximately $7.3 billion, and with net cash on hand of nearly half a billion its enterprise value is about $6.8 billion. Given that it is on track to exceed its 2006 free cash flow generation of $300 million, the free cash flow yield of 4.4% compares favorably to the yield on five-year treasuries, and the 10% growth rate of recent years looks like a nice inducement for taking on the added risk.

By some common measures (5x book value and a P/E in the mid-20’s) the stock doesn’t exactly look like a bargain. But these measures overlook the cash flow generating power available to software companies. With essentially fixed costs and high margins, each dollar of sales contributes mightily to cash.

Although a recession or slowdown in Dassault’s key end markets or further dollar weakening could delay investor rewards, Dassault’s current valuation and long-term prospects appear to justify the wait.

Disclosure: Short naked put options on Ansys (ANSS)

Topics: ANSYS (ANSS), Agile (AGIL), Autodesk (ADSK), Dassault Systemes (DASTY), MSC Software (MSCS), Oracle (ORCL), Parametric (PMTC), SAP (SAP), Siemens (SI) | No Comments