COVID-19 Is a Challenge for Humanity, Dassault Systèmes Leads the Fight

Dassault Systèmes

About: Dassault Systèmes SE (DSY:FP)

A contempory investment opportunity as Dassault Systèmes looks to confront COVID-19 and deliverlong-term value

Summary

The investment community is seeking opportunities that will not only thrive in the climate of coronavirusbut also have a capacity to deliver value once the global economy returns to a new sense of normality.

As at the close of trading on May 26, 2020 Dassault Systèmes SE (DAST) is trading just 5.00% off the 10-year high and since the close on December 31, 2019 i.e. capturing the lockdown period, Dassault Systèmes SE washigher by 0.96%.

This compares well to the CAC 40 which on the year is lower by 22.95% and fellow member of the CAC 40 Schneider Electric SE (SCHN) that had fallen 6.05%. From the U.S. a key rival in the digital transformation solutions space is Autodesk (Nasdaq) which has risen by 8.75% on the year.Dassault Systemes SE’s performance on the year also compares favourably to the YTD performance of top German rival and DAX 30 component SAP SE. Over this period including the lockdown, SAP stock has dropped 8.79%.

One can see Dassault Systèmes SE has not raced ahead of the pack, nor has it fallen behind the pace. That said, given the current price proximity to the 10-year high investors may question what scope there is for further upside.

Cash Is King

The earnings call for Q1 2020 on April 23 revealed that in the first quarter to be impacted by the COVID-19 lockdown the top line was booked at EUR 1.13 Billion registering growth of 18.33% YoY, whilst bottom line retreated 30.1% to EUR112.4 Million.

Cash flow has never been so essential to all corporations; with that in mind it was encouraging to see the net cash balance rise to EUR298.6 Million 244.41% YoY up from a deficit of EUR3.91 Billion in Q4 2019. Although overall cash on hand fell by 22.53%, the balance of EUR2.24 Billion is encouraging. That represents a gain of EUR300 Million on the quarter.

Given the weak showing of the peer group as represented by the CAC 40 I see this as a positive and is a compelling reason to keep an interest eye on Dassault Systèmes SE.

Thesis Summary

Just as we wondered what economic landscape would emerge after the global financial crisis, so the same questions are asked nowonce economies are reopened.Certain sectors will struggle and many smaller firms and perhaps a few larger ones may not survive.

Dassault Systèmes SE is well placed as key questions post COVID-19 will be what be done to ensure the health, safety and welfare of people around the world.  The “3DEXPERIENCE” platform that the firm operates can be regarded as a driver of innovation that will exploit and leverage solutions to the current challenges.

This interactive system empowers global teams in the corporate structure to cooperate remotely from the safety of their homes. This has delivered business continuity during the lockdown such as playing a key role in “StopCovid”, a project to develop a mobile contact tracing app for France.

The “3DEXPERIENCE” platform has also accelerated a wide range of open innovations to resolve COVID‐19 issues and these have created medical software, SIMULIA XFlow to simulate and assess virus dispersal in the Leishenshan Hospital in Wuhan, China.

Looking ahead to a post COVID world the active investment in agile work practices Dassault Systèmes SE is pioneering work to allow internet connectivity to enable the expansion of business to virtual environments with easy access to mission critical information. This will be the motive force for efficient project management and a sense of community among project teams no matter how physically remote.

DassaultSystèmes SE … What Constitutes Good Business

Dassault Systèmes SE provides project lifecycle management solutions enabling businesses to create and share experiences in 3D. Among key activity platforms are:

SOLIDWORKS:
A 3D design software for 3D and electrical design, simulation, product data management, and technical communication.

CATIA:
An engineering and design software for product 3D computer-aided design.

GEOVIA:
A system that models and simulates the earth.

BIOVIA:
Providing a scientific collaborative environment for biological formulated products and advanced materials.

Looking Beyond COVID-19

The key for future share price performance will be how Dassault Systèmes SE can harness its strong position in the virtual world and influence change and improvements in the real world post the COVID-19 crisis.

This means making such technologies relevant for life after lockdown. This will be driven by the leadership of President, Dominique Florack and Vice-Chairman/CEO Bernard Charles.

As the global economy has been shaken by the COVID-19 pandemic so there will be a constant need for a system such as BIOVIA to model and deliver simulations within the biotech world and the material science world.

Good and reliable information is critical as an input; however, the real prize will be the power of a simulation platform to deliver accurate and most importantly “actionable” predictions.

Therefore acquiring “Medidata” for USD5.8 Billion in June 2019 came as an increasing number of technology services suppliers are moving into “bioinformatics”. This is going to be a new source of profitability as life science rapidly embraces digitalisation of the mass fields of data.

The way Dassault Systèmes SE has been clear about utilising merit-based arguments and guarding against a “tick-box” mentality will ensue that any success the company has enjoyed during the lockdown will not lead to complacency.

Overcoming Competitive Threats

One must respond to a challenge that readers may pose in that there are several strong competitors in this area. Dassault Systèmes SE reported in the Q1 2020 earnings statement that globally there has been a strong adoption of Medidata. Looking ahead, the company appears to be well placed to win new accounts as it pushes into the realm of data science, data analytics and predictive modelling.

This is a logical step as the company already has partnerships with medical device manufacturers, biopharma and biotechnology research institutes, and governmental regulatory agencies. It shows how the senior management are looking to diversify the revenue streams.

Earnings Review

Dassault Systèmes SE reported in its Q1 2020 figures that the twelve-month earnings at EUR567 Million has declined by -4.6% compared to the previous year. In addition, this figure was disappointing given the average earnings growth rate over the past 5 years of that was registered at 12%. That could be seen if this marked a new pattern of slowing down.

Revenue generation is rather heavily reliant on services at 88.6% with the balance coming from software. The signs are that as the “3DEXPERIENCE” platform expands, software applications and enhancements are set to rebalance the revenue streams.

The geographic source of revenue is well balanced between the Americas at 39% of the total and Europe at 37%. Asia accounts for just under a quarter of the revenue at 24%.

One must consider the margins of Dassault Systèmes SE and ask if the company has a unique problem or if the peer group in the industry has encountered similar issues.

In terms of returns from investment, Dassault Systèmes did not deliver a 20% return on equity (ROE), recording 10% instead. Furthermore, its return on assets (ROA) of 4.0% is below the FR Software industry of 5.7%, indicating Dassault Systèmes’are utilised less efficiently. And finally, its return on capital (ROC), which also accounts for Dassault Systèmes’ debt level, has declined over the past 3 years from 13% to 6.5%. This correlates with an increase in debt holding, with debt-to-equity ratio rising from 11% to 23% over the past 5 years.

Valuation

Dassault Systèmes reported Q1 2020 financial results that showed recurring software operating margin and EPS booked at the higher end of Non-IFRS guidance.

The highlights were:

  • Q1 non-IFRS basis: total revenue 14 Billion
  • Operating margin 29.2%, EPS EUR0.95, +9%
  • Q1 non-IFRS recurring software revenue 83% of total software
  • Q1 Cash flow from operations of EUR458 Million
  • Board of Directors proposes annual dividend of €0.70 for the 2019 FY
  • 2020 non-IFRS financial framework: Targeting Stable YoY 2020 non-IFRS EPS of about EUR3.65

Looking ahead the objectives for Q2 were for non-IFRS revenue to be in the range ofEUR 1.04 Billion to EUR1.07 Billion with an operating margin target of 25% at the low end.

Casting a view for the full year 2020 the following guidance forecast were ambitious, however achievable:

  • Non-IFRS Revenue Objective: EUR4.50 to EUR4.55 Billion, growing about +12 to 13% in constant currencies
  • Non-IFRS Operating Margin Objective: about 29.5%
  • Non-IFRS EPS objective EUR3.65 to EUR3.72, ranging from 0% to +2%

These objectives are deliverable as with the larger clients Dassault Systèmes SE has secured multi-year contracts. The one flat spot could be the exposure to Boeing, although the sentiment is that on the full year contract worth EUR 20 Million, Dassault may have to absorb a 10% to 15% reduction on fees.

Earlier this note covered the acquisition of Medidata. The Q1 figures, suggest that the objective of full year growth at 13% is certainly achievable.

The case of investing in Dassault Systèmes SE on a value basis is well summarised in the following financial data tables.

Financial Data

Summary

Cash Flow

Ratios…Dassault Systèmes SE v Industry

Ratios… Dassault Systèmes SE TTM v 5-Year Average

Ratios… Dassault Systèmes SE TTM v 5-Year Average/continued

Takeaway

The valuations above reveal that in an era when estimating one’s demand curve is extremely difficult Dassault Systèmes SE, with the benefit of multi-year contacts in place is well placed. There may be a concession of up to 15% on certain contracts, however, the current ratio is well placed relative to the past five-years.

This is exemplified by the high closing cash balance at the end of Q1 2020 and the excellent margin levels when compared to the five-year averages.

I believe that at the current price Dassault Systèmes SEprovides a good opportunity in this space to deliver good returns for investors. Of course, one may have a reservation about the P/E ratio at 68.91, however, let me repeat that the “3DEXPERIENCE” platform is expanding. As such software applications are set to increase the share of revenue from software. Cash is King, and this corporation has plenty of cash on hand.

Disclosure: I currently have no position in this stock. 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.