Thesis

Dassault Systèmes (OTCPK:DASTY)(OTCPK:DASTF), the French-based pioneer and market leader in a broad range of 3D software applications, has had a challenging year so far, with both the three- and five-year charts showing less than appealing trends.

This is primarily due to the global economic slowdown, which has resulted in delayed customer signings. These negative factors began impacting the company’s earnings in 2023, with the effects intensifying in 2024:

Unlike most growth stocks, Dassault Systèmes is cyclical, meaning it is highly dependent on a functioning economy. During economic downturns, Dassault Systèmes tends to be adversely affected.

My thesis is that, while this dependence can be a disadvantage during a positive economic cycle, it becomes an advantage in times like now—at the end of an economic downturn, just before an economic upturn. Therefore I am sure, that the stock will generate great returns in the next 12 to 24 months if bought right now.

Company overview

Dassault Systèmes (original ticker DSY) is a software-as-a-service (SaaS) company that, unlike many others, is not new but long established. Founded in 1981 as a spin-off from Dassault Aviation in France, DSY has a long history as a market leader in 3D software, product solutions, design, and simulation. Initially focused on addressing the aerospace industry’s need for sophisticated drafting tools to streamline development and manage the increasing complexity of aviation design, DSY has successfully expanded into numerous other markets, such as automotive, and broadened its product portfolio to meet the global and cross-sector demand for 3D simulations and animations.

Let’s take a quick look at their products:

1. CATIA (Computer-Aided Three-Dimensional Interactive Application)

• Purpose: CATIA is a multi-platform software suite for CAD (computer-aided design), CAM (computer-aided manufacturing), CAE (computer-aided engineering), and 3D modeling.
• Industries: Primarily used in aerospace, automotive, industrial machinery, and architecture.
• Key Features: Advanced 3D modeling, systems engineering, and surface modeling. It’s known for its ability to handle complex product design and development.

2. SOLIDWORKS

• Purpose: SOLIDWORKS is a solid modeling CAD and CAE program.
• Industries: Widely used in mechanical engineering, product design, and manufacturing industries.
• Key Features: 3D design, simulation, product data management, and design validation. It’s known for its user-friendly interface and is highly popular among small to medium-sized enterprises.

3. ENOVIA

• Purpose: ENOVIA is a collaborative innovation and PLM software.
• Industries: Used across various industries for product lifecycle management.
• Key Features: Provides capabilities for collaboration, planning, and data management. It integrates various stakeholders across the product lifecycle, from design to manufacturing.

4. DELMIA

• Purpose: DELMIA is focused on digital manufacturing and operations.
• Industries: Manufacturing, logistics, and supply chain management.
• Key Features: Virtual manufacturing, robotics simulation, production planning, and operations management. It helps companies optimize their manufacturing and operational processes.

5. SIMULIA

• Purpose: SIMULIA is a suite of simulation applications for realistic product behavior analysis.
• Industries: Aerospace, automotive, consumer goods, and high-tech.
• Key Features: Finite element analysis (FEA), computational fluid dynamics (CFD), and multiphysics simulation. It’s used to predict how products will perform in real-world conditions.

6. 3DEXPERIENCE Platform

• Purpose: The 3DEXPERIENCE platform is a cloud-based business experience platform.
• Industries: Broadly applicable across industries like automotive, aerospace, life sciences, and more.
• Key Features: Combines data from various Dassault Systèmes tools into a single interface for collaborative innovation. It integrates all aspects of the business, including design, engineering, simulation, and marketing, into a unified digital environment.

7. BIOVIA

• Purpose: BIOVIA provides scientific innovation lifecycle management and laboratory informatics.
• Industries: Life sciences, chemistry, materials science.
• Key Features: Solutions for data science, laboratory data management, molecular modeling, and simulation. It supports research and development in pharmaceuticals, biotech, and materials science.

8. GEOVIA

• Purpose: GEOVIA provides solutions for modeling and simulating the earth.
• Industries: Mining, geosciences, and natural resources.
• Key Features: It focuses on geology, mine planning, and production management, helping companies optimize natural resource management.

9. EXALEAD

• Purpose: EXALEAD offers big data and information intelligence solutions.
• Industries: IT, finance, healthcare, and manufacturing.
• Key Features: Provides search and analytics solutions to transform large volumes of data into meaningful information for decision-making.

10. NETVIBES

• Purpose: NETVIBES is a dashboard intelligence software.
• Industries: Used in marketing, social media management, and business intelligence.
• Key Features: Aggregates and monitors information from various sources like social media, news, and internal data to provide real-time insights and analytics.

11. 3DVIA

• Purpose: 3DVIA offers 3D communication and content management tools.
• Industries: Retail, marketing, and product design.
• Key Features: Helps in creating and managing 3D content for marketing, sales, and training purposes, making it easier to communicate complex ideas visually.

12. DRAFTSIGHT

• Purpose: DRAFTSIGHT is a professional-grade 2D CAD product.
• Industries: Architecture, engineering, and construction.
• Key Features: It’s an affordable alternative to other 2D CAD software, offering essential tools for drafting and editing 2D designs.

13. TOSCA

• Purpose: TOSCA offers structural and topology optimization solutions.
• Industries: Automotive, aerospace, and industrial machinery.
• Key Features: It optimizes the shape and topology of structures for weight reduction and improved performance.

CATIA, DSY’s flagship product, has traditionally accounted for 30-35% of their software revenue. However, DSY has increasingly focused on its 3DEXPERIENCE platform, which integrates CATIA and other products into a comprehensive solution. The goal is to enhance the user experience and diversify revenue streams beyond reliance on any single product.

As the product descriptions suggest, DSY serves a broad customer base across various industries, including aerospace and defense, automotive and transportation, industrial equipment, life sciences, consumer goods and retail, energy and materials, high-tech, and construction and architecture. A closer look at specific companies reveals that DSY’s customer base includes many high-profile, investor-favorite firms:

• Apple (AAPL): Apple uses Dassault Systèmes’ design and simulation tools in its product development process
• Intel (INTC): Intel uses SIMULIA and other Dassault Systèmes solutions for semiconductor design and manufacturing processes
• ExxonMobil (XOM): This energy giant uses Dassault Systèmes solutions for simulation and engineering of complex oil and gas projects
• Procter & Gamble (PG): P&G leverages Dassault Systèmes solutions for product design and innovation in consumer goods
• Airbus (OTCPK:EADSF): One of the world’s largest aerospace companies, Airbus uses Dassault Systèmes’ solutions like CATIA and the 3DEXPERIENCE platform for aircraft design and development
• Tesla (TSLA): Tesla uses the 3DEXPERIENCE platform for its innovative approach to electric vehicle design and development
• Johnson & Johnson (JNJ): Johnson & Johnson uses the BIOVIA and 3DEXPERIENCE platforms for research and development in the pharmaceutical and medical devices sectors

According to their Q2 2024 earnings, DSY serves an impressive 350,000 customers globally. Although DSY does not disclose the revenue contribution of its top customers, it is typical for companies like Dassault Systèmes that the top 10 customers contribute between 15-25% of total revenue.

As previously mentioned, DSY serves customers worldwide. In terms of revenue share, DSY generates the most revenue from North America, Europe, and Asia-Pacific, followed by other regions such as Latin America and the Middle East. By country, DSY’s largest markets are the United States, Germany, France, Japan, and China.

Company financials

DSY boasts a strong, consistent, and ‘clean’ growth story.

As illustrated in the chart, DSY has consistently increased its revenue, free cash flow (FCF), and earnings per share (EPS). Since 1993, revenue has grown at an average annual rate of 13.8% to nearly €6 billion, FCF at 18.6% to €1.42 billion, and EPS at 14% to €0.79. Over the last five years, growth has slowed slightly but remains impressive, with average annual growth rates of 11.3%, 12.7%, and 13.2%, respectively.

Despite this growth, profitability has remained consistently high:

For a SaaS company, the gross profit margin is particularly significant, as it indicates how well a company can scale and how much resources are available for R&D and marketing. Generally, a gross profit margin above 80% is considered strong for a SaaS company.

Other important metrics for a SaaS company:

Recurring revenue: SaaS companies typically have a high level of recurring revenue. This is advantageous, as it makes revenue more predictable and easier to plan for both management and analysts.

In DSY’s case, 80% of software revenue is recurring. Of this, 45% comes from subscriptions, indicating that this portion of the revenue is likely to persist over a longer period.

DSY predicts that the recurring/subscription revenue share will rise in 2024:

Revenue retention rate: The revenue retention rate indicates how much revenue an existing customer generates after the initial period. Unfortunately, DSY did not disclose this metric in its latest earnings reports. The last time it was disclosed was in Q2 2023, with a retention rate of 99.5%. Typically, a retention rate above 100% is desirable, as it indicates that the company is growing revenue without needing to expand its customer base. It also suggests that customers are satisfied with the products and are increasing their usage of them. However, in DSY’s case, existing customers reduced their spending by 0.5%, at least in Q2 2023.

Balance sheet

In the title and at the beginning of the article, I referred to ‘clean’ growth. By ‘clean,’ I am referring to the company’s balance sheet. While growth companies often struggle with debt and profitability issues, this is not the case for DSY.

Currently, DSY has significantly more cash and short-term investments than total debt, meaning it could theoretically be debt-free tomorrow. With a debt-to-capital ratio of 31.5% and a debt-to-revenue ratio of 0.6x, it is clear that DSY has no significant debt issues and is not directly impacted by rising debt costs.

Growth can be funded efficiently due to DSY’s high levels of cash and FCF, enabling the company to support further expansion without compromising profitability.

DSY’s recent share price and business development

As mentioned earlier in the article, DSY’s performance over the last three years has been anything but satisfactory.

Over a three-year period, DSY declined by more than 27%, compared to the S&P 500’s gain of nearly 27%. As a result, DSY has underperformed the broader market by 54% in just three years. As shown in the chart, DSY and the S&P 500 followed a similar trajectory until early 2024. Since the beginning of the year, DSY has declined, while the S&P 500 has performed strongly. Why is that?

The downturn began with the largest three-day price reaction the company has ever experienced following its earnings report. February 1st marked a low point, with DSY dropping 13% after its Q4 2023 earnings report.

The market was spooked by a combination of missed expectations and weak guidance:

• Muted growth in the Americas for Q4: The Americas saw 7% growth, described as ‘rather muted’ compared to the strong growth of the previous year, indicating a slowdown in DSY’s key region.
• Market volatility in Asia, particularly China: The Asian market grew by 3%, falling short of management’s and analysts’ expectations, with the Chinese market particularly disappointing at just 5% YoY growth.
• Impact of COVID-19 on MEDIDATA’s Performance: MEDIDATA, a significant part of Dassault Systèmes’ Life Sciences segment, saw its software revenue growth slow to 6% for the year, with just 2% growth in Q4. MEDIDATA’s growth could not keep pace with the elevated COVID-fueled growth of previous years.
• Impairment related to GEOVIA: The call also mentioned an impairment of approximately €36 million related to the GEOVIA brand, primarily due to the discontinuation of business in Russia and portfolio restructuring.
• Lower software revenue than expected: While overall financial targets were met, revenue fell just below the mid-point of DSY’s guidance. A shortfall in software revenue was partially offset by higher service revenue, but it highlighted weaknesses in their core business.
• Guidance was somewhat disappointing: DSY projected growth between 8-10% in 2024, below previous levels. Additionally, DSY’s management cited a complex geopolitical environment that is causing caution among their customers.

The market’s concerns were justified. Reviewing their latest earnings, the situation has worsened. Here are DSY’s Q2 2024 earnings:

Total revenue came in approximately €30 million below the low-end guidance, which had projected only a 7% YoY increase. Due to a 5% increase in operating expenses, the operating margin also fell below the low-end guidance. EPS provided some relief but only managed to reach the low end of the guidance at €0.30 per share, representing a 10% YoY increase.

The primary reason for these disappointing earnings was a slowdown in software revenue, particularly in CATIA and SIMULIA, along with a 3% YoY decline in MEDIDATA. According to management, CATIA and SIMULIA were particularly impacted by delays in decision-making by major customers. This was emphasized in the earnings call transcript:

Pascal Daloz, CEO: “First, the delays in the customer decisions caught us by surprise in Q2. And at the same time, looking ahead, we can confirm we have a robust pipeline which is structurally stronger in the second half compared to the first one. Additionally, we remain on track to close this year the majority of the deals that have been delayed.”

Rouven Bergmann, CFO: “We experienced cautiousness in customer signings towards the very end of the quarter in a complex geopolitical environment. The relative strength in the bottom line… was driven by a lower expense growth, strong interest income from cash invested, and a lower tax rate.”

Pascal Daloz, CEO: “Now zooming in Aerospace & Defense. Customers have a huge backlogs due to the manufacturing ramp-up delays, which is caused by the supply bottlenecks. This has created a cash flow issue for them and impacts, obviously, their investment plans.”

In summary, DSY was affected by an unexpectedly challenging market environment, which caused their largest customers to postpone investments in DSY’s software. Nevertheless, DSY anticipates closing the majority of these postponed deals by the end of the year. As a result, they lowered their 2024 full-year guidance:

Total revenue growth has been revised down to 6-8% from the previous 8-10%, and EPS growth has been adjusted to 8-11% from 10-12%.

DSY is heavily relying on a more positive second half of the year.

While these earnings are far from positive, they were somewhat expected. As mentioned in the earnings call transcript, the aerospace market is not in a strong position to make significant investments at this time. The automotive sector, one of DSY’s largest, is being heavily impacted by the German market environment. Germany is currently lagging behind other European countries and the world in terms of economic growth. Negative sentiment and low growth prospects have led German car manufacturers, including Volkswagen Group (VWAGY, VLKAF, VWAPY), BMW AG (BMWYY, BAMXF), and Mercedes-Benz Group (MBGAF, MBGYY), to rethink their budgets and limit spending. Other industries, and indeed much of the German corporate sector, are also currently quite restrained.

The numbers clearly reflect the economic weakness in Germany and the Euro Area. Germany experienced 0% GDP growth in 2023 and only 0.1% in 2024. While 2025 is projected to see higher growth, it remains well below past levels. For the Euro Area, GDP growth is slightly better but still not strong. France, which is not included in this chart, had 0.7% GDP growth in 2023 and 2024 and is projected to see 1.3% growth in 2025 (source: EU). While the US and China experienced strong growth in 2023 and 2024 compared to Germany, France, and the Euro Area, both are projected to have slower growth in 2025. Given these circumstances, DSY’s customers’ hesitation is understandable. While this doesn’t improve the recent earnings, it does provide an explanation.

Reasons to buy DSY

There are a lot very good reasons to buy DSY at current prices. First of all, apart from the last three years, DSY performed very well:

Over the past ten years, DSY has generated a total return of over 260%, equating to an annual return of 13.7%. At its peak, DSY was up 480%, or 27.2% annual returns. Over a 20-year timeframe, these gains extend significantly, with a total return of over 1000%.

I’ve already mentioned DSY’s ‘cleanliness’ several times, and this is definitely a reason to consider buying. It’s rare to see growth stocks with such a clean balance sheet. The Altman-Z score, a metric used to assess solvency risks, is currently 6.19, which is excellent and places DSY in the 82nd percentile globally, meaning only 18% of companies have a better Altman-Z score.

The market environment is bound to improve sooner or later. As shown in the GDP chart, general GDP trends are expected to improve as early as next year. On a smaller scale, when examining specific sectors, I see DSY in a favorable position. As a German, I like to discuss the automotive sector, particularly German car manufacturers. Currently, we are witnessing a shift in the sector. The image of the ‘almighty German car manufacturers’ is fading due to a lack of innovation, high prices, and poor BEVs. In recent years, German cars have become more expensive while declining in quality. One of the distinguishing features of German cars has been their interior quality. I drive a fairly expensive Audi and can attest that the quality is still unmatched. Nevertheless, even proud Germans are disappointed by the declining quality of our cars. Mercedes, once known for its luxurious interiors, has seen a significant decline. The gap between German cars and those of other manufacturers has narrowed significantly. When it comes to BEVs (electric vehicles), German car manufacturers have been slow to adapt. Additionally, some opposition parties are refocusing on the combustion engine instead of BEVs, likely for political gain rather than practical reasons. The end of combustion engines is inevitable, and BEVs are unstoppable, even if many are reluctant to admit it. By focusing on combustion engines, German car manufacturers are ceding market share to Chinese competitors. In the near future, as Chinese and other car manufacturers begin to dominate the European market, German car manufacturers will need to catch up, likely turning to DSY for faster and more efficient product design to remain competitive. In general, companies will need to defend their margins in the future. With a struggling middle and lower class, products will need to remain relatively affordable. DSY’s products assist in designing and manufacturing more cost-efficiently. To save costs on building and maintaining physical testing or simulation stations, the trend is shifting toward digital testing and simulation. Furthermore, with the rise of Gen Z and subsequent generations, online shopping will increasingly dominate the market, and the connected experience will need to become increasingly sophisticated. DSY contributes to this, as demonstrated in the example of Asics:

In summary, DSY is well-positioned to benefit from several trends that are likely to accelerate in the future.

Another reason to consider buying DSY is its current valuation:

The decline in the share price has significantly reduced valuation multiples. EV/sales is now back down to 6.7x, a level last seen during the COVID-19 low. The 10-year average is 7.6x, indicating that we are currently 12% undervalued on an EV/sales basis. Given DSY’s long-term profitability, we can also use the P/E ratio to assess the current valuation. Since earnings have held up better than sales, the P/E multiple is even lower. Currently, DSY is valued at a P/E of 25.6, a level not seen since 2015. The 10-year average is 34x, indicating that DSY is currently about 25% undervalued. To illustrate this further, we can refer to a Fastgraphs chart:

The blue line represents the share price derived from multiplying the average P/E of the last ten years by the EPS projected by analysts. As you can see, over the past ten years, DSY has rarely traded this far below its fair value as it does now.

Comparing DSY’s valuation with the broader market makes the situation even more compelling.

DSY’s P/E ratio is currently 1.3x compared to the S&P 500’s P/E. As shown in the chart, over the last ten years, DSY has traded at an average of 2.04x compared to the S&P 500, making it as cheap as ever. This discrepancy is due to DSY’s decreased valuation and the S&P 500’s increased valuation. The same applies to the overall market, represented here by an MSCI World ETF, where DSY’s current valuation is 1.5x compared to an average of 2.27x. When compared with the technology sector, which DSY belongs to, the P/E multiple drops to 0.98, indicating that DSY currently has a slightly lower P/E than the technology sector. Historically, DSY has typically traded at around 1.86x the P/E of the technology sector. Thus, compared to a possibly overvalued market, DSY presents an attractively valued investment opportunity.

DSY pays a dividend, which has grown at an average annual rate of nearly 10% over the past 20 years:

While the current dividend yield of around 0.7% isn’t very high, it’s still quite decent for a technology company. More notably, DSY has grown its dividend significantly, with DPS growth averaging nearly 10% annually over the past 20 years.

To assess potential returns, let’s revisit a Fastgraphs chart:

Comparing the 10-year P/E average with analysts’ expectations (as explained above) suggests a potential total return of 20.2% by the end of 2026. Even using the lowest average P/E of 29x (over a 19-year timeframe), we still see a potential total return of 12.4% by the end of 2026. However, I believe the analysts may be slightly too optimistic.

If purchased now, I believe the projected 20% total return is highly likely, with a strong possibility for even greater gains.

Risks to my thesis

As you know, there is no investing without risk. Naturally, there are risks associated with DSY, including the possibility that the stock doesn’t rise as expected or even falls further. However, I believe this scenario is unlikely.

There is the risk that the market environment could deteriorate further, either on a sector basis (aerospace, automotive) or a country basis (Germany, France), which would negatively impact the stock price.

There is also the risk of competition. However, given DSY’s long and successful history and the current competitive landscape, I don’t see much risk here. I couldn’t find any company offering products or services similar to DSY’s, and it seems unrealistic that such a competitor could emerge suddenly within a few years.

Analysts and management could be wrong, and future earnings could be lower than currently expected. However, I believe analysts have already been fairly conservative in their expectations. Additionally, DSY’s management has a strong track record over an extended period.

Conclusion

Unlike most growth/tech/SaaS stocks, DSY has an extensive history, a strong track record, and a unique position in the market. The market is expected to grow in the future, and DSY’s current issues stem from a challenging market environment rather than problems within the company or its products. Furthermore, the low valuation provides room for potential gains, and the stock price has already factored in a significant amount of negativity—perhaps too much—which should offer investors a margin of safety.

Therefore, I rate DSY as a buy at current prices.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.