Aveva is a leading developer of Computer Aided Design (CAD) software for the oil and gas, infrastructure and marine industries. The software provides engineers with the virtual nuts and bolts needed to design and build complex structures, such as offshore platforms, petrochemical plants, nuclear power stations and ships. On the back of optimism about a V-shaped recovery, the shares have surged 260% since their March 2009 lows. I suspect this run is about to end. Here’s why.
Firstly, with global GDP set to be dragged down by continued difficulties in Europe and America, Aveva’s key markets will begin to dry up again in early 2011.
In fact, at the last update on 7 July, the board admitted that although eastern Europe and Brazil were strong, this was being offset by “subdued” activity in North America. And most of the firm’s income is derived from large-scale capital projects for which funding will become more expensive if there is another contraction in lending. Secondly, Aveva could get squeezed by rivals such as Dassault Systems and Intergraph, who are much larger and better funded. Thirdly, a large slug of the group’s turnover is denominated in dollar-related currencies – so a falling greenback (something I expect) will hit profits.
Aveva (LSE: AVV), rated BUY by Investec
Finally, there is the valuation. City forecasts are for 2010/2011 revenues and earnings per share (EPS) to be £162m and 56.4p respectively, rising to £176m and 63.1p for the period ending March 2012. Assuming these somewhat stretching targets are achieved, the stock trades on lofty 2011 enterprise-value-to-sales and price-to-earnings multiples of 24 and 21.4 respectively. And it only pays a skinny 1.3% dividend yield.
Aveva is a quality business with good earnings visibility (69% of sales are recurring). And it is likely to benefit from higher demand as more of its IT products are required due to increased safety concerns following the Gulf of Mexico disaster. But I would rate the shares on more like ten-times 2011 operating profits. After adjusting for the £150m cash pile, I get an intrinsic worth of £10.30 per share.
Recommendation: SELL at £13.56