Ansys (ANSS) is the global leader in engineering simulation. It provides software that enables its customers to design and manufacture more effective and efficient products. Engineers use its finite element analysis software to create computer models that simulate how the design and materials used in a product impact strength, elasticity, vibration, fluid flow, electromagnetism, temperature distribution, and other physical elements. The name Ansys comes from the words analysis and systems, and with over 45,000 customers, Ansys sells its applications into every major manufacturing sector. Similar to our investments in the technology businesses Autodesk, PTC, and Trimble, we have followed Ansys for fifteen years and watched the company help its customers design and manufacture better airplanes, cars, bridges, mobile phones, and almost anything we see around us. With a history of double-digit revenue growth, industry-leading operating margins in the mid 40’s, and about 75% of its business coming from recurring subscriptions, Ansys is valued as a growth business. The stock has traded at a considerable premium to the market during the many years we have researched the company. During the fourth quarter, the stock declined 25% from its high in September, and we chose to initiate the investment. The core aspects of our investment thesis are: Ansys software provides design advantages so that their customers compete more effectively and win; the digital revolution—time-to-market has to be faster and product cycle times are shrinking—increases customers’ need for Ansys software; and, the company will grow revenues at several times the rate of the average S&P 500 company over the next three years. Management has been judicious with their allocation of capital and the company has no net debt. We expect the revenue growth to drive strong free cash flow—the company generates a remarkable ~$0.35 for every $1.00 in revenue—and for management to use this cash flow to invest in R&D and acquire new technologies to continue to outdistance their competition.
Founded in 1970 and based in Canonsburg, Pennsylvania, Ansys has over 3,300 employees, $1.3 billion in revenues, and a roughly 20% market share of a $7 billion global market. With a total enterprise value of $12.6 billion, it is the only comprehensive simulation platform with best-of-breed simulation across all major physics disciplines. The company invests nearly 20% of its revenues in research and development, and at three times the size of its closest competitor, it has leading platforms in structures, fluids, electromagnetics, optical, and semiconductor power. These include products like Multiphysics Simulation, Polyflow, and BladeModeler. Customers range from Airbus and Boeing to Qualcomm, Volvo, and Whirlpool. Taiwan Semiconductor, one of the largest semiconductor companies in the world, recently awarded Ansys a number of innovation awards for technology aspects including power integrity solutions for systems-on-chips (SoCs) and automotive reliability requirements for advanced chip design. In a simple example, the adjacent Figure I shows the design of an integrated circuit board using Multiphysics Simulation. The software simulates the thermal stress on the board. The designer can adjust the design and, in real time, see the expected effect on temperature and the resulting impact on the board’s efficiency. This is a good example of a digital twin, which is a virtual model of the physical world. The use of digital twins is gradually permeating all industry. The advent of the internet of things, big data, and artificial intelligence means that product developers can replicate physical assets and processes to create comprehensive models in which to evaluate design options. These aspects drive increased use of simulation in the automotive and healthcare verticals. Currently, 35% of the bill of materials for a car is digital components. This number will soon rise to 50%. Additionally, a partnership with PTC, another investment holding, deepens Ansys’ integration into computer-aided design (CAD) and computer-aided manufacturing (CAM).
Through the tailwind of the digital revolution, management expects Ansys to sustain double-digit organic growth—growth was 12% in the quarter that ended September 30. Ansys trades at about 25-times 2019 expected free cash flow, which we think is reasonable given the market leadership, continued growth opportunity, strong free cash flow generation, and mid to high-teens return on capital. Along with the portfolio’s investments in Autodesk, PTC, and Trimble, these four companies now represent a major thesis targeting investment opportunity in the digital world. We’ve owned Autodesk for over ten years, and we hope to have Ansys create a similar long-term positive impact on the portfolio.
Martin Marietta Materials (MLM) is a leading U.S. natural resource-based building materials company with more than 100 years of high-quality construction aggregate reserves. These are crushed stone, sand, and gravel. The company has over 300 quarries, mines, and yards as well as two cement plants and nine asphalt plants, and plays a critical role in supporting U.S. physical infrastructure growth and maintenance. With a #1 or #2 position in 90% of its local markets, Martin Marietta has a strategic presence across the U.S. It is especially strong in the south and southeast, with its most dominant resource positions in east Texas and the Carolinas—geography is critically important. The “heavy-side” of the construction materials business is highly localized. Transport of the materials is expensive, so quarries and mines located near large metropolitan centers enjoy near monopolies and very high barriers to entry from new competition. The accompanying map (Figure II) of the U.S. shows business locations relative to large metropolitan population centers. Our investment in Martin Marietta is geared toward growth in the United States as opposed to around the world and leverages the U.S.’s need to invest in highways, bridges, and public transit projects. While U.S. GDP has grown for ten years, construction aggregate consumption has lagged. U.S. consumption was 2.4 billion tons in 2017. It reached a peak of 3.4 billion tons in 2006 and a trough of 2.2 billion tons in 2010. We think there is a structural need for higher consumption of aggregates in the U.S. In 2015, the U.S. Congress approved the Fixing America’s Surface Transportation Act (FAST Act), which calls for a five-year $305 billion investment into federal highways and public transportation programs. The current administration has since increased this investment. In response to this clear opportunity, Martin Marietta’s capable management’s approach has been to enhance local leadership positions through additional acquisitions. Alarmingly, the U.S. ranks 15th in the world in infrastructure spending as a percentage of GDP. The U.S. is falling behind here, which creates inefficiencies in our economy. We see this as a macro opportunity for Martin Marietta that will play out over the next five years.
Martin Marietta was formed in 1993 as the successor to the materials group of the company that is now the Lockheed Martin Corporation. With an original focus in the mid-Atlantic region, the company has a total enterprise value of $14.7 billion and nearly 9,000 employees. It has sequentially expanded its business through over 90 acquisitions. Revenues have grown 9% annually for the past twenty years to over $4 billion in 2018. Infrastructure makes up about 40% of aggregate volumes, with commercial construction at over 30%, residential construction at 20%, and the remaining part of the business coming from agricultural demand for lime, and ballast demand from railroad activity. Through these activities, the company generates strong cash flow at about 15% of revenues, and invests approximately 10% of revenues back into the quarries and equipment needed for mining and producing the aggregates and other building materials. These investments continue to build the barriers to entry from potential competition, though this recurring investment limits return on capital to the high-single digits. Return on capital reached a peak of 12.6% in 2007 at the tail end of the housing bubble. While we privilege return on capital as the ultimate metric in assessing the caliber of a company, we also incorporate the underlying value of Martin Marietta’s physical reserves: about 16 billion tons in hard rock, sand, and gravel. This includes 600 million tons of limestone reserves adjacent to the company’s cement production plants. The major acquisition of Bluegrass Materials for $1.6 billion earlier in 2018 brought additional access to high-quality reserves with a strong cost profile in Georgia, South Carolina, Maryland, Kentucky, and Tennessee. The acquisition will further enable management to pursue pricing opportunities. The average aggregates selling price has been up 5% annually since 2005. The company has added over 4.5 billion tons of reserves since 2009.
Our view of Martin Marietta’s valuation and opportunity incorporates the company’s strong operating disciplines. We have met with the management team over the past ten years. Ward Nye has been CEO for thirteen years and has spent his entire career in the aggregates industry. Through its Strategic Operating Analysis Review (SOAR) process, the company has achieved a world-class safety rating while generating industry leading operational and financial performance. On our 2019 estimates, the company trades at over 11-times EBITDA and about 30-times free cash flow. These figures incorporate the company’s $3.5 billion in net debt, while the 18.5-times P/E ratio does not. Management believes the current construction cycle is not nearing its peak in the core regions it operates and thinks the cycle has a long runway for steady growth. While the global macroeconomic outlook will impact the level of growth, we think Martin Marietta can grow profits at over 10% on a compound annual rate over the next several years. This compares with a high-teens earnings growth rate over the past seven years. Given the differentiated assets and the growth rate, we think Martin Marietta can be a strong investment.