Here's why Altium Limited could be the best stock on the ASX

Here's why Altium Limited (ASX:ALU) has bags of potential.

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Altium Limited (ASX: ALU) makes software that is used to design printed circuit boards (PCBs). It is currently the fourth largest provider globally with a 10% share, but is aiming for market leadership over coming years.

Altium boasts an impressive customer base with SpaceX, NASA and Siemens Ltd all using its products. The fact that companies are using Altium to design some of the highly complex and crucial electronic systems found in spacecraft speaks volumes for the quality of its software.

The Internet of Things

Altium is poised to benefit from the Internet of Things (IOT) which has been likened to the industrial revolution. A report recently published by BI Intelligence estimates that the IOT could cause the number of connected devices to rise from 10 billion today to 34 billion by 2020. Each of those devices will require a printed circuit board which will need to be designed using software like Altium's.

Management believes the IOT will drive the convergence of mechanical computer aided design (MCAD) and electronic computer aided design (ECAD) as electronics become increasingly integrated into machines. This explains Altium's partnership with Dessault Systèmes announced in February 2016 that will see Altium's technology integrated into SolidWorks, Dessault's computer-aided design software.

Dessault is the world's largest engineering software firm and SolidWorks is used by more than 165,000 companies and so the deal is a glowing endorsement of Altium's technology. The partnership is intended to improve collaboration between mechanical and electronic design teams that often use disparate IT systems.

A multi-faceted approach

Altium has implemented a multi-tiered marketing strategy over recent years as it aims to increase its share of an expanding pie. In 2015 the company released a free basic product called Circuit Studio which is aimed at hobbyists. Some of these users will become professional designers and hence full paying customers as they will be trained in Altium's software.

Last year Altium hired Henry Potts from market leader Mentor Graphics as part of its plans to capture the premium end of the market. He was previously the head of Mentor Graphics' PCB division and is now responsible for driving sales of Altium's specialist Tasking tools. The division has seen an immediate improvement with revenue from Tasking licences jumping to $4.4 million in the first half of 2016, up from $1.5 million in the prior period.

Altium made a couple of strategic acquisitions in August 2015 which should drive further adoption of its products. Firstly, it purchased Octopart which is an electronic parts catalogue complete with live pricing and stock levels. Octopart has more than 30 million components listed on behalf of manufacturers and distributors who pay a recurring fee. The catalogue will be integrated into Altium's software enabling engineers to create cost effective designs easily and quickly.

Altium also bought Ciiva, a cloud-based bill of materials (BOM) product that will enhance Altium Vault, a centralised platform for managing the entire design process. Altium Vault provides design version control, enables real-time collaboration and now with the integration of Ciiva will include relevant component data.

Financials

Management advises that Altium is on track to deliver US$100 million in revenue at a 30% earnings before interest, tax, depreciation and amortisation (EBITDA) margin in 2017. The company expenses all of its R&D and spends little on property, plant and equipment and so EBITDA is a reasonably good proxy for profit before tax.

The relocation of the company to the US in 2015 led to the creation of US$157 million in deferred tax assets, of which US$77 million was originally recognised in the accounts. Consequently, Altium will not have to pay any tax for some years and so in the meantime most of its EBITDA converts into net profit after tax (npat).

Altium had US$46.4 million in cash and no debt at 31 December 2016 and has a current market capitalisation of $948 million. After translating into Australian dollars, I estimate that the company trades on an enterprise value-to-earnings (EV/E) multiple of 24 based on 2017 projections. This is a fair price when you consider industry tailwinds, Altium's high quality customer base and its impressive management team.

Motley Fool contributor Matt Brazier owns shares of Altium. The Motley Fool Australia owns shares of Altium. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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