Wednesday, February 26, 2014

3-D Industry Playbook, Short And Long Term

  • In our final article, we'll attempt to present a fair valuation of the industry leaders DDD and SSYS.
  • We've taken into consideration everything we've wrote in our sister articles: industry overview and patents.
Not wanting to be trite; we'll focus on sales, accounting quality, and what we feel are relevant metrics for this industry.
Company Comparison
Stock Prices
Moving Average

On Balance Volume

The graphs above reveal strong appreciation for both 3D Systems (DDD) and Stratasys (SSYS) stock. Moreover, revenue and cash flows appear healthy, positioning the companies well to invest in future R&D and capital for growth. In 2013, the industry boomed as their stock prices exploded to new highs with the 50-day moving average continuing to exceed the 200-day moving average and On Balance Volume climbing on the momentum train.
However, after closer examination of these two companies, there are a few inconsistencies with the positive picture painted above.
Looking beyond December 2012 year end financials, sales growth explodes to 113% from Sep 2012-2013, yet net income declines -257%. This is in-line with the general industry and what we've seen from DDD.

A look into the income statement revealed SG&A rising at surprising rates. SG&A expenses from Sept. 2012-2013 was 160M.
Stratasys tried to blame this increase on recent merger and stock compensation expenses when the true increases were due to rapidly rising amortization of intangibles from 2%-16% of sales from 12 month periods ending Sept. 2012 and 2013, respectively. (Per our warning about technology write-offs...)

It may also seem like the company is gearing up for another acquisition. Issuing shares to increase its cash balance to nearly $415M and paying off its customers early to improve key ratios. (Inorganic growth driven by M&A activity).
With increased acquisitions, Stratasys' asset base is growing through intangibles. However, what investors must keep in mind is the associated amortization expense that comes with it. At the rate the company is going, this expense is expected to have a great impact on Stratasys' bottom line in the future. The question then becomes whether revenue will be able to outpace these expenses.
A stunning change we found was earnings quality. Although earnings growth for Stratasys may be projected, the sustainability is questionable as the accrual ratio explodes to a stunning 169% from Sept. 2012-2013. This is in strong contrast to 3D system's decline in the accrual ratio.
Various accounts rely on estimates based on management discretion. One area of concern may lie in accounts receivable as management continues to decrease its reserves as this account grows.
Although it could be possible that management has invoked more stringent credit policies, no such policy has been disclosed to date. Moreover, 2013 reserve information is not available at this time, which may indicate that this number was possibly too low to mention. (The fact that management expects all accounts to be paid in full seems quite odd).
3D Systems
On the other side of the story, earning quality has improved for 3D systems as their accrual ratio declines to 46%. In contrast to Stratasys, their healthy accrual ratio is further exemplified by an increasing reserves set up as accounts receivable increase.

In FY2012, although favourable growth can be seen in terms of volume for the Printer & Other Products Segment, the negative change in the price/mix for this segment is alarming. Where revenue was offset by as much as 163.7% (~64% of volume revenue). Moreover, the reduction of revenue from price/mix as a % of revenue generated from volume has ballooned from levels of 3% in 2010 and 24% in 2011. This suggests that:
  • volume is being pushed without any regards to lower average selling prices - this is either due to deals with resellers/first time entrants - clearly unsustainable
    • Management hasn't divulged the reason for such a high price/mix loss. This leads us to believe that this loss on price/mix will only be short term
    • In light of this, profitability will be harder to assess (but biased upwards)

Final Valuation
Using Bloomberg consensus estimates, the following peer valuation was conducted with peers weighted by two segments: Printers & Materials and Services. Many of the companies in the service segment offer substitute to services using 3D printers. Stratasys appears to be undervalued at $192.97 (compared to its current price of $125.31) while 3D Systems appears overvalued at a price of $68.48 (compared to its current price of $76.39).
We believe that printers and materials bring in a sizeable part of overall revenue and will continue to do so as the margins are very inflated. Services will represent a larger portion of revenues in the future as the profits will be made on providing services with the printers.
Valuation of DDD

Valuation of SSYS

The debate about 3D printing has never been about whether the technology will succeed. It irrefutably will. The question has been always been about the size of the market.
Final Investment Thesis
Short term bullish on DDD and SSYS (riding positive market news and earnings)
  • There's a lot of momentum in this industry and possibly for stock appreciation even with missed earnings (growth, 'penetration', new 'partnerships').
  • Revenue growth does not seem to be showing any signs of slowing
  • Companies that will be buying into 3D printing will have done so or are close to pulling the trigger
Medium to long term bearish on DDD and SSYS
  • Much of the industry is shrouded in hype and media - the industry is definitely here to stay but the stocks are priced in for extreme growth
  • We think the main benefactors of this industry will be indirect players - smart services using 3D printers, suppliers etc. (We will be releasing an article for a more stable long term strategy on this)
  • Revenue growth and profit margins are not sustainable
  • Technology risk is very apparent, it's possible that DDD and SSYS do not currently have the best technical implementation but a smaller competitor does

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