3D Systems (DDD) along with its main competitor Stratasys (SSYS) currently own 13.3% of the global market share for their industry, however they're the only two major players with a concentration in the market positioned to take advantage of this booming industry.
While some see the companies trading at a premium and potential growth slowing, there is a key element I believe many investors are overlooking what could be a hidden catalyst for both companies.
A common theme amongst all major players in this industry is their gross margins. Both 3D Systems, Stratasys and now ExOne (XONE) have all approached the 50% gross margin level, but the increase in margins seems to have slowed slightly over the last several reporting periods. The key catalysts for both companies is competition in materials. In my opinion, the introduction of new players to the market combined with the notion that no one company controls more than 10% of the global market share is actually a very positive sign and I believe it will take these stocks to the next level. Material Sales are the key. As the industry demand for printers grows, so does the demand for materials. It's no different than the dawn of the digital printers we're all familiar with. Let's face it, a company like Hewlett-Packard's (HPQ) revenue from printing never made much from the device sales. The key was the ink replacement. As more and more devices came on the market that used ink-jet technology, the demand for ink grew at a much faster rate than costs as so many new competitors offered different alternatives. In my opinion, the same will happen with 3D printing. To see how this plays out, let's take a look at the current margins.
- 3D Systems
As you can see from the charts, all three are teetering around that 50% mark for margins. In sticking with our underlying thesis, let's look at how demand for material can act as a catalyst for these companies. ExOne is the most recent addition to the publicly traded 3D printing field, which will fuel additional market share competition for both 3D Systems and Stratasys at a faster rate than the other 80% or so of companies that make up the sector. The result, more consumer and commercial choice, lower prices, and thus increased commercial viability. As more and more printers begin to flood the market, so will the materials that go with them. Since demand relative to other basic materials is still low, there is no shortage of supply and thus demand increase is expected to outpace cost increase resulting in higher margins on material sales.
In a report from Lux Research, it's estimated that 3D material sales will increase at a rate of about 18% inline with the growth rate of the overall industry. The projections see materials growing from 880 tons in 2012 to 9,700 tons by 2025. However costs of those materials are expected to grow at a rate of 11% relative to the overall market as new supply will reduce the current mark ups from raw suppliers. Lux is projecting the value of 3D materials to increase from $142 million to $579 million by 2025. However, it's my opinion those margins could become even wider since new major players like ExOne could add additional growth faster than expected. The bottom line, companies such as 3D Systems and Stratasys could see additional increases in gross margins of 8% or more annually, which is not being accounted for in current growth predictions.
Given the recent high volatility and speculation in 3D printing, I would previously have recommend a hold. However, improving margins due to supply and demand of material costs is a key fundamental catalyst that suggests growth and increasing valuations are sustainable. Therefore I would recommend either company as a Buy at current levels.
I recommend Stratasys as a lower risk play given that it is more focused on vertical markets such as auto, aerospace, and medical which is where the current money exists. In contrast, I would view 3D systems as a higher risk but higher reward play mainly due to a focus on serving the broadest market including consumers. While the consumer sector is still unproven, it's also untapped.
My personal preference would go towards the higher risk/reward benefits for two reasons. Number one, the current lower price equals a lower cost of profit. Number two, the recent stock split executed by management suggests it is committed to returning value to shareholders.
Either one would make a healthy addition to your portfolio and recent technical trends suggest current prices are a good entry point.
3D Systems confirmed a Bullish Continuation Triangle yesterday that signals an intermediate-term price move to the $44.00 - $46.00 range.
Stratasys confirmed a Bullish Continuation Triangle as well that signals an intermediate-term price move to the $95.00 - $100.00 range.
It's important to pay close attention to earnings and guidance as these highly watched stocks can move quickly on reports. In my opinion, the best way to enter this trade is a buy here given the technical trends for shorter-term gains, scaling down your position as it reaches target levels. This will help lock in gains providing you more tolerance for price fluctuations for a longer-term hold strategy that seeks to benefit from the lower material cost benefits we expect to see over time.