3-D Printing Stocks Printing Profits

Includes: DDD, SSYS
by: Ryan Perlowin

3-D printing is hotter than ever, but not nearly as attractive a space as it will be in two years, especially for 3D Systems (NYSE:DDD) and Stratasys (NASDAQ:SSYS). The waters are beginning to sway for 3-D printing investors, but this is still the calm before the storm - society still isn't sure what to make of the new technology, and its application and use have been minimal to none. That doesn't mean, though, that the space is unattractive for an investment. In fact, I would argue that though critics are yelling "bubble," the entire 3-D printing sector is undervalued and poised for terrific gains in the near future.

As investors, we trade stocks for multitudes of reasons - value, growth, dividends, pure speculation. Each breed comes with a different strategy for valuation. All four strategies prove to be fairly unique, though not totally mutually exclusive.

That's where we find ourselves in the 3-D printing space - it seems that the top picks in the space are speculative growth plays with a semblance of value backing, which is to say that the two major players here are hedged by a relatively fair valuation but have potential for explosive growth into the next decade.

Staggering Growth Potential

The two major industry players here are the aforementioned DDD and SSYS. They compete in a space that is not yet understood and certainly not widely adopted. Essentially, 3-D printing is still in its infancy stage. Both of the target companies are diversified in the space - they supply 3-D printing hardware, software, custom parts, and resin-based materials. Perhaps the most interesting business in which these companies engage is the sale of the resin-based materials, because of its continuous use. While the hardware and software for 3-D printing are expensive, they're a one-time purchase. The resin sales will be constant, similar to Hewlett-Packard's (NYSE:HPQ) sale of printer ink. Both companies have proprietary print materials that replicate the performance of plastics, composites and metals.

While the high profit margins seen from the sale of materials is attractive, real growth will be driven by underlying unit sales through the next five years, and the numbers are exciting - in 2012, DDD nearly doubled its unit sales, which accounted for 35% of its revenue. With increased production, the companies are becoming more efficiently scaled and generating greater profit margins - when printer sales doubled for DDD in 2012, gross profit attributable to those sales was up 120%.

Still, though, the companies are competing in a space that is undeveloped. As individual consumers and business owners, we hear stories of 3-D printers and see the industry as somewhat futuristic. The breakthroughs are happening now, though, and the industry will unlock innovative ways to lower pricing barriers and achieve mainstream distribution in the coming two years.

Valuation Backing

As noted, many players in new technological spaces are often extremely overvalued based on their potential to become major market players. That, too, is true for many companies in the 3-D printing space. While they do have the ability to be story stocks, they're also a lot more risky to go belly-up because of lack of capitalization during the next two crucial years of mainstream development.

My thesis, then, is to invest in the two major players in the industry - DDD and SSYS. Both have continually strengthening balance sheets, fair valuations, excellent instincts for new strategic acquisitions, and a strong foothold/broad reach in the consumer space. DDD trades at a forward P/E of 32.7x and SSYS at a 34.6x. Most importantly, both companies have continually beat on earnings expectations over the past three years, a sign that the companies are over-delivering on expectations in a strengthening market.

The Call

Both stocks have had a terrific year, but that doesn't mean the ride is over. If you're new to the space, begin building your position at this level with a long-term investment horizon. Any drop in the market could be an attractive place to build onto your position, and any rise in stock price will yield profits.

3-D printing will be an industry that is at the forefront of the investment conversation in two to three years. It feels that the market is beginning to understand the potential of these companies - but their valuations are still fair given current market expectations. Now is the time - with fair valuations and staggering growth potential - to join the 3-D investment movement.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.