At the end of March this year, I wrote an article and gave 3D Systems (NYSE:DDD) a price target of $47, at the time of writing that article the stock was trading just above $30. However, since then the stock has more than doubled and currently trades over $77 per share. In this article, I have tried to incorporate new data and the future contracts along with new products and tried to analyze whether the increase in the price is justified or it is just a short-term rise. Let's first take a look at the model and assumptions used in the model. Along with the assumptions, I will also provide pro-forma earnings and valuation models.
Model and Assumptions
I have tried to keep my assumptions in line with the expectations of the company. For future growth in revenues, I have used organic growth number that lies somewhere between the forecasted growth number for 2013. Revenues for the company are growing at over 35% per year, at the moment. For the first five years (hyper-growth period), I have used a 30% growth rate in revenues. However, the growth in revenues will start to fall to eventual 4% over the next four years in the valuation period. 3D systems is aggressively adding to its product portfolio as well as new geographic regions. As a result, I believe my revenue growth assumptions are in line with the growth shown by the company.
On the expenses side, I have followed the same approach and assumed a declining growth rate in manufacturing expenses due to economies of scale and operational efficiencies. At the moment, 3D systems have a gross margin of around 51%, which I believe will go up during the hyper-growth period, and then finally, it will settle around 57%. Total operating expenses are currently around 34% of the total revenues. However, these expenses are expected to come down as a percentage of total revenues as the increase in revenues has been much larger than the increase in operating expenses. Also, as the company establishes itself in most of the geographic regions, the operating expenses will grow at a slower pace. Furthermore, tax rate at the moment is around 10% -- I have used a flat tax rate of 12% for the sake of simplicity. There is some tax benefit carried forward as well for the company - as a result, predicting the exact tax rate for the company becomes a complicated matter.
Pro-Forma earnings shown above have been calculated using the above mentioned assumptions. According to my calculations, 3D Systems should be able to maintain solid operating and net profit margins even after the hyper-growth period.
For valuation, I have used a 13% discount rate, which I believe is appropriate for a high growth volatile stock. However, 3D Systems have shown that the company has solid basis for growth and a strong product portfolio, which will ensure the impressive growth in revenues. As a result, the discount rate may come down further for some investors - however, I believe 13% is an appropriate discount rate at the moment for the company.
For the free cash flow calculation, I have taken net income as the starting point. All of these net income figures represent projected net income based on above mentioned assumptions. To reach at free cash flows, I have made adjustments regarding, depreciation, amortization, interest expense and other non-cash items such as restructuring expenses/gains, gains/losses on equipment sale and taxes. Furthermore, investment in fixed and working capital has also been taken into account.
Free cash flows beyond 2022 have been projected at a constant growth rate of 4% and discounted at the discount rate of 13% (adjusted for growth rate) to calculate terminal year free cash flows. After calculating free cash flows for each year, I have discounted those free cash flows at 13% to reach at the present value, and added them to achieve $5.54 billion in discounted free cash flows. According to my free cash flow model, 3D Systems' stock should be trading at around $54 per share. At the moment, the stock is trading at around $77 per share.
The free cash flows analysis indicates that the stock is currently trading at above its fair price. It shows that the current stock price does not represent the true picture of the company's business; rather it is due to the excitement among its investors. In the short-term, the stock price might remain inflated - however, in the long term, I expect the price to converge to the fair value. On the other hand, companies in rapidly growing sector can have longer periods of inflated stock price due to the positive news. I believe the 3D Systems stock is currently overvalued based on the hard facts and the figures. However, I will keep my stance on the stock as a solid long-term investment, albeit a bit expensive at the moment.