Prior to today, 3D Systems (DDD) was one of the most beloved stocks on Wall Street. Unfortunately for investors, that changed abruptly this morning after the company pre-announced extremely disappointing results (press release available here). Shares are down 25% today and have fallen 40% from their 52-week high. Has DDD finally fallen too much or is there more downside ahead?
3D Systems is now looking to earn $0.83-$0.87 for all of 2013 compared to the $0.93-$1.03 that it previously had guided to. This would imply that DDD's fourth quarter was far weaker than analysts were expecting. Analysts were looking for $0.30 in the quarter, and it appears 3-D will deliver about $0.20. Importantly, that figure is down from last year's earnings of $0.26. 3-D is also guiding to $513-$514 million in revenue for the full year, which is within its previous guidance of $500-$530 million. Based on this guidance, fourth quarter results should be in the $153-$155 million range, which is in the vicinity of analyst estimates ($155.7 million).
Interesting, this revenue result is a lot stronger than last year's figure of $102 million. Essentially, DDD is growing sales 50% annually, and about 30% of this growth is organic. However, none of this growth is flowing to the bottom line. 3-D is blaming an unfavorable product mix for this. Like with traditional printers, printers have lower margins than their supplies have. As a consequence if the company is selling a higher proportion of printers, it will see a margin decline. Now in the long run, this is actually good news. Obviously, printer sales are needed to generate future supply sales. By selling more printers, future supply sales will increase, which given their higher margins are fantastic for profit growth.
Given the company's 2014 guidance, this scenario is not playing out. In 2014, EPS will be $0.73-$0.85 on revenue of $680-720 million. In other words, 3-D is expecting revenue to grow 36%, but earnings will fall between 2% and 16%. Similarly if we look back to 2012 (results available here), the company earned $1.25 on sales of $353 million. Even though the company has doubled revenue, it is earning less per share. Interestingly in that report, the company expected 2013 EPS to be $1.00-$1.15. The company is reporting results well below that guidance, which has to leave investors a little concerned about whether DDD will even meet 2014 guidance.
When earnings fall over a three year period that sees revenue double, there is more that is going on than an unfavorable product mix and higher R&D investments. It is a warning sign that commoditization is hitting the industry. 3-D printing is starting to become a crowed space with other companies like Stratsys (SSYS), ExOne (XONE), and Voxeljet (VJET) competing for business. Further, it is well known that traditional printer giant Hewlett-Packard (HPQ) is interested in entering the sector. Of course, HPQ has unparalleled resources and could afford extremely low pricing to gain share and push competitors out of the market, which would be horrendous for DDD's margins.
At the end of the day, profit growth and not revenue growth drive stock prices higher. While DDD clearly has a fantastic track record of growing sales, this growth is of little value without corresponding EPS growth. Instead, investors are faced with a company growing revenue dramatically but simultaneously earning less money. Even after this drop shares are trading 69x 2014 earnings even though EPS is below 2012 and 2013 levels. This valuation makes little sense, and the only reason to buy DDD is on the hopes of a takeover. In an industry quickly commoditizing, profit growth will be extremely difficult to achieve.
Now, some investors may continue to believe that DDD can turn its problems around and get revenue growth to translate into profit growth despite its inability to do so since 2012. In this scenario, I wouldn't be willing to pay more than 36x earnings (equal to annual revenue growth). Using this valuation, DDD shares should be trading at $28-$30, which suggests nearly 50% of additional downside. Even for those bullish on 3-D printing, this company remains extremely expensive. This quarter was the canary in the coal mine so to speak. While shares are down quite a bit, fair value is even lower. Paying 70x earnings for a company with declining EPS is a likely way to lose money. As painful as it may be for some who are long at higher prices, DDD is a must sell given its lack of profit growth.