- 3D Systems reports an inline but uninspiring Q1 and more importantly, shows less confidence in its 2014 guidance.
- Due to rising competition, revenue growth is becoming tougher and costlier.
- While gross margins are unlikely to be supportive soon due to the rising weight of consumer products.
- We continue to believe that our $26 bear-case valuation for 3D Systems is becoming more and more likely.
In our Friday preview, we said that we did not feel confident heading into 3D Systems' (NYSE:DDD) Q1 release and that the earnings risk was still on the downside despite the profit warning made earlier this year.
As we expected, Q1 revenues were ahead of the Street ($148m vs. $146m) but the gross margin was significantly down (-130bps year-on-year) and EPS was merely in line at $0.15.
More importantly, the company adopted a more cautious approach regarding its 2014 guidance, stating that "management expects a greater portion of revenue and earnings to be generated during the second half of 2014, as the full impact of its new products and services materializes."
In our view, this clearly suggests that the level of confidence in the 2014 guidance has declined and could imply that 3D Systems is finally taking notice of the severe risks we have been highlighting since the beginning of the year. Our thesis is that the expiry of key patents between 2014 and 2017 will spark increased competition and pricing pressures across the industry as open-source hardware printers will be able to integrate laser sintering. The bulls will argue that revenue growth remains healthy and that there is no sign of weakening growth. That's true but it's worth noting that 3D Systems now finds it increasingly difficult to significantly beat consensus (the revenue beat was just +1% in Q1) and that revenue growth is becoming much more expensive than it used to be as the company has to step up R&D and sales & marketing efforts. In all, business has become much tougher.
Another source of concern is margin expansion, with 3D Systems stating in its press release "the resulting mix delayed anticipated expansion of our gross profit margin." We believe that the company will find it difficult to solve the gross margin equation soon. Most investors expect in the same time consumer products to take off and group gross margins to expand. This is unrealistic as the consumer segment will probably be much less profitable due to lower ASPs and intense competition from Asian low-cost printer makers. In all, we would expect consumer products to put continued pressure on group gross margins.
Admittedly, the highly-profitable materials business could provide some upside at some point… but remains a mystery for the time being as it keeps growing at a lower rate than printers (+41% vs. +53% in Q1). This could confirm what Terry Wohlers said not a long time ago, that "a significant number of machines bought by hobbyists are also sitting idle. They generally print out a part or two and forget about it."
And obviously, this is not encouraging for the investment case.
Even if a trading buy could be tempting following the stock's decline year-to-date, we continue to believe that our $26 bear-case valuation for 3D Systems is becoming more and more likely and that the stock is a falling knife as we see no supporting newsflow ahead.