Seeking Alpha
Long/short equity, growth at reasonable price, research analyst, deep value
Profile| Send Message|
( followers)  

The 3D printing market continues to remain hot as top competitors 3D Systems (DDD) and Stratasys (SSYS) again surged to new all time highs last week. The sector has been hot amid advancing capabilities of additive manufacturing via localized 3D printing even now affordable at home. On top of that, Stratasys reported results last week that helped boost the stock and the sector even more.

Stratasys is a leading manufacturer of 3D printers and production systems for prototyping and manufacturing applications. The company is set to complete the merger with Objet in Q3.

Previously a preview was completed of the earnings report for Stratasys. The research suggested that the company had a history of predictable earnings reports and that investors should expect a beat on earnings on August 1st.

Ironically, the company only reported inline earnings, but it more importantly guided up for the rest of 2012. The other important headline was the announcement that the distribution agreement with HP (HPQ) had been terminated.

While the deal with HP wasn't material to financials as it never really worked out, it should highlight to investors the risks that exists if this now unleashes the behemoth printing giant into the sector. Considering the vast potential in the sector, the biggest risk probably comes from an outside threat.

Q2 Earnings Highlights

The Q2 earnings were actually disappointing per the preview as the numbers only came in line with the estimates of $0.32. The highlights were as follows:

  • The company reported record revenue of $49.4 million for the second quarter ended June 30, 2012, a 31% increase from the $37.8 million for the same period last year.
  • System shipments totaled 776 units for the second quarter of 2012, compared to 735 units for the same period last year.
  • Non-GAAP net income was $7.0 million for the second quarter, or $0.32 per share, representing a 39% increase over the non-GAAP net income of $5.0 million, or $0.23 per share, for the same period last year.

While the unit shipment growth would normally be a concern, management did a solid job of explaining away the issue due to a shift in products. Ultimately the revenue growth number tells the bigger story.

The real concern is that net income was only $7M. Though solid profit margins for a young growth company, it does highlight the relative size of the numbers such that a HP could quickly swamp this sector. In fact, R&D expenses at only $4.1M would be pocket change to HP.

Guidance

Stratasys revised its financial guidance for the fiscal year ending December 31, 2012:

  • Revenue guidance of $193 million to $198 million, versus previous guidance of $183 million to $193 million.
  • Non-GAAP earnings guidance of $1.31 to $1.38 per share, versus previous guidance of $1.29 to $1.38 per share.
  • GAAP earnings guidance of $0.83 to $0.98 per share, versus previous GAAP guidance of $0.97 to $1.13 per share.

These numbers are superb and clearly surpass any lingering concerns from Q2 results. Even more importantly, the numbers don't factor in the accretive numbers expected from the Objet merger.

Stock Performance

As mentioned in the earnings preview, the stock performance of 2012 had been one of two periods of explosive moves followed by months of flat returns. Now it appears that the stock has hit a third period of explosive growth.

The stock has now gained more than 200% since last October when it traded below $20 to start the month. It spent last week comfortably over $60. This is an incredible run for any stock, but it is always concerning that investors are now ignoring the potential risks in the sector.

12 Month Chart - Stratasys


(Click to enlarge)

Objet Merger

The major news this quarter remains the merger with private Objet. Objet is a leading manufacturer and rapid prototyping company based in Israel. This merger of equals will help provide scope and leadership to this advancing industry.

The combined company will be a powerhouse in 3D printing and direct manufacturing with pro-forma revenues announced recently of $277M in 2011 and $83M for Q1 2012. That 2011 total was significantly higher than what previously bigger competitor 3D Systems reported at $230M. The quarterly number is also higher.

While the company further highlighted the accretive nature of the deal, the earnings call was actually very sparse on details. Even going so far as to mention that financial details of Objet would be provided within a couple quarters of closing. Though not too alarming it seemed strange that after providing Q1 pro-forma numbers that the company would be so quiet on Q2 numbers and even guidance.

The merger remains on track to close in Q3 with Stratasys shareholders owning 55% of the shares. With the diluted shares at roughly 40M, the combined value is at $2.54B now with Stratasys trading over $66 on Monday.

Larger Threats

The sector likely faces some unknown threats or at least ones not known to the markets at this point. If HP was interested enough to resell 3D printers, than what will keep the printing giant from building its own printers?

General Electric (GE) has already announced a push into using additive manufacturing processes whether 3D printing or something else. At the recent Farnborough Air Show the company announced the making of parts for the LEAP engine by using the SLM 250HL additive manufacturing machine. What is to stop this manufacturing giant from building machines as well?

What about the manufacturers of CNC machines improving the ability to rapidly deliver products? Anybody being displaced by these 3D printers could alternatively build competing technologies.

Investors always need to keep an eye on the unknown risks before being willing to pay such rich prices for a stock. Clearly the giant technology companies of the world see the success of the sector and no doubt the stock prices. Naturally building a competing technology or product might not be simple, but assuming Stratasys and 3D Systems have this market as a duopoly might be disastrous to an investment thesis.

Valuation

While guidance slightly increased the low end earnings forecast, the increased stock price outstrips that increase. The high valuation mentioned in the earnings preview is now even higher.

If one assumes a 15% increase in 2013 earnings for the combined entity based on the accretive Q1 pro-forma numbers, than Stratasys trades at over 38x forward earnings.

Conclusion

The 3D printing and direct digital manufacturing sector has a ton of potential for further disrupting the manufacturing process. Unfortunately the stocks now account for that future growth making investments at these prices questionable.

A major issue concerning these valuations is that revenue growth isn't exactly off the charts. The organic growth only appears to be in the 20% range suggesting that valuations in the 35x range probably are maxed at the top end.

As previous mentioned, this sector is impressive in that it is profitable as this early stage compared to a lot of the social media stocks. The concern though is that only $7M in quarterly earnings won't be enough to hold off threats from new entrants if a GE or HP entered the sector. In fact, the high stock prices might encourage new entrants to fight over preciously small profits.

The stock has had a major run and merger integration of two near equals doesn't always happen without problems along the way. Investors might be best served to tread lightly as expectations are now sky high and risks are being ignored.

Source: Stratasys: Don't Ignore The Risks