Stratasys Still Has Significant Upside Potential

| About: Stratasys, Inc. (SSYS)

Edited by Kate Boehme

Stratasys (NASDAQ:SSYS) manufactures and markets 3D printing, rapid prototyping, and direct digital manufacturing systems. Stratasys products help engineers and designers create physical models and prototypes directly from a computer aided design workstation. In addition, customers who do not yet possess Stratasys systems, or do not have enough capacity to run the systems themselves, can print from their CAD files at Stratasys. The company has a worldwide network of resellers and agents that covers markets across North America, Europe, South America, Asia, and Australia. Stratasys also has a service business unit. It is the leading figure in the market, currently providing around 44 percent of the world's 3D printing solutions.

Stratasys follows an aggressive business plan; the company is increasing the number of available distribution channels throughout the world, as well as introducing new and improved products. Stratasys is extremely active in market expansion through mergers and acquisitions. Generally, mergers or acquisitions are made in order to increase the company's portfolio or the quality of the products. In pursuit of these goals, in May 2011, Stratasys acquired Solidscape Inc. for $39.1 million. Solidscape manufactures high-precision 3D printers and has been a leader in casting applications in need of ultra-fine detail. Acquisition of Solidscape gives Stratasys entry in a new market; the company thus plans to exploit this advantage to gain entry into under-penetrated markets such as jewelry, dental, and precision industrial casting.

More recently, Stratasys announced a merger with the privately-held company, Objet Ltd. Objet is a leading manufacturer of 3D printers for rapid prototyping. Stratasys expects that the merger will develop synergies in respective sales channels. Merger with Objet has placed the new joint company into a leading position within the high-growth industry of 3D printing and direct digital manufacturing.

Industry Overview

The additive manufacturing industry has shown some phenomenal growth in the past. In its 23-year history, the industry has seen a compound growth rate of 26 percent a year. Additive manufacturing is currently a $3.1 billion dollars industry, but it is expected to grow significantly as manufacturers look toward decreasing manufacturing costs. This additive industry provides the tools for revolutionizing the manufacturing processes of almost every industry; it can help reduce shipping costs, supply chains and even the lead-time.

Three-dimensional printing is changing the landscape of the printing industry. Designers are rethinking their approach toward new product development. Stratasys is currently the market leader in additive manufacturing, and the company is well placed for further growth. Well executed acquisition strategies, and new product development, has located Stratasys in a wonderful position to profit from their growing industry. I also think there is a high take-over possibility. Traditional printer manufacturers, such as Hewlett Packard (NYSE:HPQ) might be interested in entering into the revolutionary 3D printing systems. Eastman Kodak (EKDKQ.PK) tried to enter into 3D printing market, but it was too late for Eastman Kodak. The 132 year-old company dried up its financial sources by investing a fortune on traditional printing systems.

Financial Performance

Stratasys announced record results for the second quarter; this period exhibited 31 percent revenue growth over the previous year. In Q2 2012, revenue figures stood at $49.4 million, while for the same quarter in 2011, the figures were only at $37.8 million. Furthermore, the EPS of $0.32 for Q2 was in line with market expectations.

Meanwhile, Stratasys has increased earnings guidance from a range of $1.29-$1.38 to $1.31-$1.38. In addition, revenue guidelines have also been changed by company management, from $183-$193 million to a current range of $193-$198 million. The P/E ratio for the stock is quite high at 74.49, largely due to high expectations for both the industry and the stock itself.

Expectations for the growth of Stratasys are high. The PEG still stands at 3.14. Meanwhile, the company profit margin stands at 10.78 percent while the operating margin is 17.08 percent. The total cash reserves amount to $51.16 million.

Competition

At the moment, Stratasys has little competition from within the industry. In fact, it only has one real competitor: 3D Systems Inc. This lack of competition comes mainly from operating in a market that is still subject to conservative model-making and prototype development methods. Instead of utilizing progressive methods such as those provided by Stratasys, many companies instead employ engineers who, working from blueprints or CAD files and using manual processes, perform the prototype development and fabrication.

Stratasys is the only producer of 3D modeling devices employing a single-step, non-toxic technology similar to FDM technology. Conversely, the 3D printing and other RP systems developed by competitors in the field, entail further post-processing procedures, such as curing the part following assembly. Stratasys also benefits from using a FDM technology that does not depend on any kind of laser or light technology as is used by other companies.

Valuation

In this valuation model, I take into account both the earnings and the expected growth of the company, in order to establish the true value of the stock. Stratasys is operating in an industry with phenomenal future growth prospects. In addition, Stratasys experienced earnings growth of over 100 percent during the previous year and 40 percent growth in the current year. I expect the earnings to continue to grow at a 35 percent rate over the next five years, and at 25 percent for the following four years.

According to this valuation mode, the earnings growth can be expected to slow to a stable rate of five percent at the end of a nine-year high growth period. As Stratasys does not pay any dividends at the moment, I have assumed a payout ratio of 35 percent beginning from the fourth year, which will gradually increase to 40 percent where it will plateau. It is important to mention, however, that these earnings growth projections are a little conservative, and could potentially be higher. Nevertheless, the industry will almost certainly experience a boom in the near future, which will cause Stratasys to grow considerably.

I have calculated the discount rate using the Capital Asset Pricing Model (CAPM). Treasury yield for ten-year bonds is 1.60 percent currently, while the market has been averaging a return of four percent in the previous ten years. Given an average market return over the last 15 years of 6.5 percent. Stratasys has a Beta of 1.45. With these numbers, it becomes possible to discount Stratasys's discount rate:

R= 1.60%+ 1.45(6.50%-1.60%)

R= 8.705%

 

 

Valuation

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

                       

Earnings

$1.31

$1.77

$2.39

$3.22

$4.35

$5.87

$7.34

$9.18

$11.47

$14.34

$15.06

Payout Ratio

0.00%

0.00%

0.00%

0.00%

35.00%

35.00%

35.00%

40.00%

40.00%

40.00%

40.00%

Dividends

0

0

0

0

$1.52

$2.06

$2.57

$3.67

$4.59

$5.74

$6.02

                       

Discount rate

8.71%

8.71%

8.71%

8.71%

8.71%

8.71%

8.71%

8.71%

8.71%

8.71%

8.71%

Discount Factors

N/A

N/A

N/A

N/A

0.72

0.66

0.61

0.56

0.51

0.47

26.95

Terminal Value

                   

$162.35

Discounted Values

       

$1.09

$1.35

$1.56

$2.05

$2.35

$2.71

$76.56

Fair Value

$87.67

                   
Click to enlarge

Summary

The additive manufacturing industry is in the earliest growth stage of its life cycle, but it is likely to develop substantially in the coming years. Stratasys is the leader in the market by a considerable margin, and has become an industry pioneer. They therefore have enjoyed significant competitive advantage over its industry peers. This company has already been growing at an exceptional rate, with an excellent rate of revenue and earnings growth rate. Once the industry enters its expected boom, earnings for Stratasys will demonstrate even more positive trends. According to the fair valuation model exhibited here, the stock should trade at $87.67. The stock can be expected to keep rising as the market continues to show confidence in both the company and its growth prospects.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.