As mentioned prior, the 3D printing sector has appealing growth potential, but the valuations of the two main players have typically been at elevated levels. The stocks of 3D Systems (DDD) and Stratasys, Inc. (SSYS) were expensive in spite of the fast growth rates until the September swoon. Now 3D Systems can add a short attack to the equation.
The company is a leading provider of 3D content-to-print solutions including 3D printers, print materials and on-demand custom parts services for professionals and consumers alike.
As written back on October 10th with the stock around $34, the sell-off provided a good entry point into the stock and the sector. A great Q3 earnings report helped counter the short theory and sent the stock surging to over $42 before the market closed for two days.
Q3 Earnings Highlights
The company reported the following highlights for Q3 2012:
- Non-GAAP adjusted earnings of 32 cents per share for the third quarter of 2012.
- Revenue increased to $90.5 million, a 57% increase, over the third quarter of 2011, on 26% organic growth.
- For the third quarter, gross profit grew 69% on higher revenue and gross profit margin expansion of 350 basis points over the 2011 quarter to 51.8%, driven by printers and materials gross profit margin improvement.
- The company raised its annual guidance for the full year 2012, expecting its revenue to be in the range of $345 million to $365 million and its non-GAAP adjusted earnings per share to be in the range of $1.20 to $1.30.
- The company generated $44.0 million of cash from operations in the first nine months of 2012, and ended the third quarter of 2012 with $183.9 million of available cash.
Gray Wolf Research - Short Theory
Last week, Gray Wolf Research published their article on Seeking Alpha, making claims that the company was misstating organic growth and stuffing the channel amongst other items. While the market reacted as if the report claimed fraud, the real meat of the story hit at unsustainable growth rather than improper accounting.
The biggest claim of overstated organic growth actually comes down to how companies report the future revenue growth from an acquisition. As 3D Systems discussed on the conference call, the company accounts the growth from an acquisition as organic after 12 months if the product achieving that growth was produced while owned by 3D Systems.
All companies report organic growth in a similar manner hence the key to monitoring the success of a company comes down to per share numbers. The commonly used earnings per share or even revenue per share or cash flow per share adequately factor in the fact that growth in absolute numbers aren't meaningful if it doesn't impact the relative per share numbers.
The supposed inflated one-time sell-in to Z Corp resellers might actually be true and account for a partial reason that Q1 earnings smashed estimates. Unfortunately for the short thesis, the fact that earnings continue to increase sequentially suggests that any benefit has more than been offset by actual sales.
The cash flow issue is far from relevant as it focuses on the past. The real issue will be whether the rapidly growing revenue base generates cash flow going forward. The company generated $44M from operating activities in the first nine months of this year.
The most concerning issue is the ability to continue growing with Research & Development expenses remaining exceptionally low at around 6% of sales. The company might be generating short-term profits by limiting those expenses. 3D Systems is also buying research via these acquisitions that might allow it to keep those costs lower. It lets other companies develop the new concepts, while not having to fund losing ideas.
In some form, the over $315M in goodwill and intangible assets on balance sheet are payments for successful R&D programs. These expenses weren't incurred by 3D Systems, but it paid other companies for the successful development projects.
As mentioned in the Q3 earnings preview, a big concern with 3D Systems at the time was the unpredictable earnings reports. The company had a history of solidly beating or just meeting estimates.
The Q2 numbers came in right at the expectations of $0.27 so the reported $0.32 for Q3 was surprising. Analysts had expected a sequentially flat quarter. Typically, hot momentum stocks continuously beat and raise estimates, but this company had not done that until recently in two out of the last three quarters.
The key going forward after pushing beyond Q3 is that earnings for 2013 have started climbing higher, going from $1.33 60 days ago to $1.38 30 days ago to $1.52 currently. With the Rapidform deal adding up to $0.09 to those estimates, 2013 numbers could easily exceed $1.60 now. In fact, the high analyst already has an estimate of $1.87.
The stock currently trades at $42, approaching the all time highs. It now trades at 25x expected updated 2013 earnings of around $1.70. After the huge run by Stratasys and the delayed Objet merger, 3D Systems appears to be the better deal in the sector.
6 Months Chart - 3D Systems
With the strong Q3 earnings, 3D Systems remains a compelling buying opportunity around the current price. The stock valuation has become cheaper over the last few months as earnings expectations have expanded while the stock has been flat to down.
While the short theory regarding R&D remains one worth watching, the other issues remain either baseless or industry norms in the technology sector. Major corporations such as Cisco Systems, Inc. (CSCO) and Dell Inc. (DELL) routinely make purchases that are eventually absorbed into organic growth numbers.
The key remains whether the company is able to absorb the new businesses and foster them into growing business lines once part of 3D Systems. For now, the company has been a huge success and the only question remains valuation that for now is compelling.
Disclosure: I am long CSCO.
Additional disclosure: Please consult your financial advisor before making any investment decisions.