ARC Group: Industry Expansion And Acquisitions To Drive Earnings Growth

About: ARC Group Worldwide, Inc. (ARCW)
by: Ross Capital

ARC delivered revenue growth of 36% in its latest quarter. Profit converted into a loss.

The market ARC serves is expected to grow in the future.

Profitable acquisitions will help the company in extracting a bigger share of market growth.

Currency hedging will mitigate the impact of Euro depreciation.

ARC is undervalued by 12%.

ARC Group's (NASDAQ:ARCW) share value has gone up by 14% in a month. The company is a provider of 3D-printing services in the US. ARC has remained a top performer in the industry for a long time: the company's revenue growth has averaged 138.4% over the past three years, while the industry has seen its top line increase at a far lesser rate of 4.9%. With the macro environment proving favourable for ARC, this trend is expected to sustain ahead.

In this article, I will evaluate the company's financial strength by reviewing its performance in the latest quarter. Later, I will discuss factors to support my quantified upside of the company.

Second Quarter

During the period, ARC achieved revenue growth of 36% as the top-line figure surged to $27 million. The year-over-year increase came on the back of healthy industry conditions which led to record sales in the company's Tekna Seal business. ARC also attained significant leverage through effective promotional activities, which helped in acquiring more customers during the quarter.

EBITDA, however, grew by only 30 bps to $3.8 million. The smaller rate of growth was achieved mainly due to a reduction in inventory levels at AFT to improve working capital, and changes in the company's employed workforce and contracted labour staffing level.

The net result was a loss of 0.4 cent per share, which failed to beat the analysts' estimate of 4 cents and came significantly below the year-ago profit of 10 cents. Nonetheless, the earnings momentum is expected to improve in the future, owing to the reasons discussed below.

Market Expansion

The market for 3D printing is forecast to grow at a CAGR of 14% over the next six years. The reason behind is that the adoption of 3D printing is expected to increase across various sectors such as aerospace, healthcare, industrial and education. 3D printing makes it possible to manufacture a product with just about any design complication. Therefore, the technology is valuable in developing goods that require accurate measurements. As an example, a jaw implant for a patient or a key aircraft component demands specific fitting, which could be achieved by computerized 3D printers without incurring high wastage of materials.

While the industry conditions will provide a tailwind to every player in the sector, several factors indicate that ARC will stand out as a winner: first, the company is acquiring firms that have a potential to extract a bigger share of market growth; in the past one year, ARC has bought several companies out of which the acquisition of ATC and Kecy are poised to benefit investors in the long run.

This is because ATC is one of the industry's leading plastic injection molders, and sells turnkey-plastic-injection molding services as well as tooling knowledge to customers in high growth markets including the medical, electronic and defence sectors. With a revenue-generation potential of approximately $17 million, the acquisition is a good vehicle for riding the current market boom.

Similarly, Kecy is a dominant player in the precision-metal stamping industry. While the company is lucrative on its own and generates $26 million in sales every year, what's important to note is that the acquisition's customer base will provide ARC a bigger catalyst for future growth. This is because ARC is the first company that supplied Kecy metal 3D-printed prototypes. With familiar business processes, the company will easily be able to introduce its other products to the acquisition's customers without having to spend large amounts on marketing or promotions.

Secondly, ARC has hedged its foreign inflow of cash in order to remove the negative impact of currency fluctuation. In January, the company entered into several currency contracts which will prevent it from experiencing a loss from the depreciation of Euro. The decline has already pushed ARC's EBITDA down by approximately $250,000 since the beginning of 2015, which is significant given that the company could have generated a profit if the conditions weren't there. With that being said, the contracts will ensure that investors get to enjoy gains in both the top and bottom line during the upcoming period.

Bottom Line

Industry growth, profitable acquisitions, and currency hedging has led the analysts to believe that ARC's earnings will grow by 293% to 55 cents per share in 2016. The growth in earnings will ensure that the stock-price trend sustains ahead.

ARC also remains undervalued through several metrics that investors tend to rely on: the company's trailing P/E of 57.5x is above the 19.5x industry average, but the forward P/E of 14.1x is below the industry average. ARC's price-to-sales multiple of 1.1x is 21% lower than the industry average and the price-to-book ratio of 3.6x is well below the 4.9x industry average. Adding the fundamentals reveal that the company is undervalued by 12% (see table above). Therefore, ARC holds a buy rating.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.