A Quantitative Breakdown Of 3D Systems: Still A Short Candidate

| About: 3D Systems (DDD)

Summary

Even after shedding 75% of its market cap, 3D Systems is still expensive by every measure of value.

Price performance has been brutal recently, TTM EPS growth saw a massive decline, and profitability is extremely weak. Even revenue growth is decelerating.

Short interest is extremely high. We think this indicates further downside rather than a possible squeeze.

3D has already taken the earnings day hit by essentially pre-announcing their earnings. Still, the company has missed EPS estimates five times in a row and revenue three times.

We expect huge underperformance from 3D Systems over the next twelve months.

A) Introduction

3-D printing is an amazing breakthrough in manufacturing, and is likely to be a growth industry for years to come. Nevertheless, it is extremely difficult to pick the individual winners in these types of fast-paced industries. The excitement generated by novel technologies, such as 3-D printing, often leads investors to trade reason for hope. History has shown that these new "glamour" industries are prone to irrational overvaluation. 3D Systems Corp (NYSE:DDD) and Stratasys (NASDAQ:SSYS) are prime examples of this, as they were both darlings of Wall Street almost exactly a year ago. Since then, 3D has shed almost 75% of its market cap, falling from about $100 to it's current price of $25. This was punctuated by 3D's premature earnings warning last week, that sent the stock price down over 10%.

In determining whether a company will be a good investment now, we look to the past for guidance. What the past tells us is that valuation, price momentum, earnings momentum, and business quality are the best metrics in predicting future stock returns. At this point, 3D Systems falls flat on every single measure.

B) Value Breakdown

We take a quantitative approach to investing, preferring to focus our analysis on a certain set of metrics that have a strong predictive ability. This means that we only look at metrics that have an academically tested track record of predicting returns in the past. We'll start by analyzing 3D's value profile. This is important to look at as "Value stocks (with low ratios of price to book value) have higher average returns than growth stocks (high price-to-book ratios)". 3D's valuation profile is shown below:

Source

Besides its solid book value multiple (2.16x), 3D looks expensive by every measure of value. Both its sales (23.26%) and earnings (0.43%) yields are way below the overall market, sector, and industry group averages. Both metrics are calculated using trailing twelve month revenue/net income over market cap. It's tough to find stocks with worse earnings yields than the current 10-year treasury yield, but 3D qualifies.

Free cash flow yield (2.63%) is pretty terrible as well, and less than half the industry group average (5.5%). Based on each of these metrics, 3D systems is rated as "Moderately Overvalued," and comes in the 11th percentile of all stocks based on these valuation metrics. Based on the average returns of stocks with a similar valuation rank, we expect significant negative ex-ante alpha due to valuation over the next twelve months (-7.13%).

C) Growth & Momentum Breakdown

Next we'll look at 3D's growth breakdown, specifically focusing on price momentum, EPS growth, and profitability efficiency. Price momentum is particularly important, as the momentum anomaly is almost as strong as the value anomaly (see here). EPS growth & profitability also have predictive power to a lesser degree, as initially outlined in James O'Shaughnessy's seminal book "What Works On Wall Street." Companies with expensive valuations can still be good investments if growth is strong enough. 3D's growth breakdown is shown below:

With such an expensive valuation, one would think that 3D would have strong growth and profitability metrics. As we can see from the chart above, 3D falls in the bottom 30% in every growth metric. Particularly worrisome is the stock's weak price momentum, with the stock dropping 35.53% over the last six months and 47% over the last twelve. This is during a period when the average stock in the overall market gained 5.2%, and the average stock in the sector gained 9.68%. While many falsely believe that what goes down must come up, history has shown time after time that momentum and price trends are very good predictors of mid to long-term future returns. The trend in 3D points to even lower levels.

3D's net income also fell dramatically over the last 12 months, declining 73% from a ttm basis (comparing the sum of the last four quarters to the previous four before that). 3D managed a weak 0.99% return on equity and 0.85% on assets, both well below the industry, sector, and overall market averages. Overall, our model ranks 3D's growth/momentum profile in the 5th percentile of the entire market. We expect significant ex-ante headwinds from here given its ranking, and how stocks with these type of growth profiles have historically performed versus the market.

We should mention that we know that 3D is generating huge revenue growth at the moment, with the last three quarters averaging out to a 23% YoY gain. It's just that revenue growth is not a metric that predicts future stock returns. Buying a basket of stocks with the top 10% highest revenue growth rates would not have meaningfully differed from buying the overall market. Thus, it does not factor materially in our overall thesis. And even if it did, revenue growth has been decelerating for 5 straight quarters.

Business Quality Breakdown

Another key metric to watch is the quality of the company's earnings and business. In a world that is overly fixated on the short-term bottom line, investors tend to put a greater emphasis on earnings quantity rather than earnings quality. This leads to artificially high prices for companies that have low quality earnings. 3D's business quality is shown below:

The company spends a solid amount on research and development, with R/D making up 11.53% of sales over the last twelve months. This is right in line with the industry average (11.75%) and ahead of the overall market. R/D spending suppresses income in the short-term but leads to long-term benefits, so its a good sign that 3D has maintained R/D spending.

What is really interesting from this chart is 3D's extremely high level of external financing. External financing (trailing twelve month debt + equity issuances) now makes up 60% of the company's assets, versus 2% for the average stock in the market. High levels of external financing are bad in the long-run, because of future interest payments & equity dilution.

Overall, our quality model rates 3D's business and earnings quality poorly, placing it in the 19th percentile of all stocks based on these metrics. Once again, holding everything else equal and based on how stocks with similar earnings quality have performed in the past, we expect moderately negative ex-ante (-3.59%) alpha over the next twelve months.

"Smart Money" Breakdown

Now that we've broken down 3D's valuation, growth, and momentum profile, we'll look at how the "smart money" is playing the stock. To do this, we'll analyze the short float and institutional transactions, as historical testing has shown both to be good predictors of subsequent future returns (see here & here). 3D's "smart money" breakdown is shown below:



For the most part, company insiders and institutions have mostly maintained their 3D positions over the last few months. With that being said, short interest is still at an astronomically high level at 36.26% of the total float - more than 10 times the market average. This is a worrying sign as short sellers have a good track record of predicting declines when they crowd into a trade. While some may argue that this is fuel for a potentially squeeze, historically, it has meant further downside. You don't want to let the "smart money" make your decision for you, but the fact that it confirms a sentiment is a good sign. Overall, we'd classify the "smart money" as bearish on the stock.

Earnings Momentum Breakdown

Earnings momentum is a critically important, yet underfollowed metric. We've noticed that almost no one pays attention to it, yet stocks release earnings every three months and see their stock price swing wildly based on the results. Essentially, we've found through historical backtesting (and common sense) that stocks that have a track record of beating analyst expectations are much more likely to beat again in the future. The following breakdown shows 3D's earnings momentum breakdown:

3D missed EPS consensus estimates by 35% last quarter, extending its streak of misses to 5 straight. 3D has only beaten the EPS consensus 2 out of the last 10 quarters. On the revenue side, 3D missed consensus by 8.85% last quarter, marking its third miss in a row. 3D has only beaten the revenue consensus 4 times in the last 10 quarters. We also like to look at growth rates, as stocks with strong growth rates tend to beat estimates more often. 3D's EPS declined 18.75% last quarter on a YoY basis, while revenue increased 21.1%.

Analysts polled by Zacks expect $0.01 in EPS and $159.28 million in quarterly revenue. Based on what we talked about above, our earnings model puts the probability of an EPS beat on the consensus estimates at 0-45%, and expects 3D to miss. We put the probability of a beat on the revenue consensus at 55-65%, and expect a small beat (0-5%).

This info may seem outdated to investors now that the company has already lowered guidance ahead of earnings - which sent the stock down over 14%. While the stock may not see another decline now that it has already lowered expectations, it's key to remember that this is a stock with decidedly negative earnings momentum. If the company fails to beat even its lowered guidance, then expect the stock to get crushed further.

Conclusions & Summary

Psychologically, its tough to short a stock that has already come down 75% from its peak. With that said, by using metrics with an extensive historical track record of predicting future returns, our analysis clearly points to further downside. At the very least, investors have to know that they are betting against the odds in holding on to 3D right now. While not everyone puts as much weight in quantitative analysis as we do, it's key to know that the quantitative profile of the stock is unequivocally bearish.

Our conclusions on 3D Systems are summed up in the box below:

3D Systems combines an expensive valuation, horrible growth profile, bad earnings quality, and heavy short interest. Additionally, the company has disastrous earnings momentum, with 5 straight EPS misses and 3 straight revenue misses.

Overall, our model expects -24.7% of ex-ante 12-month alpha from 3D Systems. This means we expect it to underperform the returns of the S&P 500 by 24.7% over the next 12 months. Thus, adjusted for beta, if the S&P 500 returns 10% over the next twelve months, we would expect 3D Systems to return -14.7% based on its risk profile.

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. The author has no business relationship with any company whose stock is mentioned in this article.

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