Stratasys (SSYS) has been diligent in their efforts to reduce costs and increase cash flows while progressively moving towards profitability. I believe Stratasys is positioning themselves for success in the soon-to-be-booming market of additive manufacturing, and that there is an asymmetric opportunity for an investor with a 2-10 year time horizon.
Since 2012, Stratasys saw their share price soar as they boasted double-digit revenue growth in an atmosphere that was buzzing with hysteria surrounding the future of 3D printing and additive manufacturing ["AM"]. Investors bid the stock up, sending Stratasys' valuation sky high. It was an industry-wide rush as Stratasys' competitor, 3D Systems (DDD), went along for the ride as well:
However, after Stratasys' reverse merger with Objet in 2012, followed by further acquisitions and lowered guidance from management, their share price was sent into a tailspin. In addition to this, patents had expired for several 3D printing systems, triggering an influx of new supply and competition industry-wide:
Stratasys' decisions at the time sent investors running for the hills. Mergers and acquisitions are rarely seen as a positive catalyst for the acquiring company, and Stratasys was no exception. However, those decisions made years ago have now set the stage for an opportunity I believe you should seriously consider.
Growing Products and Partnerships
Stratasys has been quietly at work since falling out of the limelight with investors, focusing on cost-cutting through improving operational efficiency, while simultaneously rolling out a batch of new products announced in May 2019 during the Additive Manufacturing User Group conference.
(Source: Q1 2019 Earnings Slides)
Stratasys also recently announced that they were deepening their partnership with Boom Supersonic, a Colorado-based company building history's fastest supersonic airliner, signing a seven-year extension. In addition, Marshall Aerospace and Defence Group, one of the largest privately owned and independent aerospace and defense companies in the world, is now using Stratasys to print flight-ready parts for their military, civil and business aircraft.
So why is this news significant? A basic understanding of Stratasys' business model will make it clear. Stratasys' main industry verticals are:
- Consumer Products
While Stratasys does offer a variety of 3D printing desktop solutions, the bulk of Stratasys' revenue is derived from their higher end AM products, specifically in the aerospace and automotive industries, where they sell their printers at low margins, so that they can drive sales of their higher-margin proprietary consumables (printing materials) and services. Stratasys wants to be a "one-stop shop," and building long-lasting relationships is essential to their "razor-and-blade" business model. It is also a signal that aerospace companies like Boom Supersonic and Marshall Aerospace and Defence Group are planning to further adopt AM for 3D-printed flight hardware. I think we are seeing the beginning of a transition where companies have been using AM for prototyping, and shifting towards companies using AM for production on a larger scale.
A Milestone and a Moat
If the above was not enough to capture your attention, Stratasys' announcement during their Q1 2019 Earnings Call was very revealing. The company announced that their Fortus 900mc and ULTEM 9085, used in Stratasys' Aircraft Interior Solution configuration, is the only system qualified to meet NCAMP qualification from NIAR, which are recognized by the Federal Aviation Administration [FAA] and the European Aviation Safety Agency [EASA]: (Source: Q1 2019 Earnings slides)
Despite growing partnerships and new products, revenue growth has been anything but impressive, clocking in only 1% GAAP growth year over year in Q1 2019.
However, it is the path to profitability that I would like you to focus on. In 2018, the company posted a loss in net income of $10.96 million, a 72.58% decrease in losses year over year. To put into perspective how impressive the turnaround has been, Stratasys hasn't been profitable since 2013, having posted a loss in net income of $26.95 million. Two years later, in 2015, Stratasys posted a loss in net income of a whopping $1.37 billion, a year-over-year loss of 1,049.59%. So while the top-line growth is nothing to write home about, the company has been keeping their nose to the grindstone.
Taking the above into account, as of the time of this writing, Stratasys' closing price of $29.97 is, in my opinion, just slightly in the higher range of the valuation they deserve. Since about April of 2015, Stratasys has been trading between 1.2x and 2.4x Price to sales ratio (NTM).
(Source: Author via Koyfin)
Stratasys is currently trading on the higher end of that range at 2.2x P/S (NTM), following a decent rally on June 28, 2019. Despite stagnant revenue growth, the market could be pricing in future earnings surprises, as the company has consistently beaten EPS estimates in the last few quarters.
(Source: Author via Seeking Alpha)
However, revenue results have been slightly mixed.
(Source: Author via Seeking Alpha)
In addition to Stratasys' consistent progress towards profitability, another metric I would like you to focus on is Stratasys' decreasing costs of revenues. Since 2015, cost of revenues has been in steady decline, from $390 million to $338 million in 2018. This indicates to me that Stratasys is becoming increasingly more efficient in their operations. And while some investors may argue that this could merely be a product of an overall decrease in the cost of 3D printing technology, when comparing these figures to Stratasys' competitor, 3D Systems, they are not boasting the same trend. (Although 3D Systems' revenue growth has been higher, they have missed revenue estimates in the previous 3 quarters.)
(Source: Author via Seeking Alpha)
In addition, when comparing cash flows from operations, it is clear that Stratasys is also unique in this measure, steadily increasing their cash flows year over year, while 3D Systems has seen a significant decline.
(Source: Author via Seeking Alpha)
In addition, R&D expenses have been relatively steady for Stratasys since 2016, with a slight increase from 2017-2018. In an industry that must continuously innovate to stay ahead of competitors and expiring patents, this is not a metric you want to see decrease significantly going forward.
A looming concern for investors is that Stratasys has been without a CEO since June 1 of 2018. Since then, Elan Jaglom has been serving as interim CEO, and there has been no indication from management when a new CEO will be chosen. And despite the increase in cash flow from operations year over year, the company saw a decrease in generated cash from operations in Q1 2019 posting $4.6 million versus $27.1 million generated for the same quarter last year. However, I believe management's reasoning for this was more than acceptable, stating that the reduced cash flow was primarily due to the timing of tax payments, and proactive steps to increase inventory levels in order to advance fulfillment time and support product demand. I interpret that comment to be very positive, overshadowing the negative connotation of the drop in cash flow for the quarter. As regards the constant cyclical risk of expiring patents as mentioned previously, Stratasys faces fierce competition from competitors as they fight for market share in this rapidly growing industry. Pricing power is firmly in the consumer's hands as supply far exceeds demand. Also, deep-pocketed companies like HP Inc. (HPQ) and General Electric (GE) can spend and innovate at a pace that most companies in the 3D printing space cannot contend with, including Stratasys. For Stratasys to succeed going forward, they need to continue deepening current partnerships and forging new ones all while maintaining a high pace of innovation.
The beginning of a secular shift
If you have been following Stratasys for some time, you may be aware of their joint efforts with Boeing (BA) and Ford (F) to push the limits of 3D printing past prototyping and into the industrial realm via Stratasys' Infinite-Build (H2000). The end game in this space is to use 3D printing to augment and eventually replace the traditional assembly line altogether, by simplifying assembly through reduced part counts. Stratasys' H2000 is the company's first effort to push these boundaries. The H2000 can print parts of unlimited length, allowing companies to build larger parts with faster production times.
On a global scale, we will be observing a shift in 3D printing and AM that I do not believe many investors are aware of: (Source: Statista)
This represents an astounding measure of growth, with the global additive manufacturing market size projected to grow by 28.8% next year. If Stratasys can continue to innovate, expand, and refine their operations, there will be significant market share for the taking going forward.
Despite the lack of a permanent CEO, I am really impressed with Stratasys' continued stability, success, and vision. In fact, the lack of a CEO further strengthens my conviction in this company. A captain-less crew that can steer the ship this well thus far is a vessel I want to be aboard. Stratasys has consistently beaten estimates over the past few quarters, and I anticipate further earnings beats in the future, as they continue to forge and deepen customer relationships. Although top-line growth is still stagnant, and the stock's price action is quite volatile, the investor with a time horizon of 2-10 years, I believe, will enjoy a considerable appreciation in capital. In an environment obsessed with high growth SaaS stocks, I do not think investors are paying very much attention to Stratasys, and that can be to your advantage. This is an exciting time to be an investor in a space that will undoubtedly revolutionize the world of manufacturing.
Disclosure: I am/we are long SSYS, BA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I may take a long position in GE within the next 72 Hours.