The ExOne Company (XONE) is a global provider of 3D printing machines, products, materials and services to industrial customers. Over the past decade, the company has been able to take advantage of the burgeoning additive manufacturing industry to secure steady revenue growth for their ever-expanding suite of products. However, of late, XONE, like many companies in the additive manufacturing industry, has begun to struggle against a backdrop of global macroeconomic uncertainty and increased industry competition.
After market hours on Thursday, October 10th, XONE released modified Q3 guidance that showed drastic cuts to revenue estimates. In Q2, the company had posted $15.3 million in revenue, with an impressive 41% YoY revenue growth figure. Q3 had been expected to continue the trend with revenues over $15 million. However, guidance was lowered to between $10 and 11 million due to some $5 million in system installation delays. Shares fell sharply on Friday after the news.
Today, I don't want to draw a conclusion on whether or not XONE is a BUY (let's wait for Q3's actual results), but rather I'd like to discuss what I believe the company's recent drop in share prices illustrates about the recession vulnerability of the industry as a whole.
You see, it wasn't just delays in the installation of systems that caused investors to panic and abandon XONE shares on Friday. In fact, XONE expects to complete the delayed system installs by Q4 so short-term revenues shouldn't be overly affected.
Instead, the investor fear, I believe, comes from an undeniable fact I have touched on repeatedly when covering the additive manufacturing industry, a manufacturing slowdown hits newly adopted, capital intensive manufacturing operations like additive manufacturing first. Additive manufacturing is not a recession resistant industry.
The Macroeconomic Slowdown in Additive Manufacturing
When US ISM manufacturing data reveals contraction (below 50), additive manufacturers begin to struggle to bring on new clients and that's what we have seen thus far in the second half of 2019.
Couple the manufacturing slowdown with increasing competition and many investors are beginning to realize the additive manufacturing industry is witnessing some growing pains, despite its bright future.
XONE CEO John Hartner's words on Thursday during the guidance cut are the perfect evidence of this phenomenon:
"While we mentioned macroeconomic concerns in our second quarter earnings release and teleconference, the broadening global manufacturing slowdown has become more evident in our customer discussions. Heightened customer uncertainty, coupled with the mid-year timing of our new product launches and related execution challenges, have impacted our ability to achieve prior expectations for revenue growth in 2019."
It appears the manufacturing slowdown may be worse than expected. In September, the manufacturing sector in the U.S. lost some 2,000 jobs, primarily driven by a lack of demand, according to the Institute for Supply Management's ISM manufacturing index. New orders, backlog, raw materials, inventories, exports and imports also contracted across the board in September. Numbers like this would surely be far worse during a recession, leaving the industry vulnerable.
The good news, however, is on Friday, China and President Trump agreed to halt the trade war escalation. This is the first positive development in sometime out of the trade war fiasco and it will undoubtedly help assuage manufacturer fears and uncertainty. A trade deal would definitely be a positive development for the additive manufacturing industry, although I'll admit I believe the chances for a unilateral trade agreement between the U.S. and China anytime soon are slim.
Increasing Industry Competition
Competition within the additive manufacturing industry has also been increasing steadily over the past decade as patents have expired and more capital has been sunk into the industry by deep pockets like HP, Inc. (NYSE:HPQ) and General Electric (GE).
This has resulted in a glut of supply for customers who now have their pick between a number of different 3D printer. This will, of course, increase overall industry pressure during a recession.
In particular, the metal 3D printing segment, which is a large part of XONE's business, has seen increased competition including end-to-end producers who hurt XONE's hold on the industrial space. XONE does have sand and ceramic capabilities that are more proprietary, still competition for their business as a whole has certainly increased.
XONE put a lot of capital into R&D to develop the X1 25PRO metal printer, for example, and now that system has considerable headwinds due to global macroeconomic uncertainty and new entrants in the space.
The good news is the annual Wohler's Report on the additive manufacturing industry noted an impressive 79% YoY increase in total metal printer system sales in 2018.
Hopefully, there is enough to go around, but I fear XONE's industrial specialization won't help them avoid competition forever given the increasing capabilities and new entrants into the metal market seen below:
- GE Additive - Direct Metal Laser Melting and Electron Beam Melting
- HP - Metal Jet Tech
- Markforged - Metal Printing Suite
- Protolabs - Profitable, European and Increasing Metal Printing Capabilities
- Stratasys - Low Cost Contender
- Xometry - Running Online Ad Campaign For Low Cost, Quick Metal AM
- 3D Systems - The Original, and Still At It
- Materialise - The Other European Metal AM Play
Margins, Equity Dilution and Cash Flow Concerns
XONE has consistently been unable to achieve a profit despite relatively high gross margins. In response, management initiated the 2018 global cost realignment program which has greatly improved profitability metrics over the past year.
XONE's adjusted EBITDA for 2019 should be close to breakeven for the first time since 2013. Despite this, cash and equivalents have steadily fallen for the past three years and FCF remains negative.
XONE detailed in their Q3 guidance announcement that management is confident they have the capital to continue operations and achieve their long-term goal of profitable growth. However, it seems XONE is perennially cash poor. Luckily, the company doesn't have a lot of long-term debt to contend with, only $1.4 million.
One of the biggest issues I have with XONE, however, is the company's continued share dilution caused by this cash poor status. XONE pays an inordinate amount in equity based compensation and that is expected to continue through 2019 and beyond. Share dilution is a serious problem that shareholders should be aware of.
Valuation and Conclusion
I don't want to draw any conclusions on XONE before the Q3 report which comes out in the beginning of November. That should give us a more clear picture of how the company is holding up against new industry pressure, and if new systems are continuing to sell.
However, in my view, the almost 13% drop in share prices after Thursday's reveal may have been over the top. XONE may not growing revenues at the same clip it did during Q2, but the company hasn't lost any contracts, they are simply delayed. Although I consider myself a long-term investor, a savvy trader may be able to make some money on Monday as I believe share prices of XONE will recover somewhat, especially with the positive China trade news coming out.
Although I am concerned about global macroeconomic uncertainty and industry competition, XONE has been able to find an attractive niche within additive manufacturing while maintaining growth which makes them one to watch going forward. The company's price to sales ratio has also fallen significantly off highs from before 2017.
Although XONE is not a BUY at this point, because of current headwinds and the unknowns of Q3, I will be awaiting Q3's report eagerly to see how XONE performs.
Perhaps the most valuable piece of information that comes from the analysis of XONE is the confirmation of a slowdown in additive manufacturing industry customer's appetite. This type of slowdown when we are at the end of the longest bull market in history with historically low unemployment rates should be a warning to investors about the potential devastation that additive manufacturers could create on a portfolio during a recession. Additive manufacturing plays are high-risk, high-reward investments that require caution and thorough research. The ExOne drop is a reminder of the associated risks in this growing industry.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.