- Proto Labs provides on-demand manufacturing with a self-service portal aimed at companies looking for prototypes and small-series production.
- The company has been able to switch from low-volume to high-volume rapidly, partially limiting revenue losses due to the pandemic.
- It has the best financial metrics compared to peers.
- Economic recovery, together with product upgrade and synergies generated by the 3D Hubs acquisition may result in an earnings beat for FY-2021.
- In a world increasingly characterized by supply-chain challenges, induced by COVID and geo-politics, Proto Labs has a solution.
Last year brought many unforeseen challenges for Proto Labs (NYSE:PRLB) because of COVID causing revenues to regress as from the second quarter and extend to the whole of 2020. Now, with infection rates still high in Europe where the company launched a new manufacturing facility in November, top-line could be impacted.
Figure 1: Share price performance and quarterly revenues.
Furthermore, when compared to other 3D printing plays, the company has a digital manufacturing model which has allowed it to respond more rapidly, by delivering critically-needed components for the manufacture of healthcare equipment.
This ability to have switched from producing lower quantities used for prototyping to higher quantities used for production purposes could be vital in the current industrial environment synonymous of supply chain interruptions.
With launch of its platforms first in Europe and more recently in the U.S., Protolabs, a player in rapid production of prototypes and small series parts, basically aims to provide an on-demand platform with a self-service portal. For this purpose, the company has worked with thousands of product designers, engineers and procurement teams around the world, with the imperative to reduce product development times and simplify project costing. This represents a paradigm shift for project stakeholders, who previously had to interact for days before the purchase order could be issued, compared to hours now.
Figure 2: Launch of the new Protolabs 2.0 platform.
Source: Protolabs investor presentation.
This launch comes as the engineering and manufacturing industries around the world are struggling to solve complex challenges in their markets and supply chains. In response, the simplicity of Protolabs 2.0 platform, boasting an intuitive and user-friendly allows users to manage prototyping and production requirements with the possibility of analyzing financial feasibility of different options.
Such platform features can enable acceleration of product development for industries ranging from automotive, aerospace, medical, heavy industry to electronics, with customers simultaneously availing themselves of the company's three main services, namely, injection molding, CNC machining and 3D printing. To this end, amid the overall slump, printing revenues for 2020 followed an upwards trend.
Revenues were impacted by COVID due to industrials shifting their priorities to focus on production and supply chain challenges rather than continue with routine R&D activities, an area which requires the prototypes produced by 3D printers.
Figure 3 : Revenue from each service down except for 3D printing.
Source: Protolabs investor presentation.
Hence, full-year 2020 revenues of $434.4 million declined 5% compared to 2019 as the company served about 40,000 product developers, a decline of 15.7% compared to the prior-year. Had it not been for the $18 million of COVID-related orders, the decline would have been more pronounced. Thus, the company was able to produce components for ventilators and diagnostic equipment, as well as personal protective equipment for healthcare providers.
As a result of lower production volumes and the need to absorb fixed costs, non-GAAP gross margin for FY-2020 was 51% compared to 52% in 2019. Turning to operating expenses, total non-GAAP operating expenses totaled $37.4 million in Q4-2020, $4.1 million more than in the third quarter, mostly due to expense relating to Protolabs 2.0.
Extending to the whole year, the new platform required R&D expense of $3.7 million. This increase was offset by reduced sales and marketing spend due to lower travel and converting to virtual Trade Shows, as well as other cost management measures, including executive and board compensation reductions.
Consequently, total non-GAAP operating expenses was reduced to $143.7 million in 2020, compared to $144.5 million in 2019.
This ability to exercise cost control and bring expenses below prior-year levels while continuing to invest in the future through Protolabs 2.0. has meant a positive EBIT (operational) margin compared to peers.
Figure 4: Comparison of key metrics.
Source: Seeking Alpha
For this matter, these companies operating in different sectors and industries of the economy do not necessarily compete with other at all times, but they all do offer 3D printing activities. Now, this is an area which has seen a lot of M&A activities since the last seven years resulting in a fiercely-competitive sector with many players subsidized by cheap money. Also, balance sheets have deteriorated with high debt levels.
However, in the case of Proto Labs, its profitability and better cash position shows that it offers more sustainable long-term growth opportunities.
The profitability should fall slightly going into Q1-2021 with non-GAAP gross margin expected at approximately 48%, or 200 basis points lower than for the fourth quarter, due to the addition of 3D Hubs, which currently operates at a lower gross margin than the legacy Proto Labs business.
Valuations and key takeaways
The acquisition and subsequent addition of 3D Hubs for approximately 75% of the first quarter will result in increased operating expense of $2 million to $2.5 million. Additionally, there should be an increase in amortization costs associated with the acquisition together with a depreciation of approximately $1.5 million pertaining to older assets. This latter amount will be recurrent for the remaining quarters.
Moving to staff costs, there will be an increase in compensation costs of approximately $1.5 million related to increased payroll taxes in Q1-2021, and a one-time equity compensation expense associated with the CEO transition. In this case the current President and CEO, Vicki Holt will be replaced by Rob Bodor, Vice President and General Manager of the Americas for the past six years. During his tenure at Protolabs, the latter has also served as Chief Technology Officer and drove the 3D Hubs acquisition.
To offset some of these increases, quarterly R&D expenses will decrease slightly in comparison with 2020 levels, as some employees and external contractors that have been dedicated to Protolabs 2.0 shift to other projects. Also, foreign currency is expected to have $1 million to $1.5 million favorable impact.
Still, due to uncertainty in global economic recovery especially due to lockdown in Europe and Brexit, as well as seasonal flatness (in demand) seen in December continuing in January and February, revenue guidance for Q1-2021 are in the $108-$118 million range, compared to $105.2 million in the fourth quarter. One noteworthy point is that Q4-2020 results was helped by partial revenues of approximately $5 million from the 3D Hubs acquisition.
Pursing further, as a result of 3D Hubs integration expenses, asset depreciation, consensus Earnings per Share estimates for 2021 are at a low of $1.97.
Figure 5: Earnings per share, past and forecast.
Source: Seeking Alpha
Drilling further, the non-GAAP diluted earnings per share of $2.36 for 2020 represented a $0.42 per share decrease from 2019. Out of the $0.42, lower volumes and gross margins equated to $0.12 and 0.14 per share impact, respectively.
Now, there are indications that volumes should be higher in 2021, when considered as a whole.
Firstly, with Germany's economy on track to recover pre-pandemic industrial activity levels by the fourth quarter of 2021, if not earlier due to containment measures to cap infection rates being harsher than in other nations and the U.S. manufacturing sector growing at its strongest pace since 1983 with the ISM Manufacturing PMI rising to 64.7 in March from 60.8, industrial activity is set to bounce back strongly.
Secondly, 3D Hubs just like Proto Labs operates as an online manufacturing platform that offers businesses on-demand access to a global network of 240 manufacturing partners from 20 countries. Its platform already offers the same range of manufacturing services as for Proto Labs. In 2020, the firm generated $25 million in revenue at a compounded annual growth rate (CAGR) of more than 200 percent since 2017.
Therefore, there should be significant horizontal integration synergies for the combined entity through an extended network of manufacturing partners, and a broader selection of capabilities, pricing, and lead time options. The acquisition aims at achieving $1 billion in revenues, which would potentially represent roughly 150% of annual growth for Proto Labs.
Figure 6: Break-up of EPS differential between 2019 and 2020.
Source: Table built by author from Q4-2020 earnings script.
Coming back to FY-2021, the company should beat earnings expectations by approximately $0.26 (0.12+0.14), thanks to higher volumes and acquisition synergies, in turn signifying better gross margins.
Consequently, the earnings should be higher at $2.23, instead of the expected $1.97. As a result, based on ~61x forward price to earnings multiples, I come up with a share price of $135. This remains a long-term target materializing somewhere in March 2022 after the Q4-2021 earnings report. In the meantime, the stock could dip to the $115 level in May due to revenue levels being temporarily under pressure.
Looking across the board, 3D printing is a highly-fragmented industry, with product innovations frequently disrupting normality. Proto Labs does not seek to compete head-on through technological breakthrough and sales of individual machines to manufacturers like 3D Systems (DDD). The latter also offers a 3D printing service, but at a much lower scale.
On the other hand, Proto Labs is very well structured as a low-volume manufacturing services play with a huge amount of production capacity distributed across its locations. Most importantly, it has demonstrated ability to switch to higher volumes during the pandemic.
It also faces competition from the likes of ExOne (XONE) in Additive Manufacturing, but is well diversified in services like CNC (automated control of machining tools through computer), an area that was impacted by the pandemic, which is poised for recovery as we go into 2021.
Finally, Proto Labs has been able to provide a cloud-type interface to manage the production process, thereby making things simpler and less expensive for customers, especially the smaller ones which cannot afford to invest in a machine. Extrapolating further, as a result of economic pains accompanying the pandemic, it is this cost factor which may turn into extra competitive strength, at the same time soothing some supply-chain challenges faced by industrials.
This article was written by
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