Proto Labs - Some Thoughts After Recent Excessive Volatility

Summary

• Proto Labs is a diversified custom-made manufacturer, helping its clients with a wide range of production technologies.
• With time to market becoming ever more important, Proto's services are in great demand.
• Over the past decade, this company has grown to become a nearly half a billion player in the custom-made field.
• Shares have seen a huge momentum run coming out of Covid-19, followed by an equally huge 60% reversal in recent weeks.
• While appeal has improved following this big pullback, I am still awaiting some further pullback to initiate a position.
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Proto Labs (NYSE:PRLB) has been a secular growth play which develops custom parts and while it is not necessarily a pure 3D printing play, the company has, at times, been regarded as a 3D play. Truth be told, the 3D segment is just a minority of Proto's operations, although I must say that I like the long-term growth story and potential for the company.

Shares fell ''victim'' of a huge momentum run higher over the past year amidst great momentum in the so-called momentum stocks, yet, after a 60% pullback, appeal is emerging in a rapid fashion.

Customization

Proto Labs claims to be the largest and fastest digital manufacturing source for rapid prototyping and on-demand production. Services included in the wide range of solutions include injection molding, sheet metal fabrication, CNC machining and 3D printing, among others.

The company has an annual revenue of nearly half a billion dollars which serves nearly 50,000 project developers. An employee count of roughly 2,500 workers serve these customers from 12 locations. The active customer base largely include the medical and healthcare sector, computer electronics as well as industrial machinery, aerospace and automotive, among others.

On a total revenue base of $459 million, Proto relies largely on its injection molding business which with $217 million in sales was responsible for nearly half of total sales. $155 million in CNC machine sales were responsible for a third of sales. 3D printing was responsible for $61 million of sales in 2019, equal to 13% of total sales as the company has a small $21 million sheet metal business as well.

A Former Take

Truth be said is that my last coverage on Proto was a while ago, as I covered the company back in 2017 when the 3D momentum run lifted shares of Proto Labs as well, as an acquisition at the time triggered me to establish an investment thesis on the company.

In November 2017, I concluded that shares were fully valued despite a nice bolt-on acquisition of Rapid Manufacturing Group. I observed that Proto went public in 2012 with sales of just $125 million at the time. Shares rose from $30 since the offering to $90 a year later amidst an initial momentum run. This was followed by years of stagnation and after having fallen back to $50 earlier in 2017, shares did recover to $90 in November 2017 when the company announced the purchase of Rapid. With earnings pegged around $2 per share while the company still held a substantial net cash position, valuations were high at roughly 40 times earnings.

While this was a steep multiple, the $120 million deal for Rapid looked relatively compelling at just around 2.7 times sales, while Proto Labs traded at 6.5 times sales. Pegging earnings at just over $2 per share, I felt comfortable to apply a rather steep 25-30 times earnings multiple to these earnings, or $60-$70 per share on the back of the secular growth trends.

Shares only rose further to $160 in the summer of 2018, fell to $100 ahead of Covid-19 as the moves last year were rather dramatic. Shares hit a low of $60 during the initial Covid-19 pandemic, actually hit $280 in February of this year as momentum in certain names was rather strong. Ever since, shares have seen a big pullback to $120 now, having lost more than half their value in less than two months.

The Fundamentals

Halfway through February, the company reported its 2020 results as the strong share price momentum did not rhyme with the cold hard financial numbers. Full year sales were down 5% to $434 million, as the 3D printing segment was the only business unit which reported growth in sales, although 2% annual growth was not too convincing. Net earnings fell from nearly $64 million to $51 million, as earnings per share were down nearly half a dollar to $1.89 per share. Adjusted earnings of $2.36 per share were roughly half a dollar higher, although the vast majority of the gap is explained by stock-based compensation, with realistic earnings running around $2 per share.

Needless to say, multiples were very high with shares trading at $200 and change at the time. Net cash holdings of $221 million worked down to earnings of $8 per share based on a share count of 27 million shares, but that hardly impacts the multiples at which shares are trading. At $200 per hare, the company was valued at an enterprise value of $5.2 billion, or 12 times reported sales and roughly 100 times earnings.

Just weeks ahead of the release of these results, the company announced a deal in the 3D sphere, with the company paying $280 million to acquire 3D Hubs. Since its founding in 2013 the company has facilitated the production of more than 6 million items. Fortunately, $150 million of the $280 million deal was paid for in terms of Proto's stock, $130 million in cash, although there is a $50 million contingent value right included in the deal as well.

At the time of the deal, the revenue contribution of 3D Hubs was pegged at $25 million in 2020, at 11 times sales, which was largely in line with the own valuation of Proto at the time. That said, a 200% compounded annual growth rate since 2017 has been spectacular, as the deal undoubtedly was accretive to the growth profile of all of Proto Labs after it reported a decline in annual revenues in 2020 while the 3D segment was essentially posting flattish sales.

A Final Thought

On a pro-forma basis, net cash is down to $90 million as a total share count of 28 million shares now represents an enterprise valuation of just around $3.2 billion at $120. This is down $2 billion from the $200 level in February, which was already down quite a bit from the absolute high, and furthermore this is the case after it includes a near $300 million deal as well. After this move, the sales multiple has been reduced to roughly 7 times sales.

With earnings still trending around $2 per share, and perhaps around $2.50 after accounting for some accretion from the recent deal and economic recovery, valuations remain sky-high at around 40-50 times earnings. I find myself largely reiterating my 2017 conclusion that based on earnings power of $2.50 currently (actually not that much higher from the 2017 numbers) I feel comfortable to pay a 30 times multiple. This works down to a $75 per share entry target. That is still quite a bit below the current share price, as I am reiterating my discipline here.

Analyst’s 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.

Comments

[TruffelPig]

Is it time now after the earnings blow-up?

[The Value Investor]

@TruffelPig still have to look into the numbers.

[bluescorpion0]

but what makes you think they won't blow up over and over? to me this looks like a subpar business, even if its using all the buzzwords of '3d printing' and 'digital manufacturing'. I can understand mass manufacturing or high value aerospace wanting local printing for perhaps political and inflationary reasons but I can't seem to understand why anyone would care to save money or localize a prototype.

[SPC2]

Dang, great call my friend! Currently trading in low $70's.

[Mangowlyy]

I feel like the $75 price target you gave is due to the trendline that can be drawn from the lows since the IPO -- more than any single fundamental analysis reason

[The Value Investor]

@Mangowlyy Just a desired entry point based on my estimated earnings power and the multiple which I am willing to pay for it!

[beezbo]

@The Value Investor Did you end up entering a position on $PRLB since it is now under $75?

[The Value Investor]

@beezbo Yes gradually buying the dip here.

[User 10700441]

Protolabs is a growth company. They have an innovative automated way for customers get quotes and design feedback. They are innovative in their handling of tooling and low volume to mid volume parts. They are a source for plastic and metal parts. The parts service side of many many manufacturing businesses can take advantage of protolabs innovative tools.

[bluescorpion0]

@User 10700441 what happens when customers just buy a desktop 3d printer and do it themselves?

[Dinger]

@scorpion.north -
Same argument can be made of any service: You can make your own meals, versus eating out. Repair your own car, versus taking it to a mechanic. Build your own PC, versus purchasing a PC.
The paying customer is one who appreciates convenience, product quality (which is borne of trial-and-error experience), and just-in-time supplies ordering. Fortunately, there are plenty of people who are willing to pay for such services, rather than fuss with the DIY route.

[The Value Investor]

@scorpion.north Good point. I guess mostly the larger clients would do this (first) as it all depends on efficiency of 3D solutions over time.

[Dinger]

The $200 was due to FOMO in the tech sector, and a number of companies hit (insane and unsustainable, IMO) new stock price highs. Money appears to have rotated out of the tech sector in the past half year, and thus those stock prices are at more reasonable, and perhaps sustainable, levels.
Who can really say where we go from here? Government stimulus checks and subsidized low interest rates will continue to support the market, until they don't.

[bluescorpion0]

in the conglomerate failures of old days paying with overpriced stock was a chain letter ponzi scheme type affair that destroyed massive value and eventually bankrupted many companies , or to be sold to rivals for pennies on the dollar. why would 3d hub shareholders accept protolab shares if it wasn't to sell them and knowing they could get more value than they sold? remember: the seller almost always has the upper hand , especially in a broken market where price signals have been destroyed by the government