- Stratasys put out a strong Q3 2021 result which beat consensus on the top line, the bottom line, and even put out solid guidance ahead.
- The problem though, is that its business isn't growing all that fast.
- What's more, Stratasys has thin free cash flow margins, at approximately 6% for 2021.
- At 3x this year's revenues, the stock appears cheap, but I contend that it's arguably closer to fairly valued.
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Stratasys (NASDAQ:SSYS) is a 3D printing manufacturer. Even though it's well-positioned to benefit from a rapidly growing space, Stratasys is simply not growing all that fast.
In the best-case scenario, this business is likely to be growing at somewhere between 10% to 15% CAGR over the next couple of years. That being said, given that it's priced at less than 3x this year's revenues, it appears cheaply valued, at least on the surface.
However, as I highlight below, Stratasys' ability to convert its revenues into solid free cash flows leaves much to be desired.
In sum, I believe that these shares are already close to fairly valued.
Revenue Growth Rates Improve
Source: author's calculations
Coming out of the depths of last year's negative y/y revenue growth rates and any revenue stability would be very welcome by investors.
Furthermore, given that last year's Q4 2021 reported negative 11% y/y revenue growth rates, Stratasys guide for this year's Q4 to grow by 16% y/y is obviously very welcome news for investors.
That being said, given all the recent shifts in the digitalization of parts manufacturing, investors would probably need to see more than mid-teen growth rates against a very easy comp with last year to truly get behind this company's growth narrative.
On the other hand, Stratasys recently bagged an attractive contract with the US Navy, which will aid the company's ability to reignite its revenue growth prospects into 2022.
Stratasys specializes in polymer-based additive manufacturing, also known as 3D printing solutions.
Stratasys has a specific focus on 3D printing platforms. Note, two-thirds of its revenues is derived from Products revenues and one-third comes from its low-margin Services segment.
Indeed, the big advantage of relying on 3D printing is that parts can be lighter, yet just as strong, less expensive, and personalized for the end-user.
For their part, Stratasys highlights that it expects that by 2025 nearly 50% of all discrete manufacturing will use 3D printing, up from just 10% at the end of 2019.
This all appears to reinforce what many know already, that 3D printing is rapidly gaining momentum. My only question is whether Stratasys is the best company to back in this space?
Profitability Profile is Middle of the Road
Over its past four quarters, Stratasys made approximately $55 million of cash flows from operations. While we are not given its Q4 2021 cash flow guidance, we could probably assume that for the year as a whole its cash flows from operations will reach approximately $60 million.
For this figure, I've made a 20% growth assumption from last year's Q4 2020 cash flows. Meanwhile, we are guided that its capex this year to arrive at the midpoint of around $25 million.
Hence, we are looking at around $35 million of free cash flow for 2021. Given that revenues are expected to be $605 million, this implies that its free cash flow margins will be approximately 6%.
SSYS Valuation -- Reasonably Valued
Investors are asked to pay 3x this year's revenues. For a business with heavy exposure to the 3D sector, this is a fair valuation. As you know, the 3D sector is notoriously competitive and plagued with razor-thin free cash flow margins.
Moreover, in the case of Stratasys, the investment thesis is further complicated because the business simply isn't growing all that fast. Even though during its recent earnings call management clearly has an attractive vision for the company, yet ambitions aside, we are looking at a business that's growing at approximately double digits on a sustainable basis.
What's more, as already discussed above, this is a business that's fairly capital intensive, so that its free cash flow margins are around the mid-single digits.
For context, its peer Proto Labs (PRLB) is also similarly valued at approximately 3x this year's revenues, once again reinforcing the overall valuation that investors are typically willing to pay for this space generally.
The Bottom Line
There's no question that Stratasys is in a dramatically better position this year than it was last year. And there's also no question that management has a clear vision of what's needed to ignite its growth prospects over its near term.
There's also clearly a rapidly growing sector, 3D manufacturing, for Stratasys to take market share in.
The only question that investors have to answer is whether there's enough margin of safety by paying 3x this year's revenues, or whether the stock is already fairly valued.
And I'm inclined to believe that this stock is already close to fairly valued rather than undervalued.
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This article was written by
Michael Wiggins De Oliveira is an energy specialist whose primary focus is capitalizing on “the Great Energy Transition” - the confluence of decarbonization, digitalization with AI, and deglobalization - to achieve greater investment returns. Through his 9+ years analyzing countless companies, Michael has accumulated outstanding professional experience in the energy sector and a following of over 40K on Seeking Alpha.Michael is the leader of the investing group Deep Value Returns. Features of the group include: Insights through his concentrated portfolio of value stocks, timely updates on stock picks, a weekly webinar for live advice, and "hand-holding" as-needed for new and experienced investors alike. Deep Value Returns also has an active, vibrant, and kind community easily accessible via chat. Learn more.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.
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