Did 3-D Printing Investors Finally Figure Out That Margins Matter?

Raise your hand if you'd invest in a company that's growing like a weed, even if it's only growing the top line. Would you hold on even if that company had no easy path toward a long-term profit explosion?

Put your hands down, Amazon investors... you don't count.

Anyone else? Not too many people. That makes sense, doesn't it? We don't invest in nonprofits when we buy stocks. Without earnings, a company has nothing to return to shareholders, and nothing to reinvest in its business. Revenue growth is great, but margins matter. A company that makes a billion widgets, but can't turn a profit, will eventually lose out to the company that can figure out how to scale up widget-making profitably.

Investors are finally coming to understand that about 3-D printing stocks, which is why 2014 has been such a horrible year for Stratasys (NASDAQ: SSYS  ) and 3D Systems (NYSE: DDD  ) . Both stocks have slipped significantly today after the latter warned that it would not manage to grow its earnings at all in 2014, a warning made worse by the fact that 3D Systems had to downgrade its own earnings guidance for 2013. This wasn't even the first such slip -- Stratasys also warned of weaker earnings in 2014 several weeks ago, precipitating another sectorwide drop.

Revenue is nice, but margins matter. Where are they in the 3-D printing industry? Right now, they're low, and going lower:

SSYS Revenue (TTM) Chart

SSYS Revenue (TTM) data by YCharts

DDD Revenue (TTM) Chart

DDD Revenue (TTM) data by YCharts

Keep in mind that these are GAAP results and, as free cash flow has not been moving ahead of earnings per share, it's hard to argue that real profits are substantially better than the adjusted figures. Smaller 3-D printing companies tend to do worse on the bottom line. ExOne (NASDAQ: XONE  ) has yet to post an annual profit in its life as a public company, although it's getting closer. Tiny voxeljet (NYSE: VJET  ) has no profit to speak of, but its market cap is still 39 times its annual sales. Here's a quick look at how these companies are valued today, and what it might take for their valuations to look a little bit more sustainable:

Company

Market Cap

Price to Earnings

Price to Sales

3D Systems

$6.55 billion

136.9

16.9

Stratasys

$5.39 billion

N/A

14.4

ExOne

$592 million

N/A

15.5

Voxeljet

$531 million

N/A

38.9

Source: Yahoo! Finance.

Is your nose bleeding yet from these sky-high valuations? But some companies should be overpriced, because their growth rate is so monstrous that they'll soon blow us all away with huge earnings. Let's assume that the present market caps of these four companies stay the same, but revenue and earnings continue to grow. How much would it take for them to get to more sensible valuations -- which we'll define here as P/E ratios of 40, and P/S ratios of four, for a reasonable net margin of 10%?

Company

Revenue Needed

Earnings Needed

Growth Needed *

3D Systems

$1.64 billion

$164 million

257% and 272%

Stratasys

$1.35 billion

$135 million

237% and N/A

ExOne

$148 million

$15 million

252% and N/A

Voxeljet

$132-million

$8 million

874% and N/A

Author's calculations assume same market cap with P/E ratio of 40 and P/S ratio of four.
* Revenue and earnings from most recent trailing-12-month data, via Morningstar.

Only 3D Systems has managed to post positive GAAP earnings over the past several years. In 2010, its adjusted profit margin was 14%, and its GAAP profit margin was 12.2%. In 2011, its adjusted profit margin was 17.8%, and its GAAP profit margin was 15.4%, which is still a record GAAP margin for the company. In 2012, its adjusted profit margin was 19.2%, but its GAAP profit margin was just 11.1%.

For 2013, 3D Systems anticipates an adjusted profit margin of roughly 17%, which is lower than last year's, and it expects an adjusted profit margin of just 11.6% for 2014. Given the company's increasingly divergent adjusted and GAAP earnings, the final results could look significantly worse. This is the best 3-D printing company you can buy today, the only one that's been consistently profitable during the past few years, and its margins are undeniably shrinking. If scale and market leadership can't give 3D Systems the pricing power it needs to maintain its margins, is there really any hope for the other 3-D printing companies?

This may just be the tip of the iceberg for 3-D printing profitability. The industry has been highly insulated from real competition for years thanks to a bevy of patents protecting its core technologies; but that protection is about to fall apart. The earliest patents that expired were those for fused deposition modeling, and we can see the outcome of those expirations in the wide range of low-cost consumer 3-D printers available today. By the middle of next year, a number of laser sintering and stereolithography patents will have expired.

These two 3-D printing methods are much more precise and more advanced than those now churning out little plastic gewgaws in thousands of cheap desktop machines around the world. History has shown that when competition is allowed to proliferate in hardware manufacturing, profit margins are quickly pushed to the floor. All it takes is the full investment of a major industrial concern, and 3D Systems, Stratasys, and their smaller compatriots may find it nigh-impossible to maintain even the illusion of profitability afforded by adjusted earnings.

Margins matter, and the 3-D printing industry is neither growing quickly enough, nor keeping costs contained enough, to justify even its post-drop nosebleed valuations. Competition is coming, and it won't be kind to your favorite 3-D printing stocks.

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Read/Post Comments (8) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 06, 2014, at 1:04 AM, elmer wrote:

    I purchased DDD because motley fool said how great it was now I got SCREWED .

  • Report this Comment On February 06, 2014, at 2:37 AM, yahoo123 wrote:

    True.

  • Report this Comment On February 06, 2014, at 4:47 AM, Pietrocco wrote:

    Alex, congrats.

    This is one of the best free articles that I have read from TMF. And I have read many!!

    I will immediately add you to the Fools I follow.

    Lorenzo (shorted DDD at 85 and very happy now)

  • Report this Comment On February 06, 2014, at 10:44 AM, elmer wrote:

    Well Motley Fool made a fool out of me once NEVER AGAIN what a bunch of BS .

  • Report this Comment On February 06, 2014, at 8:15 PM, threepinhed wrote:

    It is a little frustrating to be getting opposing opinions on this stock from TMF. I was looking online yesterday after the big drop and TMF was calling it "a buying opportunity". I realize that we wont all agree all of the time, but it would have been nice to at least present the two opposing opinions at the same time. That way you wouldn't have just had a bunch of readers buy the stock today to be slapped upside the head as soon as the market closed.

    I didn't buy any. I have enough.

  • Report this Comment On February 07, 2014, at 4:28 AM, CSCarson123 wrote:

    Hi Alex,

    Thanks for your "against-the-grain" position. It gives us another perspective to consider. The other opinions I have been reading don't just focus on the net margin/cashflow, but talk about the expenses that are depressing these margins. The argument is that higher R&D costs during the "ramp-up" phase are depressing margins, and this is good for long-term growth and development. Thus, the margins should improve over the long-term (assuming no strong pricing pressure, which you highlight as one of the biggest risks). With improving margins, this significantly changes the table above (which assumes 10% net margins). What's your view on this line of thinking?

    Thanks,

    CSC

  • Report this Comment On February 07, 2014, at 9:12 AM, TMFBiggles wrote:

    @ CSCarson123 -

    If you believe that 3D printing is going to be a major technology in the future, you have to accept that there will be major competition among manufacturers of 3D printers as the technology becomes commonplace. Believing otherwise is to ignore over a century of evidence to the contrary in a wide range of industries.

    Except for Apple, can you name a single hardware manufacturer that has ever been able to hold the line on margins in the face of rising competition? Ignoring the impact of competition on margins is silly. If the industry is important, it will become more competitive. If it's not important, why are you investing in it?

    - Alex

  • Report this Comment On February 07, 2014, at 9:40 AM, dp23peace wrote:

    TMF is for long-term investors. I don't think we "got screwed" yesterday. I'm not mad at TMF for penning a contrarian opinion. To me, it's better than pretending everything is perfect with their picks. We should all look at both sides and decide what risk we are ok with.

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