This Manufacturer's Earnings Reflect a Possible Looming Recession

Proto Labs (PRLB -0.33%) stock plunged 10.4% on Thursday after the quick-turn contract manufacturer released weak third-quarter results before the market opened. Shares are down 14.8% in 2019 through Friday, Oct. 25, versus the S&P 500's 22.5% return.

We can attribute the market's reaction to the Minneapolis area-based company's revenue falling short of Wall Street's consensus estimate, along with fourth-quarter guidance for both the top and bottom lines coming in lighter than analysts had expected. Management continues to characterize the global macroeconomic environment as "weak." (Whether the U.S. slips into a recession remains to be seen, but here are three stocks that should be recession-resistant.)

Here's how the quarter worked out for Proto Labs and its investors.

Image source: Proto Labs.

Proto Labs results: The key numbers

Data source: Proto Labs. YOY = year over year. GAAP = generally accepted accounting principles. EPS = earnings per share.

GAAP gross margin came in at 50.8%, down from 52% in the second quarter. Adjusted gross margin was 51.5%, down sequentially from 52.6%.

Wall Street was looking for adjusted EPS of $0.74 on revenue of $119.4 million. So, the company slightly beat the earnings estimate, but fell short on the top line.

Proto Labs had guided for adjusted EPS between $0.69 and $0.77 on revenue of $116 million to $122 million. So, its earnings came in near the high end of its expectation range, and its revenue landed closer to the low end of its outlook range.

Results on both the top and bottom lines deteriorated sequentially, as in the second quarter, sales rose 5.7% year over year -- or 7% in constant currency -- and adjusted EPS slipped 3%.

On the earnings call, CEO Vicki Holt said that revenue growth in the company's legacy services was about 4% in constant currency, while revenue in the Rapid Manufacturing business declined 14.3%. (Proto Labs acquired New Hampshire-based Rapid, which has computer numerical control [CNC] machining and sheet metal operations, in late 2017.)

Revenue results by service provided

Data source: Proto Labs.

By geographic region, revenue grew 2.4% year over year to $92.9 million in the U.S., declined 2.6% (up 2.1% in constant currency) to $20.7 million in Europe, and rose 12% (7% in constant currency) to $3.8 million in Japan

What management had to say

Here's what CEO Holt had to say in the earnings release about the anemic quarter:

Our business grew year over year in the third quarter in an industrial environment that has continued to soften throughout 2019. Despite a weaker macro climate, our customer retention rate remains high as we continue to delight our customers by expanding and improving our industry-leading digital manufacturing offer.

Q4 guidance

On the earnings call, CFO John Way outlined the company's weak fourth-quarter outlook:

• Revenue in the range of $109 million to $115 million, representing a decline of 3.4% to an increase of 2% year over year.
• Adjusted EPS of $0.59 to $0.67, representing a decline of 20% to a decline of 9%.

Going into earnings, Wall Street had been modeling for adjusted EPS of $0.70 on revenue of $117.9 million in the fourth quarter. So the company's guidance on both the top and bottom lines fell short of expectations.

A looming recession?

The U.S. and global industrial sectors are fragile, according to many monthly indexes and other data, including earnings reports from industrial giants. And the majority of business economists -- 74% -- believe that a recession is coming by 2021.

So, while Proto Labs is a well-run company whose stock should perform well over the long term, most investors may want to favor more recession-resistant stocks now.