When 3D printing company Proto Labs (PRLB -1.66%) reported earnings last week, showing a near-50% drop in per-share profits from a year ago, I admit that I was a bit confused as to why investors bid the stock up 12% on that news.
On the one hand, yes, Proto Labs beat Wall Street estimates for the quarter. Yes, its earnings were less awful than expected -- but they were still pretty awful.
Management blamed "a challenging economic environment, amplified by rising interest rates and slowing manufacturing activity" for the company's weak sales growth (up barely 1% year over year) and even weaker profits performance. Worse, management said buyers are taking longer to place orders, and are choosing cheaper services over more expensive ones when possible -- indicative of belt-tightening among Proto Labs' customers.
Analysts crunching the numbers now predict Proto Labs will grow its sales barely 1% by the end of this year ($495 million this year versus $488 million last year), and that earnings might be off 21% -- $1.19 per share.
Why, then, I wondered, would investors bid up Proto Labs stock on these numbers?
But then I wondered: Might it be that investors are looking at a different number entirely?
Proto Labs' best number
Specifically, investors might be focusing on Proto Labs' free cash flow rather than its earnings -- because, as it turns out, Proto Labs looks a whole lot healthier when you focus on its cash flow statement instead of its income statement.
Net income for the fiscal first quarter was only $2.7 million -- $0.10 per share, as calculated according to generally accepted accounting principles (GAAP). Actual cash profit at the company, however -- free cash flow -- was a more impressive $19.2 million, and free cash flow over the past 12 months approached $45 million.
Valuing Proto Labs
And how much does it cost an investor to capture a piece of these powerful cash flows? With a market capitalization just under $790 million, and a balance sheet brimming with $64 million in net cash (no surprise there, because Proto Labs' free cash flow is constantly refilling the bank account), Proto Labs carries an enterprise value of only $725 million -- or about 16 times trailing free cash flow.
That's pretty cheap.
It gets even cheaper when you consider that analysts polled by S&P Global Market Intelligence are forecasting 25% annualized profits growth over the next five years. In the nearer term, projections call for Proto Labs to generate $75 million in free cash flow by 2024. At today's share price, therefore, the company is selling for less than 10x the FCF it generated two years from now.
For a company growing at 25%, that sounds really cheap.
E-valuating Proto Labs
Is 25% growth a realistic expectation for Proto Labs? That's hard to say, but it's not un-realistic. As industrial manufacturers continue to emphasize redundancy and security of supply chains in order to avoid the disruptions experienced during the pandemic's height, on-demand printing of small batch items, which Proto Labs provides, seems a logical solution.
Additionally, hiring Proto Labs to produce prototype and small batch items via 3-D printing means the company's customers don't have to acquire expertise in 3-D printing themselves, nor risk investing in the wrong kind of 3-D printing machine. They can simply outsource these decisions to Proto Labs. That prospect should sound attractive to them.
From an investor's perspective, meanwhile, an investment in Proto Labs makes it possible to bet on "the future of 3-D printing" in general, without having to bet on one single manufacturer of 3-D printers to come out on top and outperform its rivals. An investment in Proto Labs is, in essence, agnostic as to specific 3-D printer technologies -- or specific 3-D printer-manufacturer stocks -- because Proto Labs can buy whatever is best and use it to produce the best products.
To me, that sounds like a winning strategy. And the potential to buy into a future of 25% growth at a 16x (or 10x) valuation seems like a brilliant way to bet on the future of 3-D printing.
