3-D printing stocks have been getting pummeled in 2014. 3D Systems (NYSE:DDD), the sector's largest player by market cap, has been one of the worst performers, with its stock price cut in half since the start of the year.
Investors have likely sent 3D Systems' shares tumbling because they deemed the company's fourth-quarter 2013 earnings results and 2014 outlook subpar for such a highly valued stock. Of course, general market sentiment is also a big factor, as just about all the highly valued, high-growth (aka "momentum") stocks have experienced considerable pullbacks.
My purpose here isn't to delve into all the factors that have cost 3D Systems' stock about 50% of its value in 2014, but to highlight one factor I don't think many individual investors are aware of: operating cash flow. It's far from the only reason for 3D Systems' price fall, but I believe it is one of the reasons that professional investors have punished the stock more than many individual investors seem to believe is warranted.
The tale of two metrics
There's a huge disparity between 3D Systems' trailing-12-month (which is full-year 2013 here) operating income and its cash flow generated from operations.
Here's the same data, but on a quarterly basis, so you can see that the fourth-quarter 2013 was the primary reason for the annual disparity shown in the chart above:
Ideally, we'd like to see the reverse of what is shown in these charts. We'd like the cash flow generated from operations (which appears on a company's cash flow statement) to be greater than its reported operating income (which appears on the income statement). At the least, we'd like the two numbers to be in the same general ballpark.
This is because reported "earnings," or net income, and operating income are just accounting measures, while cash flow is the real McCoy when it comes to money. All sorts of legitimate developments can greatly affect a company's reported earnings and operating income. This isn't so with cash flow.
The reason I considered operating cash flow here instead of free cash flow is because 3D Systems, as is typical for high-growth companies, is investing a lot of cash in activities intended to fuel long-term growth. So we'd be handicapping such a company by looking at free cash flow (more specifically, by comparing FCF to net income). Operating cash flow, on the other hand, solely deals with the company's operating activities, since it doesn't include investing and financing efforts.
OK, so 3D Systems' cash generated from operations was considerably less than its reported operating income. Why does this matter?
Because investors who are solely considering net income and operating income, and ignoring cash generated from operations, are getting a rosier-than-accurate picture of how the company's core operation performed in the quarter. This is because the most commonly used valuation measures (such as price-to-earnings, or PE, ratio) and key metrics (such as operating profit margin and net profit margin) are based on a company's reported earnings and operating income.
Let's get to some specifics.
|Year||Operating Income||Cash Flow from Operations||Operating Margin||Operating Margin (using cash flow)|
|2013||$80.9 million||$25.2 million||15.8%||4.9%|
|2012||$60.6 million||$51.5 million||17.1%||14.6%|
Investors only looking at reported net income and operating income after the company's last earnings report were aware that 3D Systems' 2013 operating margin decreased somewhat from 2012. They could easily calculate or read from news reports that the operating margin went from about 17% to nearly 16%. They wouldn't, however, know that the company's operating margin based on cash flow decreased much more than that, cut into a third.
It's important to remember that the fourth quarter of 2013 dragged down the company's cash flow from operations for the entire year. Long-term investors know that one quarter is just one quarter, and cash flow will vary for numerous good reasons, so not too much emphasis should be placed on just a single three-month period. That said, this divergence between operating income and cash generated from operations should be monitored going forward, as it could be cause for concern if it persists.
More specifically, investors should hone in on the following items in 3D Systems' cash flow statement as they accounted for a good chunk of this divergence: accounts receivable and inventory.
3D Systems' CFO provided good explanations during the conference call for why the company didn't collect the cash it was owed from creditors in the fourth quarter at the same rate it previously had (accounts receivable), and for the inventory buildup beyond that in line with revenue growth (inventory). Timing of sales and a changing business model, which involves more product being sold through resellers, were reasons cited for the outsized increase in receivables. Primary reasons cited for the considerable inventory buildup included that a couple of the product lines didn't sell as well as the company had projected (such as the consumer products), and the company introduced a slew of new products between EuroMold and the Consumer Electronics Show, so it was beefing up production.
The Foolish takeaway
I want to be clear that at this stage there is no reason to believe that anything has considerably affected 3D Systems' profitability prospects. This articles is talking about one quarter, and one quarter hardly makes a trend. Additionally, there seemed to be good reasons for the cash flow situation in the fourth quarter.
That said, cash flow from operations is a metric that investors should monitor going forward.