A Valuation Approach For 3D Systems

Last month, I wrote an article on 3D Systems (NYSE:DDD). There, I focused on analyzing the company organization and the product conception philosophy. In other words, I was interested in the growth potential of the company. However, in this text, I want to present a different perspective about 3D Systems. I want to present an analysis from a valuation perspective.

3D Systems has achieved profitable growth

Looking at 3D's historical operating performance:

Table1 – Gross and profit margins 2014 to 2009

We can see that the company has performed well in terms of gross margins from 2009 until 2013. Last year, the gross margin had a significant decline in line with the overall downturn in the company operations. In terms of profit margin, DDD made similar progress by significantly improving its profit margins from 2009 to 2013. In 2012, the company achieved its best profit margin for the analyzed period at 14.5%.

The margin performance is one of the things that make me like this company so much. Basically, the company has already shown the ability to achieve strong profitability even before achieving, let’s say, USD $1 billion in sales. At the same time, DDD has been able to grow very fast, capitalizing on the growth spurt of the whole industry.

Underperforming the general market

3D Systems has proved its worth by achieving profitable growth. However, the fact that the industry is still small increases the likelihood of hiccups along the way:

Graph 1 – Stratasys (SSYS) vs. 3D Systems (DDD) vs. S&P 500 (SPY) from 2013 to present 

 

After a good performance in 2013, both Stratasys (SSYS) and 3D Systems started a prolonged disinflation process. Presently, both companies are underperforming the S&P 500 (SPY) by a wide margin as you can see in graph 1. This makes me believe that the downward movement in the stock price is related to the investment community's perception of the whole industry rather than just a 3D Systems specific issue.

Valuation exercise

One interesting exercise is to compare the profits for 3D Systems under different assumptions. In the following table, I have selected 2 main drivers: sales growth and profit margin.

Table 2 – 3D Estimations for profits in 3 years given different growth rates and profit margins

(In the first row we have the margins, in the left column we have the revenue growth rate. Figures in thousands USD.)

The previous table offers estimations for the next 3 years under different scenarios. In my opinion, the scenarios are the most probable given the present information. I am selecting a 10% to 40% annual growth rate interval and a 7% to 15% profit margin range. However, outcomes outside of this set of scenarios are possible and will lead to very different results from the ones I will present shortly.

Obviously, the different outcomes inside our table 2 will lead to very different earnings multiples. Based on my experience, I selected the following possible scenarios:

Table 3 – Estimations for the earnings multiples for 3D Systems 

As an example, selecting a 10% margin and a 30% growth rate we would result in an earnings multiple around 35x. This would mean a market cap around USD $5 billion which compares with the current market cap around USD $2.4 billion. Assuming 120 million shares outstanding by then, the resulting stock price would be around USD $38.66. The next table summarizes the whole set of stock prices under the selected scenarios.

Table 4 – Estimations for stock price for 3D Systems in 3 years under the different scenarios 

Conclusion

The presented scenarios offer a broad view about the possible upside/downside relation for this investment case. The important aspect here is to understand that 3DS stock price will be extremely sensitive to variations in sales growth and profit margins.

 

(Photo credit: 3D Systems)

I believe this is investment has a high upside/downside relation, which means that the payoffs may be much higher than the capital at risk. However, there is a lot of uncertainty related to the company sector. Therefore, I believe this investment is suited for an aggressive investor that also uses well diversified portfolios. Only this way will it be possible to accommodate capital losses that may arise from this investment.