In this article, a valuation of Stratasys (SSYS) is conducted based on the statements of the top management team. In the last two conference calls, profitable growth was set as a goal; first actions such as cost-cutting are already being carried out to achieve this goal. 

Further methods are being applied to gain additional perspectives on future revenue growth. One is based on ARIMA, which is consequently exclusively mathematical, and another approach is based on the market assessment of 3D printing derived by Wohlers Associate.

Thus, you, the reader, can choose which model is most appropriate, given your assumptions.

Business Model & Management Assumptions

In 2019, SSYS generated approximately two-thirds of its revenues from sales of 3D printers, precisely, FDM, PolyJet, and stereolithography 3D printers. Related services create the remaining third.

Full-year sales of SSYS peaked in 2014 at $750bn. Five years later, in 2019, sales were only $635bn. This is a 15% decline and contrasts the development of the overall 3D printing market. To reverse this trend, Yoaf Zeif was appointed as the new CEO as of February 18, 2020.

During the conference call of the first quarter of 2020, Yoaf Zeif gave the following statement:

"As part of my first 100 days as CEO, I have been directing a deep-dive diagnostic and strategic review of the company. Later in the year, I plan to share a more extensive view of how Stratasys will look as we lead our industry forward with strong and sustainable growth for many years to come."

In the latest conference call, the management team got more specific regarding their approach to achieve profitable long-term growth. By reducing the workforce by 10%, the firm intends to decrease operating expenses and thus achieve a positive operating margin.

According to the analysis derived by SSYS, the overall 3d printing market is expected to continue to grow. Dominated is this growth by Polymers, which represents an area of expertise of SSYS. SSYS has the potential to be a market leader in this industry segment and will set the focus on achieving that position. It is intended to secure long-term growth. The earnings call slides provide further insight into the approximate size of this growth.

The polymer segment of the 3d printing market was $5bn in 2019, split between prototyping and manufacturing. SSYS expects this market to grow to $10.5bn by 2025, which represents a respective CAGR of 16% going forward. Consequently, this growth rate will be the foundation for calculating the upcoming revenues of SSYS.

Figure 1: Total Addressable 3D-Printing Polymer market 2019 to 2025

Source: Earnings Call Slides Stratasys 2020 Q2

2020 Q2 Earnings

SSYS announced its second-quarter earnings of 2020 on August 5 before the market open. They achieved $118bn of revenue given an expectation of $122bn; this represents a YoY decline of 27,9%. EPS amounted -$0,51 per share and, therefore, also missed estimates by three cents. Nevertheless, the company is very liquid and, hence, well prepared for future uncertainty. Their cash position proves this; cash on hand of SSYS is $313M. It represents 42% of the current market capitalization of $753M (August 21, 2020). Since the last earnings, which were not influenced by COVID, Q4 of 2019, cash on hand has decreased by $9M. Given the cash-cushion and the current uncertainty, this decrease of approximately 3% in cash on hand can be neglected.

In order to generate both positive cash flows and EPS in the future, cost-cutting is applied. A staff reduction of 10% and a four day work week is currently being implemented. Besides, the management team emphasized that the measures mentioned above should not restrict the targeted growth.

When looking at the Price to Book ratio of 0.73, SSYS appears to be extraordinarily cheap. However, SSYS has goodwill of $386M, because there is nothing connected to goodwill which could provide value, it has no intrinsic value, and therefore it is not possible to sell it. When subtracting total liabilities and goodwill from total assets, we are left with a book value of $732M. This is what I define to be the adjusted book value of a firm. When Dividing the market value by the book value of all assets, adjusted by goodwill, the Price to book ratio is still 1.12. Maybe due to this cheap pricing, the stock price barely moved after earnings, even if expectations were undercut.

Assumptions for the DCF analysis

Management expects its respective market to grow by 16% annually. By assuming a stable market share, future revenues can be calculated. To include a more optimistic perspective, I picked the estimation of Wohlers Associates of the 3d-printing market development until 2024. The respective CAGR is 26%. My third approach for estimating is solely based on math. Firstly, I collected revenues beginning in 2005. To be able to find the most appropriate ARIMA model, I used the autoarima function in R. Consequently, resulting in ARIMA (0,1,1)(0,1,1) being the most fitting model. Due to the negative trend of revenues since 2014, the forecasts continue to draw this negative trend.   

Figure 2: Forecasts from ARIMA (0,1,1) (0,1,1)

Source: created by author with R

Figure 3: Estimated yearly revenues of SSYS

Source: created by author

The other critical assumption is the target operating margin. I did three separate valuations for the margin being 5%, 10%, and 15% by 2024.

Putting management's statements into a DCF analysis

While I start my stock analysis most often by contemplating pricing strategies (multiples), I apply a discounted cash flow analysis to look at the stock from a second perspective. If both methods indicate an undervaluation, I add the stock to my portfolio. I find the management's estimates to be the most precise and likely. Therefore, I chose a high-growth period of five years and used the revenues derived by utilizing the CAGR of 16%. 

Figure 4: DCF analysis - High-growth phase

Source: created by author

I adjusted the cost of debt gradually to the industry average and the effective tax rate to the marginal tax rate.

Because there are different methods to determine beta and the market premium, I will explain how I came up with a cost of equity of 8.71% during the high-growth period of SSYS.

rf = 0.63%       10 year treasury bill rate (as of 08/24/2020)

rm = 5.68%     implied market premium (I used buybacks + dividends as cashflows)

β = 1.6            transformed unlevered peer-group beta by PRLB's market value of equity and debt

Figure 5: DCF analysis - Terminal value

Source: created by author

After that, I calculated the terminal value. I set the risk-free rate as growth rate. The debt to equity ratio is equal to the industry average. Over time SSYS' ratios will approach the industry averages. Hence, I used the beta and cost of debt of the peer group.

Figure 6: DCF analysis – Calculation of value per share

Source: created by author

Lastly, I discounted the terminal value and added it to the present value of the FCFF in the high growth phase. By subtracting the market value of outstanding debt, which are mostly operating leases, I get the fair market value of equity. Divided by outstanding shares, the value of equity is $13.72 per share. That implies the stock is overvalued by 8.48%.

I repeated the described DCF-analysis for all three approaches and the three abovementioned operating margins for each approach.

Figure 7: Comparison of different approaches

Source: created by author

Conclusion

By putting management words and estimations into a DCF analysis, the stock appears to be slightly overvalued. However, the main question is how high margins will be going forward. From 2011 to 2012, operating margins were hovering around 15%, if SSYS manages to strengthen margins to the same level, the stock is strongly undervalued. Generally, I don't particularly appreciate investing in companies with negative operating margins and declining sales. It is due to the necessity of a turnaround to make SSYS a successful investment. With the predicted growth of the 3D printing market and the change of CEO, I believe such a turnaround might be possible. Especially the present cash position of $314M allows the company to focus on the long-term. Simultaneously, it turns SSYS into a value play with limited downside risk. Therefore I will steadily buy SSYS.