XMTR - Xometry: Still Positive On The Long-Term

2023-04-04 18:39:03 ET

Summary

• Despite recent challenges, I believe XMTR is well-positioned to serve a massive TAM and has the potential for long-term growth and margin expansion.
• In the near term, XMTR is facing challenges due to macroeconomic headwinds that have led to a decline in revenue and a slowdown in buyer demand.
• The company will need to demonstrate a clear improvement or path to recovery to maintain strong revenue growth despite the uncertain macroeconomic climate.

Description

I originally had a buy rating on Xometry ( XMTR ) with the headline thesis that XMTR uses AI to power its on-demand manufacturing marketplace. It provides a marketplace where businesses can quickly and easily locate reliable manufacturers of unique parts and assemblies. Problems, such as increased demand, new technologies, and shifting supply chains, are plaguing the manufacturing sector. XMTR is well positioned to solve these problems by using AI to improve the way manufacturers find and connect with potential buyers and suppliers. However, I overestimated XMTR's ability to tide over the tough macro headwinds that has been impacting many other businesses as well. XMTR attributed test conversion and behavioral changes among suppliers for the revenue headwinds related to algo/pricing changes in their latest quarterly earnings report for 4Q22. I believe these changes are driven primarily by macroeconomic factors. Although the intra-1Q23 pricing commentary was more optimistic in February compared to January, I still believe that sentiment and expectations have been damaged. I anticipate investors will shift from a long bias to a sidelines stance as they wait for XMTR to demonstrate a clear improvement or path to recovery. XMTR, in particular, will need to demonstrate a strategy for maintaining strong revenue growth despite the uncertain macroeconomic climate. However, I think some investors will also appreciate the efforts made by management to boost profits. As we move into FY24, I believe the company will benefit from the management's discipline, as shown by their investment and efficiency initiatives (consensus now has positive EBITDA in FY24).

Despite my current worries, I continue to look on the bright side of things in the long run. While there are many online B2B marketplaces connecting businesses with manufacturers of industrial parts, I continue to see XMTR as a frontrunner serving a massive TAM (there are over 700,000 manufacturing businesses in the US alone). The XMTR platform makes use of real-time pricing technology to present orders from buyers to a group of industrial parts producers. In the years ahead, I anticipate this dynamic to create a space for growth and margin expansion. I stand by my buy recommendation but warn that volatility in the near term may be high.

Short-term impacts

My original post was bullish, and the thesis still stands. In this article, I detail the bearish scenario that investors might face in the near future. According to the recent earnings, XMTR's supplier engagement began to significantly rise by the end of the third quarter, spurred by a rise in the number of small and medium-sized manufacturers actively seeking contracts. As a result, selling prices were lowered, leading to a decline in overall revenue. Although this resulted in a revenue miss for 4Q, the bright side was that XMTR's gross margin was maintained and consumer demand was still robust in 3Q22. Initially, I assumed this was an isolated incident and that business would quickly recover. However, in 4Q22 XMTR experienced a slowdown in buyer demand due to the macro environment, with orders falling to 41% from 55% in the previous quarter and customers trading down. To gain market share, XMTR lowered prices; however, this strategy did not increase demand and had a negative effect on Marketplace's gross margin. As a result of these factors, management provided dismal outlooks for 1Q23 and FY23 revenues and adjusted EBITDA. Two things come to mind if I were to take a pessimistic stance as an analyst:

1. The near-term demand outlook is bleak, and there are no visible catalysts for things to improve in the coming quarter. As a result, there is no "floor" for valuation in the near term. Also, this may not be the end of the story. If the macroenvironment deteriorates, XMTR may see further impacts.
2. If things continue to deteriorate, will XMTR repeat its strategy and further erode gross margin? The fact that management arguably made a mistake the first time shows that they are not strategizing well in my view. As a result, how credible is the FY23 guidance?

I note that while all these are speculative thoughts, the point is that narratives drive share price in the near-term, especially in a weak macro environment. All of these can be summed into: elevated uncertainties, and investors clearly despise uncertainty today.

Positives

Positively, XMTR found that supplier job accepts had leveled off, AOV had begun to recover in 1Q23, and YTD orders were up 40%. I still believe that XMTR has a great long-term opportunity and is well-positioned to become the leading marketplace for on-demand manufacturing, but I am concerned about the company's ability to execute in the near future and have grossly underestimated the impact that a slowdown in global manufacturing could have. It will take several strong quarters for XMTR to justify its high valuation, in my opinion.

Summary

In conclusion, while I maintain my buy rating on XMTR in the long term, I acknowledge the challenges the company is currently facing due to macroeconomic headwinds. The recent earnings report for 4Q22 indicated a decline in revenue due to changes in supplier behavior and a slowdown in buyer demand, resulting in a negative impact on Marketplace's gross margin. The near-term demand outlook remains uncertain, and management's strategy for maintaining revenue growth and gross margin is unclear. However, I remain optimistic about XMTR's potential as a frontrunner in the on-demand manufacturing marketplace, and management's discipline and efficiency initiatives may prove beneficial in the future. In the short term, investors should be prepared for volatility, but in the long run, I believe XMTR has the opportunity for growth and margin expansion.

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