2023-10-27 12:46:42 ET
Summary
- Materialise reported soft Q3 results, but the stock responded positively anyway, indicating how negative sentiment had become.
- Weak demand in the Manufacturing segment is a drag, but the Software and Medical segments are still holding up.
- Macro headwinds are likely to be an ongoing issue, but Materialise's valuation is low. Both relative to peers and based on the company's ability to generate cash.
Materialise ( MTLS ) unsurprisingly reported soft third quarter results, although improved margins on the back of cost control efforts were a bright spot. The market response to this was quite positive, demonstrating how negative sentiment towards the stock had become in recent months. Given the macro environment, Materialise’s Manufacturing business is likely to remain a drag, but the Software and Medical segments should prevent results from deteriorating too much.
I previously suggested that Materialise was facing an extended period of weak demand, and the stock is down over 30% since then. From a fundamental perspective Materialise's stock price should be significantly higher, but this may not matter in the short term as investors continue to shy away from unprofitable small cap stocks.
Market
While Materialise’s growth rate continues to fall, performance has been solid given difficult market conditions. Nano Dimension's ( NNDM ) rapid growth deceleration and the large drop in revenue at Markforged ( MKFG ) are illustrative of the issues facing the additive manufacturing market at the moment.
Weak demand is mainly impacting Materialise’s Manufacturing segment, with prototyping demand taking a hit. This is a big shift from previous quarters where Materialise had suggested that ACTech was capacity constrained. Manufacturing demand will probably remain weak in coming quarters and as much of Materialise's business is based around product development activity, it could be disproportionately impacted.
Figure 1: Eurozone Manufacturing Data and Materialise's Manufacturing Revenue (source: Created by author using data from Materialise and S&P Global)
Materialise
Materialise's third quarter earnings call included interesting commentary on the state of additive manufacturing from the company's outgoing CEO which helps to contextualize the company's strategy. In brief, additive manufacturing has demonstrated benefits across a range of applications, but still needs to be scaled. Scaling is largely dependent on manufacturing companies successfully developing digital infrastructure in their business processes. Adoption of 3D printing has been stunted by the wide range of devices, software and file formats in use. Managing this complexity increases costs and diverts resources from more productive activities.
Materialise’s investment in the CO-AM digital manufacturing platform aims to address these issues by offering manufacturers an open software platform to manage, scale and standardize their production workflows. There has been some adoption of Materialise’s cloud-based software, but the company has suggested that selling cloud-based solutions has proven more difficult than expected. The current macro environment also appears to be causing customers to postpone software investments. This is understandable given the events of the past few years, but software is at the heart of Materialise's business, and this segment has been fairly stagnant for the past four years.
Within the medical segment, demand for Materialise’s personalized instruments and guides and implants has been robust. The company also believes that it will be able to continue closing contracts with medical device manufacturers. Materialise is also targeting new applications for its technology, like tumor surgery, and personalized approaches in different surgical disciplines more generally. This segment has not been immune from economic headwinds though, with reduced investment by customers weighing on software growth.
Materialise has reportedly completed its new metal printing facility in the US which will support the Medical business going forward. In the past, Materialise has manufactured CMF implants in Belgium which has caused longer lead times for implants in the US. Materialise currently produces around 280,000 personalized 3D printed tubes and implants per year, of which less than 60,000 are for the US market. It first introduced personalized CMF implants to the US in 2017.
Financial Analysis
Materialise’s revenue only increased by 3.2% YoY in the third quarter. Growth softened across all three segments, but this slowdown was most acute within the manufacturing business.
Full year revenue is still expected to be in the 255-260 million USD range, despite the deterioration in the macro environment. This implies that revenue growth in the fourth quarter will be approximately -9% YoY. This would obviously be a soft result, but some of the decline is due to a strong comparable period in 2022.
Figure 2: Materialise Revenue (source: Created by author using data from Materialise)
Software revenue was fairly flat YoY in the third quarter, with recurring revenue up 10% and non-recurring revenue down by 18%. Roughly 70% of Materialise’s software revenue is now recurring and this figure continues to increase, indicating that the business model transition is progressing well.
Manufacturing revenue declined 3.8% YoY, which was attributed to a general slowdown in prototyping. Medical software revenue increased 10% YoY and revenue from medical device solutions increased 15%.
Figure 3: Materialise Revenue by Segment (source: Created by author using data from Materialise)
Both gross and operating profit margins were higher YoY in the third quarter due to a combination of revenue mix, operating leverage and cost control. This remains a time of investment for Materialise though and R&D expense is elevated as a result. The burden of operating expenses should decline once the demand environment improves and initiatives like the expansion of ACTech capacity, the eyewear and motion businesses and the CO-AM platform begin to yield results.
Figure 4: Materialise Profit Margins (source: Created by author using data from Materialise)
Across segments, margin performance remains varied. Medical margins are generally improving as the business scales, demonstrating the attractiveness of this business. Software margins have stabilized, albeit at a depressed level. Given the business model transition, software margins are unlikely to fully recover but should improve from current levels as R&D investments begin to pay off. Manufacturing margins are declining on the back of weak end market demand and continued investments in the motion and eyewear business lines.
Figure 5: Materialise Adjusted EBITDA Margin by Segment (source: Created by author using data from Materialise)
Valuation
Most additive manufacturing stocks have taken a significant hit over the past 6-12 months and Materialise has been no exception. It trades on a lower revenue multiple than most comparable companies, despite the fact that many peers have falling revenues and large losses. Materialise's position as a provider of software and services gives it a better margin profile than most companies in the space. Its large Medical business and the recurring nature of its software revenue also better place the company to navigate a downturn.
The Medical business, expansion of ACTech, adoption of the CO-AM platform and growth of its eyewear and motion product lines should provide Materialise with significant growth over the next 5-10 years. With scale and a moderation in the pace of investment, Materialise's margins should also improve substantially. Based on a discounted cash flow analysis I estimate that Materialise is worth at least 15 USD per share.
Figure 6: Materialise Relative Valuation (source: Created by author using data from Materialise)
For further details see:
Materialise: Positive Response To Poor Results