2023-07-28 11:34:58 ET
Summary
- Materialise's second quarter results were slightly below expectations, in part reflecting a challenging demand environment.
- The company is investing in production capacity for ACTech and its Medical business. This should help drive growth and lower costs, particularly in 2024.
- Despite short-term difficulties, Materialise has a long growth runway and should be highly profitable at scale.
Materialise's ( MTLS ) second quarter results came in slightly below expectations, resulting in a substantial share price correction, although the result wasn't really surprising given the demand environment. The next few quarters are also likely to be difficult, with the manufacturing industry continuing to contract globally and Europe in particular looking weak. Despite this, Materialise's Medical business is performing well and is probably worth more than Materialise's current market capitalization.
Macro Conditions
Unsurprisingly, Materialise is facing a tougher demand environment and this appears to be weighing on growth. Materialise observed a decline in quotation requests in the second quarter, although the effect on output has been limited so far. Despite this, management has stated that the macro environment deteriorated noticeably in the second quarter.
Materialise's outsized exposure to Europe is also likely to be problematic in coming quarters. Roughly 50% of Materialise’s revenue is generated in Europe and the region appears to be entering a recession, with economic indicators contracting sharply in recent months.
Figure 1: Materialise Manufacturing Revenue (source: Created by author using data from Materialise)
Materialise has stated that it is also facing a challenging demand environment for software, which they believe is fairly widespread. Growth is generally soft for design and manufacturing software at the moment, and a range of indicators point towards a further slowdown going forward.
Figure 2: Materialise Software Revenue (source: Created by author using data from Materialise and The Federal Reserve)
Capacity Investments
Materialise is currently investing in production capacity in the US for its Medical segment. In the past, Materialise has manufactured CMF implants in Belgium, which has caused longer lead times for the US. The new facility is expected to open this summer and should reduce delivery times for personalized implants to under a week for US patients. 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.
Materialise is also doubling ACTech capacity with a second facility that is expected to open in 2024. ACTech is currently capacity constrained, with demand exceeding what Materialise is able to deliver. In response to this, Materialise is using contractors to help meet demand, but this is expensive as customers generally require short lead times and the parts are often large and complex. Materialise believes this business will have significant growth potential once the capacity expansion is completed.
Figure 3: ACTech Facility Expansion (source: Materialise)
Materialise initially acquired ACTech to expand on its metal competencies, with ACTech focused on producing limited runs of highly complex cast metal parts. The acquisition was also expected to enable Materialise to develop and improve its software suite for Metal 3D Printing through knowledge gained in a manufacturing environment.
ACTech’s largest legacy business was related to the development of new internal combustion engines for cars, but the combination of diesel gate and the pandemic decimated this business. ACTech subsequently pivoted from small cylinder blocks and turbochargers to complex casted components for electric car drivetrains and chassis. This shift has returned ACTech to pre-COVID revenues with a more favorable margin profile.
The ACTech facility now also supports the production of a wider variety of components and larger components using sand 3D printing. This has opened new opportunities for Materialise in agriculture, mining, construction and marine vehicles, producing small series of large engine parts. The complexity of these types of parts is increasing to improve the thermodynamic efficiency of engines, which necessitates the use of precision sand printing and casting small series parts. Sand printing, molds assembly, metal casting, and post-processing steps, like CNC milling, are necessary competencies to support these types of operations, and Materialise believes that offering integrated solutions provides significantly more value to customers.
ACTech has also been moving away from prototyping towards certified production. Most of this work is confidential, but one example is the manufacturing of components for Sartorius. Sartorius is a manufacturer of bioreactors for the life science industry.
Figure 4: Illustrative ACTech Produced Parts (source: Materialise)
Financial Analysis
Revenue increased by roughly 12% YoY in the second quarter, which is reasonably impressive given the current macro environment, but also represents a substantial decline from growth in the first quarter. This is largely the result of softer revenue within the Software and Manufacturing segments. Materialise reiterated full year revenue guidance of 255-260 million Euro though, which would represent roughly 10% YoY growth.
Figure 5: Materialise Revenue (source: Created by author using data from Materialise)
Software revenue increased by 3.6% in the second quarter, and now represents approximately 17% of total revenue. This understates the importance of software to Materialise’s business though, as cross segment revenue from software products represents roughly 30% of total revenue. Growth in recurring revenue from maintenance contracts and renew licenses is also being offset by a decline in revenue from non-recurring sales. Medical revenue grew around 20% YoY in the second quarter, with strong growth in both software and medical device solutions. Manufacturing revenue increased 8.5% YoY in the second quarter.
Figure 6: Materialise Segment Revenue (source: Created by author using data from Materialise)
Margins are something of a mixed bag for Materialise at the moment, with improvements in gross profit margins and Medical adjusted EBITDA offset by depressed Software margins and a one-time arbitration expense.
Investments in the Motion and Eyewear business lines are also weighing on Manufacturing margins, as is the use of contractors to cope with excess demand. Materialise has not quantified the impact of utilizing contractors, but management suggested that EBITDA margins are likely to improve by a few percentage points when the new facility is opened.
Materialise recognized a 5.2 million Euro expense related to an arbitration award in the second quarter, which contributed to lower margins. Despite this, the company reiterated its full year EBITDA guidance, suggesting either conservative guidance or better than expected progress on costs.
Figure 7: Materialise Segment EBITDA Margins (source: Created by author using data from Materialise)
Conclusion
While growth is likely to be soft in coming quarters and investments in future growth will continue to weigh on margins, Materialise's current valuation more than reflects any potential weakness. Materialise's Software and Medical businesses both have high margins and manufacturing margins should improve over time, particularly if the consumer businesses take off. Materialise also has a long growth runway, with the additive manufacturing market expected to grow at a double-digit rate for many years to come.
It is hard to see Materialise's stock moving higher until the company is consistently profitable and the macro environment improves. This is more likely to occur in 2024, with additional capacity coming online and investments in the software business potentially beginning to payoff.
Figure 8: Materialise Relative Valuation (source: Created by author using data from Seeking Alpha)
For further details see:
Materialise: Tough Demand Environment