2023-03-08 13:34:28 ET
Summary
- SSYS's business grew in 4Q22 despite the hostile macro environment, but margins are still being squeezed by FX, logistics costs, and sub-scale profile.
- The negative free cash flow of $89 million is concerning, but the relatively healthy financial position gives peace of mind.
- I recommend remaining on the sidelines until there is more proof of accelerating operating leverage and the ensuing FCF conversion.
Investment Thesis
Adjusting for foreign exchange and the SSYS)%2C%20a,%2C%20effective%20August%2031%2C%202022." target="_blank"> divestiture of MakerBot reveals that Stratasys ( SSYS ) grew by low double digits in 4Q22, significantly outpacing the company's FY22 reported growth. Bear in mind that this expansion occurred in spite of the fact that the overall macro environment was quite hostile. However, margins are still being squeezed by FX, logistics costs, and the sub-scale profile of SSYS. Altogether, these factors resulted in a cash burn for FY22. The $89 million in negative free cash flow is concerning, especially when compared to the previous few years, but the relatively healthy financial position gives me peace of mind. SSYS's net cash is $310 million (33% of market cap). As such, it is unlikely to face any cash flow problems in the near future. On this front, I anticipate a recovery in both sales and margins, with SSYS stock on track to achieve low-single-digit EBITDA margins and positive cash flow by year's end. With regards to growth expectations, in my opinion, the FY23 growth forecast is too conservative, which I guess is fair, especially in light of the ongoing inflation and extended sales cycles resulting from customers' heightened scrutiny. However, I believe these are temporary problems that can be solved, and I anticipate that a decrease in inflation in 2H23 will remove these headwinds from SSYS. This means that until 1H23 is over, investors should brace for a high level of uncertainty, which is not healthy for the share price. It's also worth noting that the timing of SSYS's Covestro close is a catalyst that could push FY23 earnings above the high end of guidance. As a result, I would advise caution lest its earnings be less than expected if the timing is off.
SSYS's current forward EBITDA of 13x is a discount of 5x compared to its 10-year average multiple of 18x. The combination of the challenging macro environment and the currently depressed profitability metrics and cash flow, in my opinion, accounts for most of the discount. However, I am optimistic about management's cost-cutting efforts and its resolve to increase margins, especially in FY24. Over the next few years, I anticipate that SSYS will be able to expand its target audience beyond the Prototyping market, just as the TAM is expanding across production. That said, given the aforementioned uncertainty in 1H23, I recommend remaining on the sidelines until there is more proof of accelerating operating leverage and as a result, better FCF conversion.
4Q22 Results
SSYS experienced a 4.6% year-over-year decline in sales during 4Q22, due to unfavorable economic conditions, but this was somewhat mitigated by a diversification of their products. Systems revenue decreased by 11.1% year-over-year, while Consumables remained stable. Products decreased by 5.8% year-over-year, resulting in a decrease in gross margins to 55.3%, while Services decreased by 1.9% year-over-year, but gross margins improved by 297bps to 32.5%. The pro forma gross margins for the consolidated company decreased by 28bps to 48.4% due to foreign exchange headwinds, but this was partly offset by the divestiture of MakerBot. As a result, pro forma EBIT margins increased by 218bps to 3.2%. Lastly, the pro forma EPS for 4Q22 was $0.07.
Growth Outlook
Growth opportunities for service bureaus after the open material license for FDM and Origin are one of the tailwinds investors can anticipate in FY23. In addition, customers are now able to invest in multiple SSYS technologies more easily thanks to GrabCAD's unified software platform, which has led to increased sales for the company. I am also very optimistic about the exposure to the dental market with the introduction of TrueDent resin, the formation of a strategic alliance with 3Shape, and the roll-out of the J3 DentaJet printer. Another industry seeing significant growth is the healthcare industry, where a new prospective clinical study looking into the benefits of using patient-specific anatomical models for preoperative surgical training is set to begin this year.
Guidance
Revenue is projected to be in the range of $620 million to $670 million, with pro forma EPS of $0.12 to $0.24. Revenue guidance assumes positive quarterly growth, with the second half of the year contributing more than the first. As was previously mentioned, the exact time of Covestro's close determines where SSYS will fall within the range of guidance. With growth anticipated for 2H23, gross margins are projected to settle in the 48%-49% range, with a long-term goal of 50%+ margins. Pro forma EBITDA is anticipated to be in the $35 million to $50 million range, with a long-term goal of 13% to 15% of revenue. Importantly, management has guided for positive cash flow from operations to be achieved by the end of FY23.
Conclusion
In conclusion, SSYS has demonstrated impressive growth in 4Q22 despite the challenging macro environment, with low double-digit growth rates in its business. However, margins have been affected by factors such as foreign exchange and logistics costs, resulting in negative free cash flow for FY22. Despite this, SSYS's net cash position is relatively healthy, and I expect a recovery in both sales and margins, with the company on track to achieve positive CFO and low-single-digit EBITDA margins by the end of the year. However, given the current uncertainty and depressed profitability metrics and cash flow, I recommend remaining cautious and waiting for more evidence of accelerating operating leverage and FCF conversion before investing.
For further details see:
Stratasys: Wait For Evidence Of Margin Improvement And Positive FCF