Marina_Skoropadskaya/iStock via Getty Images
Marina_Skoropadskaya/iStock via Getty Images
One investment trend that was popular a few years ago was the 3D printing, or what is also known as additive manufacturing, space. Though enthusiasm around this opportunity has died down in recent years, there's no denying that opportunities in this market can still be appealing. And one company that has come to the forefront of this market is Proto Labs ( NYSE:PRLB ). In an industry known for an absence of profitability and the existence of low margins, Proto Labs has succeeded in achieving steady growth and attractive cash flow generation. And while recent performance has been a bit lumpy, the general trend for the enterprise is undeniably positive. From at least one perspective, shares of the business do still look rather pricey. But if we assume that recent margin pressures will recede back to levels that would allow the company to achieve performance comparable with what it saw in 2020, the company is probably more or less fairly valued or perhaps slightly undervalued.
The business model of Proto Labs is largely focused around two core offerings. But before we dig into that, it would be helpful to understand a little bit about its history. You see, Proto Labs did not originally start off as a 3D printing company. In fact, its past begins in 1999 when management set up a firm dedicated to injection molding. It was only in 2014 that the company dove into the 3D printing market with the aim of creating a comprehensive an integrated firm with operations that include injection molding, CNC machinery, 3D printing, and sheet metal fabrication.
Today, those investments have paid off. With its software, the company has focused on the creation of what it calls its Digital Thread. This is essentially the tying together, utilizing software and physical processes, of its product offerings for the sake of customers. By contacting it directly, customers are able to have their projects scoped out, quoted, and produced for whatever needs they might have. The company works with everything from small, one-product clients looking for a single prototype to large, multinational organizations like Lockheed Martin (LMT) and NASA.
Although the company specializes in rapid prototyping, reliability, and quality offerings through its Proto Labs business line, it acquired, earlier this year, a company called 3D Hubs. That offering, now under the HUBS moniker, provides a different kind of service. Through its online platform, HUBS allows clients the ability to get an instant quote for their projects. Not only that, the offerings include product creation that involves higher tolerances, more complex parts, add technologies, and other options that might not normally be possible with the original Proto Labs business line. Once a quote is approved, the company's online platform gets one of its global manufacturing partners to produce the item in question and then send it out to the customer who paid for it.
This particular business cost the company $280 million, plus it involves another $50 million in contingent consideration that may or may not be paid in the future. Though this may not sound like much, it is quite a bit when you consider the enterprise generated only $25 million in revenue in 2020. However, its exposure to 240 manufacturing partners spread across 20 countries does mean it has significant potential in the long run.
Financial performance achieved by Proto Labs has been generally positive. Between 2016 and 2019, revenue increased from $298.06 million to $458.73 million. But then, in 2020, driven by the COVID-19 pandemic, revenue dropped to $434.40 million. Fortunately for investors, that revenue decline appears to have been short-lived. Because in the first three quarters of its 2021 fiscal year, revenue increased to $364.52 million. That represents a rise of 10.7% over the $329.19 million generated the same time a year earlier. Growth was particularly strong in the third quarter, coming in at 16.6%. Surely, its acquisition was a contributor to recent expansion.
When it comes to profitability, the picture has been a bit more volatile. The company went from generating a profit of $42.71 million in 2016 to $76.59 million in 2018. But then, in both 2019 and 2020, it reported declines sequentially. Profits in 2020 hit $50.87 million. Still not bad for such a small business experiencing the pressure of a global pandemic. Operating cash flow followed a similar trajectory, rising from $77.50 million in 2016 to $122.93 million in 2018. By 2020, however, it had declined to $106.97 million. Management has not provided official estimates of EBITDA prior to 2018, but that figure has followed the operating cash flow trend remarkably well, falling from $126.58 million in 2018 to $107.93 million in 2020.
For the current fiscal year, there's no denying that the company has been hit by supply chain issues and rising costs. Profits in the first three quarters of 2021 totaled just $21.46 million. This is just over half the $41.29 million generated the same time a year earlier. Operating cash flow dropped from $82.38 million to $32.23 million. Even if we adjust for changes in working capital, it would have declined from $81.71 million to $59.02 million. Meanwhile, EBITDA dropped from $83.70 million to $67.29 million.
I have no doubt that supply chain issues and inflation will be transitory in nature. So because of that, I am assuming that financial results will eventually revert back to levels seen in 2020. More likely than not, performance will probably recover further to 2019 levels, but I would prefer to err on the side of caution. If I am correct about the 2020 levels, then the company's trading at a price to operating cash flow multiple of 15.2 and at an EV to EBITDA multiple of 14.3. The only way, to me, that shares look pricey, is if we use the price to earnings multiple. This comes in at 32.
To put this all in perspective, I then decided to compare the company to the five highest rated of its peers as defined by Seeking Alpha's Quant platform. On a price to operating cash flow basis, these companies ranged from a low of 13 to a high of 16.3. Four of the five companies were cheaper than our target. I then did the same thing using the EV to EBITDA approach, ending up with a range of 5.4 to 15.4. Three of the five companies were cheaper than our target.
Despite a little bit of pain that Proto Labs has seen as a result of the recent pandemic and subsequent supply chain issues and inflation, the general picture for the enterprise is positive. The company offers a unique suite of services for customers and it is likely that business will fare well in the long run. Although the business is expensive from a price to earnings perspective, and expensive compared to the competition on a price to operating cash flow basis, the pricing on that basis and from an EV to EBITDA approach makes it look more or less fairly valued or even slightly on the cheap side. So for long term investors looking for an interesting business, I have to imagine that Proto Labs might fit the mold.
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This article was written by
Daniel is currently the manager of Avaring Capital Advisors, LLC, a registered investment advisor that oversees one hedge fund, and he runs Crude Value Insights, a value-oriented newsletter aimed at analyzing the cash flows and assessing the value of companies in the oil and gas space. His primary focus is on finding businesses that are trading at a significant discount to their intrinsic value by employing a combination of Benjamin Graham's investment philosophy and a contrarian approach to the market and the securities therein.
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.