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3D Printing Stock to BUY and HOLD for the next 5 years

In my previous write up, I looked at how 3D Printing is set to revolutionize manufacturing, particularly in developed countries. Since my post, we have seen very wild price action in the stocks of the most popular 3D printing stocks. Over the last six months, ‘3D Printing’ (DDD) is up 244% YTD, ‘Desktop Metal’ (DM) is down 33%, ‘ExOne’ (XONE) is up 114% and ‘Stratasys’ (SSYS) is up 13%.

In this article, I want to tune out the noise and take a closer look at these 3D Printing companies. In doing so, I pick out the 3D printing stock which I think will benefit most from this secular growth trend.

Recap on 3D Printing

Firstly, a quick recap on why I am bullish this sector. For the full overview, see my previous article.

Additive Manufacturing (AM), also known as 3D Printing, refers to the process of building products layer by layer, using specialized printing machines. These machines are integrated with computer models which ultimately allow the user to turn digital images into physical objects.

This is in contrast to traditional manufacturing methods where objects are either formed by; (1) Subtraction, whereby you take a block of material and subtract the bits that you need, or
(2) Forming, where molds are injected with material to produce a specific object.

The Benefits of 3D Printing

There are a few key benefits associated with AM. These include:

Personalization – Unlike with traditional manufacturing, AM lets you create niche and specialized products at any scale. Even the smallest of changes to design can be programmed directly into the production process and this doesn’t require new parts. This is particularly advantageous in industries where parts need to be tailor made (e.g. medical devices)

Speedy Prototyping – In a similar vein, 3D printing allows new products to be created effortlessly without waiting on parts to be made prior to production. This makes it quicker to prototype and to test designs which is vital during the early stages of production

Complex engineering – 3D Printing can create more sophisticated designs than traditional manufacturing methods (which generally tend to be block shapes). Some of these designs include complex lattice structures (like the one below used in an automobile gear box). Such shapes ultimately allow for lighter (and more cost efficient) structures to be created

3D Printed lattice structure used for Automobile Gears

Supply chain optimization – Traditional manufacturing is either very labor intensive or very land/material intensive (and sometimes both). This has made it more prevalent in developing countries which are generally more cost competitive on both fronts. Whilst this can be a good thing (especially for consumers that benefit from cheaper prices), it does pose supply chain issues, which we all felt during the COVID pandemic as cross border flows were negatively impacted. Ultimately, the mobility of 3D printing means that supply chains can be shored up in developed countries, especially for time critical supplies (such as medical and industrial equipment).

3D Printing is set to grow exponentially

Although the technology has been around for over 30 years, 3D Printing is still in it’s very early stages of growth.

The Global 3D Printing industry is only worth around $13bn currently (measured by printing machinery and service revenues) but it is expected to grow at a 60% CAGR for the next five years (and at 25% CAGR for the next 10 years). (Even the lowest growth estimate I found online was assuming 20% CAGR for the next 10 years). This ultimately means that the industry is going to grow from being worth $12bn today, to over $125bn by end 2025.

Additive Manufacturing 2.0

The reason this industry is set to grow so fast is because it is going through a disruptive phase right now. Whereas initially 3D printing was used exclusively for prototyping (complementing traditional manufacturing), it is only now starting to compete with mass production. This is what is referred to as ‘Additive Manufacturing 2.0’.

This competition with traditional manufacturing is being fought on three fronts:

Mass production technologies
Expansion in materials inputs
Production of end-user parts

Resultingly, the most successful 3D printing company will be one which has the best technology to mass produce parts, has the widest selection of materials and that can be used directly in the creation of end-user parts.

3D Printing has low penetration with end-use parts

Market Players

There are many companies operating in the 3D printing space. However, the biggest pure-play 3D printing companies that are publicly traded are: 3D systems (DDD), Desktop Metal (DM), ExOne (XONE) and Stratasys (SSYS).

Whilst these companies have a lot of similarities, this is how I would characterize them versus one another.

3D Systems: The Dominant Player

3D systems is the largest company (by market cap) and is the self-proclaimed leader in the 3D Printing space. They have been around the longest (around 35 years) and are generally considered a legacy producer with a metals, polymers and plastics 3D printing businesses. In recent years, they have tried to build out their regenerative medicines business and have signed numerous partnerships to do so in this space. They have 100+ materials under patent.

ExOne: Legacy Binder Jetting Printing

ExOne is the market leader in legacy Binder Jetting 3D printing technology (which uses a binder to effectively glue together the different layers of material used to create parts). They have been in the industry for 20 years. They have 230+ materials and have the largest market share of Binder Jetting based 3D printers, globally.

DM: New kid on the block

DM is the disruptor in the industry. Whilst initially a metals focused 3D printing business, they have developed their polymer business through acquisitions this year (Envision Tech and Adaptive 3D). They also boast the fastest Binder Jetting technology in the market, which they refer to as ‘Single Pass Jetting’. This is about 7x as fast as the legacy system (used by ExOne). They have 225+ materials and very strong VC backing (Ark Invest, Social Capital, Ford, Google Ventures).

Stratasys: Legacy polymer 3D printing

Stratasys is focused on polymers (mostly plastics) printing (and not metals printing). As a result, they use slower (legacy) technologies for their 3D printing machines (FDM technology) and have a more limited customer base. They have been around for 30 years.

Financials Comparison (COB July 5th)

Revenue Growth

Firstly, all four companies are expected to grow revenues considerably this year. That being said, the Revenue CAGR for the largest players has actually been negative (over 3-5 years). This tells me that they are conceding market share to new entrants (and likely at a considerable rate given how quickly the industry is growing).

Cash Rich

Second, all four of these businesses have a lot of cash. The cash on balance sheet covers free cash flow for these companies for at least the next 4 years. This means that despite having negative Free Cash Flows (due to high capex spend and lower revenues), these businesses can likely maintain operations without dilutive equity fund raising rounds.

EV < Market Cap

Finally, I see a lot of people look at Price to Sales (or Price to Earning) multiples for stocks. With businesses like these which have a lot of cash on the balance sheet, this is the wrong approach. Enterprise value (which accounts for market plus debt minus cash), gives a more accurate picture of how these companies are valued. Intuitively, the enterprise value is what you’d pay for a company if you tried to buy it entirely (i.e. you own the equity and the debt). On this basis, all four companies trade still trade at a sizeable premium to forward expected revenues (but this is no way near as overvalued as typical P/E multiples would imply).

My Stock Pick: Desktop Metal (DM)

DM appears to fit my requirements the best. Financially, they are experiencing the fastest revenue growth and although they trade at the highest multiple of sales (EV/Sales), their growth is coming at the expense of the legacy entrants (that likely cannot compete with DM’s proprietary technology, such as the Single Pass Jetting System).

DM also has the strongest balance sheet. This is a reflection of the strong VC backing DM has (which has allowed it to achieve a sizeable valuation very early on). This protects the business from likely continued negative Free Cash Flows as it invests in its business during this growth phase. At this rate, DM has at least 7 years of cash to fund it’s Free Cash Flows.

Investment Risk/Reward

Assuming DM can achieve revenues in line with market consensus estimates for the next two years, continue to grow in line with broader industry growth (circa 60%), and achieve optimized margins of 20-30% (its competitors are already achieving 40% Gross Margins), I do think DM has the potential to achieve 90% return in the next five years (assuming a relatively low 20-25x earnings multiple).

It is worth highlighting that a lot of these assumptions are ‘de-risked’ as due to its order back-log, DM can already have a high level of confidence in its Forward Revenue Guidance (which is to clear $100m this year and achieve $1bn in revenues by 2025). In fact, the company has already sold out its printing machines until the 1H of 2024 (making me more confident that these revenue figures will be achieved). In the bear case scenario where growth rates and margins lag , I see 29% downside from the current share price.

Conclusion

3D Printing is still in its very early stages of growth. However, DM offers an opportunity to invest in the future and to achieve outsized returns versus it’s competition. Given that there is still a lot of growth to be felt, the price action is likely to be extremely volatile until we see continued revenue growth (likely Q4 of this year when DM’s new printers begin shipping). That being said, for the long term investor, I think DM offers an unrivalled investment opportunity.

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Ticker: DM

Stock Price (when post published): $10.87

Verdict: Moderately Bullish

Timeframe: +5 Years

Driving the bull case for Auto-Insurance

The US auto insurance market is nearly the same size as US car sales market ($309bn vs $545bn)[1]. In fact, auto insurance is the second largest auto related market in the US; 14x bigger than the Car Rental Market ($22bn), 17x bigger than Car Auto parts market ($18bn) and 5x bigger than Car repairs market ($66bn). Yet despite this huge size, the market is expected to continue to grow at a not-so-shabby rate of 3%pa over the next decade[2].

Is car ownership at risk?

On the contrary to what has been expected over the last decade, car ownership in the US is continuing to increase. 93% of households last year said they had access to at least one vehicle in the US and that number has been trending higher over the last decade[3]. Surprisingly, a large percentage of this growth has come in cities where ride sharing services such as Lyft and Uber operate, which studies put down to increasing ownership by drivers (more than offsetting decreasing ownership by riders)[4].

Whilst on paper, car ownership could see some headwinds as younger consumers delay buying a car in favor of public transport to work/ride sharing, for now this is being offset by cheaper financing costs for lease vehicles and the very large percentage of the US population which cannot functionally survive without a car[5]. For instance, millennials still account for 12% of all vehicles sold on the road today.

COVID-19[6]

We are seeing the trend away from car ownership being slowed down significantly by COVID19. The percentage of US consumers who think car ownership is necessary has shot up 14% in the last year (with 60% of those preferring to buy from a dealership).

This is despite ridesharing available to more than 20% of the US population (up from 7% in 2015)[7]. In 2020, ridesharing has experienced a massive hit to demand, with 65-70% of users between the ages of 18-24 having stopped their usage of these services due to COVID-19. Resultingly, Uber has had to lay-off 25% of its workforce (Lyft laid off circa 20%)[8].

Public transportation has experienced similar headwinds although it started from a much lower base. US public transportation has historically had very low rates of adoption (outside of a few major cities) with 45% of millennials (and 38% of general public) having reported to have never used public transportation.

US Public Transportation has a very low rate of adoption

But in the cities where public transportation started at higher levels of adoption (as a percentage of total transport) such as in New York, Jersey City and Philadelphia, we are seeing usage down significantly. In fact, across the US (according to Apple Mobility Data), public transportation remains the hardest hit mode of transport due to COVID-19 and is down 61% on average (compared to driving being down only 20%).

The outlook

What this shows is that car ownership is not experiencing a decline and if anything, the stickiness of consumer decisions to move away from public transport and ride sharing, should continue to provide a steady rate of growth for the auto insurance market over the coming years.

Case for disruption in the market

The insurance market has not changed much over the last 50 years. Put simply, the business operates on the law of large numbers – insurers collect smalls bit of data (like age and driving history), set you a premium and then hope for the majority, that they don’t get into an accident (and on the whole they do ok with 64% of premiums collected being handed out in claims)[1].

That being said, there are underlying problems in this market:

Inefficient pricing

The current auto insurance market experiences an inherent (economic) inefficiency arising from a lack of data distinguishing between good drivers and bad drivers. 35% of drivers put in more than more than half of total passenger miles and cause more than half of insurance losses[2]. However, a lack of data about which drivers are causing these losses means that premiums increase for all drivers, to offset these losses (and are not targeted at just the bad drivers). This effectively leads to 65% of drivers overpaying for auto insurance in order to subsidize the bad drivers.

Incentive Problem

There is an inherent incentive problem when trying to deal with pricing in the auto insurance market.

Firstly, the existing insurance market relies on a linear relationship between miles driven and insurance losses i.e., the less passengers drive, the less losses an insurance company is likely to experience as a result. In a market which has long been predicted (see above) to experience declining passenger car mile usage due to more public transportation and ride sharing, it becomes harder for companies to overcome the internal headaches/investments to change their pricing models.

Secondly, given that no US carrier currently has more than 20% market share, there is a reluctance on behalf of the larger carriers in particular, to fundamentally disrupt their business (via telematics-based pricing) at the detriment of conceding market share. This is a classic innovators dilemma as the larger companies have focused on sustaining technology/small scale disruptions to meet their customer needs today, instead of overhauling their business with large scale disruptive technologies for users in the future.

Both of these are evidenced by the relatively low penetration of finance technology and advanced data analytics in the US auto insurance today[3].

No carrier has more than 20% market share in US Auto-Insurance

The future of the market: Data Analytics

According to a comprehensive auto insurance study by Mckinsey, the auto insurance market in 2030 will belong to the insurers who have the best pricing capabilities[1]. In order to achieve this, insurance companies will need to adopt advanced data analytics and data collection methods (so things like: monitoring real time driving habits, integrating this with information about consumer behavior and then delineating risk to price policies). In fact, by 2030, they expect that over 90% of policies will be automatically priced and for the top tier of companies that can get this right, this will result in operational savings of over 30%.

From a compiled risk of disrupters in the insurance space, we can see this is getting some traction. Approximately 20% of new insurance technology companies are focusing on data analytics and Machine Learning models to improve pricing capabilities in the insurance market.

20% of Insure-Techs focused on Data/Machine Learning

Compiling a list of the major insurance technology disrupters, filtered by those with a market cap of minimum $1bn, there are only three companies dedicated to taking on this challenge in the auto insurance market; Lemonade, Root and Metromile. They are all currently publicly traded (Metromile is in the process of being taken public by SPAC).

How do they rank on key Metrics?

At surface level, Lemonade, Root and Metromile are similar. They all focus on data analytics, are rolling out across the US and intend to or have already expanded to insurance verticals (such as Renters and Pet Insurance). The things I like about each are that: Metromile boasts a pay per mile insurance policy, Root uses your smartphone (instead of a dongle) to track driving behaviors and Lemonade has a fully automated claims processing function (which I have personally used before).

At closer look however, Metromile comes out ahead of the competition on the metrics that will be most important. That is, Metromile is better than Lemonade or Root at (1) pricing insurance risk (i.e. lower Loss ratio), (2) retaining customers on its platform (especially important for insurance cross selling which decreases Loss Ratios by close to 15%!) and (3) has significantly higher life time value per customer in relation to the cost of acquiring these customers.

For me the most striking thing about this is that Metromile is the newest of the three businesses (originated in 2019), with the smallest customer base and in a sector where there are natural economies of scale (the more customers you have, the more data you collect, the better your pricing models).

Conclusion

The auto insurance market is a stable market and ironically, this is what will drive investor returns. The relatively sluggish pace of growth in the overall market (of 3%) has left room for tech disrupters to take a slice of the pie, which will likely come at the expense of the bigger and more inefficient providers of auto insurance. Whilst I don’t expect the industry to outperform some of the more exciting sectors that I have covered in other blog posts, I do expect the market share of tech rivals such as Lemonade, Root and Metromile to expand as they beat out these larger rivals. For now, Metromile is my pick.