3D Systems Corp. (NYSE: DDD) has been battered and beaten down for long enough that most investors wish they would have never been told about the 3D printing revolution. Maybe not all the negativity lasts forever. A so-called double upgrade was seen on Thursday, and the shares were surging by nearly 10% higher.
Merrill Lynch raised its rating on 3D Systems to Buy, and the double upgrade notation is that this hike was not from Neutral but all the way up from Underperform. Another boost here is that Merrill Lynch raised its price objective to $26 from $11 in the call.
After shares closed at $16.60 on Wednesday, the consensus analyst price target was $12.27 coming into this call. More importantly, the highest analyst price target had fallen to $17 due to endless disappointments from 3D Systems and in 3D printing in general. So, Merrill Lynch has gone from being one of the most negative ratings on 3D Systems to being the most positive of all analyst calls out there.
Wamsi Mohan, the Merrill Lynch analyst behind the call, sees the company’s new chief executive as having the experience to drive this turnaround through new strategy, alignment of cost structure and through portfolio optimization. He sees 3D Systems margins having plenty of room for expansion following significant declines after the 2013 boom year.
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Merrill Lynch itself calls this a double upgrade: “We double upgrade to Buy, raise our price objective 136% from $11 to $26 on higher cost cuts even in the face of weak demand.”
Mohan stated the investment rationale as follows:
Our Buy rating on 3D Systems is predicated on the strong likelihood that the new CEO will turn around the business through a new direction and strategy based on his experience as an executive of HP’s established printing business. The alignment of cost structure with revenue growth, implementation of strategic acquisitions, and portfolio optimization can drive earnings expansion, even while end market demand remains subdued.
Mohan also talked up the ability for 3D Systems to expand margins in more detail. He sees plenty of room for margin expansion after its gross margins and operating margins have compressed significantly since 2013 during the boom. In fact, gross margins peaked at 52.7% in the third quarter of 2013 and dropped to as low as 46.9% in the third quarter of 2015. This was largely from issues such as inventory write-downs, followed by headwinds from consumer and mix shift in products. Mohan said of operating margins:
Operating margins saw even more marked declines, peaking at 28.4% in the third quarter of 2013 and falling as low as 1.3% in third quarter of 2015 given the overinvestment in a period of revenue headwinds. We expect new CEO Joshi’s experience to meaningfully drive operational efficiencies, refocus investments and drive portfolio optimization.
Merrill Lynch showed that the past several years of its negative stance was based on a poor M&A strategy, its choice of assets that did not have complete exposure to 3D printing, boosting investments in low margin areas like consumer markets (which it is now partly exiting), an aggressive investment and channel strategy that led to a bloated cost structure, and revenue headwinds.
Mohan even sees a path to potential earnings upside, even considering weak secular demand for 3D printers. Three additional areas were highlighted for an ability for 3D Systems to finally outperform the market again:
(1) a new direction and strategy by new CEO Vyomesh Joshi (ex-HP executive who led HP’s printing business),
(2) aligning of the cost structure with revenue growth to deliver improving profitability,
(3) portfolio optimization to align the company for growth.
3D Systems has a consensus analyst price target of $12.27 and a 52-week range of $6.00 to $32.88. Its shares were up 16.5% to $19.35 early Thursday morning.
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