3-D printing has existed for 25 years as an industrial-strength method of creating prototypes, but only recently has it become all the rage as the “New New Thing” of manufacturing.  At a February 7^th forum on manufacturing hosted by The Atlantic Magazine, General Electric CEO Jeffrey Immelt called 3-D printing “the holy grail” for manufacturing:

3-D printing helps you make the product from the core up so you have less waste.  The tool is cheaper, the time is faster. If all I thought 3-D printing could do was shoes, I wouldn’t be talking about it.

Less than a week later, President Obama stressed the importance of 3-D printing to U.S. economic competitiveness in his State of the Union Address:

Our first priority is making America a magnet for new jobs and manufacturing. There are things we can do, right now, to accelerate this trend.  Last year, we created our first manufacturing innovation institute in Youngstown, Ohio.  A once-shuttered warehouse is now a state-of-the art lab where new workers are mastering the 3D printing that has the potential to revolutionize the way we make almost everything. There’s no reason this can’t happen in other towns.  

According to a September 2012 article in The Economist, over the next decade 3-D printing could be as disruptive a technology for manufacturing as PCs were to mainframe computing in the 1990s. David Bourell – a University of Texas professor of mechanical engineering – predicts that 3-D printing could become the next trillion-dollar industry. According to Wohlers Associates, the current market for 3-D printing is a little more than $2 billion per year, so a trillion-dollar market would be 500 times as large. Don’t expect those huge revenue numbers anytime soon, however; it will take a few decades to get there. On a shorter-term basis, as manufacturing costs continue to fall, Wohlers forecasts a mass-adoption of 3-D printing resulting in the market expanding to $3.7 billion in 2015 and exceeding $6.5 billion by 2019.

Unlike regular 2-D printing which merely deposits ink onto paper, 3-D printing creates physical structures. Think the Star Trek replicator, only a little less cool. Specifically, a 3-D printer reads a computer-aided design (CAD) software specification, uses a laser to melt a construction material such as plastic resin, plaster, sand, or metallic powder, and then builds the desired object by repeatedly depositing the liquefied or powdered material in thousands of microscopic layers, cross section by cross section in accordance with the CAD specification, until the object is complete. Because the object is created from a liquid or powder material, there is virtually no limit to the type of geometric shape that can be constructed.

3D printing is also called “additive” manufacturing because it only uses the material needed to make the object, which is the exact opposite of traditional “subtractive” manufacturing that makes objects by removing material via cutting and drilling. As the great Italian artist Michelangelo once said: “Every block of stone has a statue inside it and it is the task of the sculptor to discover it.” The problem with this subtractive technique is that it wastes 90% of the material used in the effort to make the desired object. The cost savings from using 90% less material makes 3D printing not only greener from an environmental and conservation perspective, but also much more affordable for small, custom-made projects that would be cost-prohibitive if done via traditional manufacturing equipment.

Consumer uses have been limited so far because of cost (up to $20,000 per printer) and the resolution of cheap 3-D printers hasn’t been good for anything but cheap plastic knick-knacks like figurines, cellphone covers, bracelets, and puzzles. Slow completion speeds of several hours are also a concern. But this is changing quickly as consumer 3-D printer costs decline below $1,000 and quality improves.

There are countless companies using 3-D printing technology, but I am aware of five publicly-traded companies that specialize in 3-D printing, as well as two private companies. I list them below in descending order of trailing-12-month revenues:

3-D Printing Companies

Source: Bloomberg

The top-two competitors recently issued their quarterly financial reports and investor reaction could not be more different. On February 25^th, 3D Systems released strong fourth-quarter results but the stock closed down 9% (after falling 20% intraday) after missing inflated analyst expectations for revenues. Q4 revenue growth of 45% and Q4 earnings growth of 44% evidently wasn’t good enough. In contrast, on March 4^th, Stratasys released slightly-less strong fourth-quarter results, but the stock jumped 7.1% in a single day and rose as much as 15.4% on the following day.

It’s hard to explain the differing investor reactions. 3D System’s stock valuation (PE Ratio) is lower than Stratasys’ and its revenue and earnings growth for 2013 is expected to be higher:

If you disregard non-GAAP EPS adjustments, Stratasys actually lost money last year and forecasts another loss in 2013 (slide no. 24), whereas 3D Systems was profitable in 2012 and forecasts a profitable 2013. The key point to remember is that one-day price reactions are dependent on previous price movements. It turns out that Stratasys had severely underperformed 3D Systems over the past three months (4.8% vs. 19.9%), so the more-positive investor reaction to Stratasys’ earnings was merely playing catch-up. In contrast, investor expectations for 3D Systems had simply gotten too frothy.

Furthermore, 3D Systems foolishly scheduled a 3-for-2 stock split on the same day as its earnings announcement, so some investors may have reacted negatively to the company’s lower post-split 2013 financial guidance, wrongly comparing it against the much-higher pre-split 2012 numbers.  

If you take a longer-term perspective, 3D Systems has outperformed Stratasys in all time frames over the past year except the latest month:

Relative Stock Performance Through March 4, 2013

In other words, there is nothing fundamentally wrong with 3D Systems! 

Another factor to consider is that 3D Systems focuses on the nascent low-end consumer end of the 3-D printing industry – a niche that offers great growth potential but is still speculative and unproven. As a Piper Jaffray analyst recently put it:

The only skepticism about this industry is on the consumer side. There has never been any doubt about corporate and commercial use.

Investors are understandably more skittish concerning a company with a less-certain future, which explains why 3D Systems has a higher 2.04 beta, compared to the 1.53 beta of Stratasys. But 3D Systems’ greater uncertainty is counterbalanced by the greater profit potential. One of the reasons that low-end consumer applications of 3-D printing have been slow to develop is because critical 3-D printing patents have stymied competition. But these patents are expiring and consumer innovation is set to explode. As Terry Wohlers of Wohlers Associates recently stated:

The fact that patents are expiring is interesting. The expiration of one key patent — IP covering fused deposition modeling owned by Stratasys — has allowed the very low end of the market, the open-source RepRap-type machines, to develop. We estimate that more than 23,265 of them were sold in 2011, compared to 6,494 professional-grade, industrial systems. This is an indication of what can happen when a patent expires. It opens the door to others in the industry. The MIT patents are expiring, and the final laser sintering patent from the University of Texas at Austin will expire in mid 2014. Of course, new patents are awarded that need to be considered. Even so, I do believe the expiration of 3D printing patents presents the opportunity for others to consider entering the business with competitive machines and materials.

I find it interesting that one of the key patents expiring was owned by Stratasys. This patent loss, combined with the fact that the Objet merger was an all-stock deal and the lockup of 16 million shares (more than 40% of the 38 million shares outstanding) expires six months after the December 3, 2012 merger closing, casts a shadow over the near-term performance of Stratasys stock.

Bottom line: 3D Systems looks like a better buy than Stratasys right now (but so do some of the other 3-D printing stocks).

Around the Roadrunner Portfolios

Brocade Communications Systems (Nasdaq: BRCD) saw the number of its shares sold short decline dramatically by 16.82%, which suggests that investors are growing more confident that the company’s turnaround is secure under new CEO Lloyd Carney. The company’s current short-to-float ratio is low at 4.1%, which earns it a safety point.

Diamond Hill Investment Group (Nasdaq: DHIL) reported fourth-quarter financial results that beat revenue and earnings estimates of the one analyst following the company. Did I mention that I like investing in neglected companies?

Full-year revenues were up 4% and earnings per share were up 12%. For some reason, net client cash flows were negative but capital appreciation and investment income more than compensated and total assets under management rose 8.7% for the year. We’ll know more about the client outflows when the company files its 10-K on Friday March 8^th.

Ocwen Financial (NYSE: OCN) reported excellent fourth-quarter and full-year financial results. Revenues blew away analyst estimates, but earnings were a bit light. Missing inflated estimates is okay in my book when earnings rise 85% for the year and the stock is trading at a forward P/E ratio under 8 and a five-year PEG ratio of only 0.23!

Similar to fellow Momentum Portfolio holding HomeAway, Ocwen exhibits very-high earnings quality with free cash flow much higher than net income for both Q4 and full-year — $220 million and $719 million vs. $65 million and $181 million, respectively. Good times should continue as the housing crisis is far from over and many more mortgage modifications are necessary. As Chairman Bill Erbey said in the conference call:

Ocwen continues to see substantial opportunities for both near-term and long-term growth. We are still in the middle rather than near the end of the opportunity that has been brought about by the mortgage crisis.

In the entire United States, the number of residential loans in default today is almost the same as the average for the last four years. This reflects the ongoing dynamic of roughly the same number of loans going into default as a result each month. The crash may have happened a few years ago, but the crisis will take much longer to cleanup than most expect.

Western Refining (NYSE: WNR) announced fabulous fourth-quarter and full-year financial results that saw Q4 earnings up an astounding 190% and full-year earnings up 62%. Both Q4 earnings and revenues blew away analyst estimates. The company continues to benefit from very-wide crack spreads between Midland-sourced West Texas Intermediate crude oil and gasoline prices. Debt was reduced by $304 million and $323 million in cash was returned to shareholders in the form of dividends and share buybacks. More buybacks are likely in 2013. No wonder the stock recently hit a five-year high!