We recommended 3-D Systems (DDD) last September, just before the stock ran from $50 per share to nearly $100. We think it’s going to do that again. The rationale is very similar to the last time and a likely short-squeeze could add a lot to push the stock higher in the very short term.
DDD makes devices that can “print” three-dimensional products for medical, industrial, or home uses. These printed parts can be solid metal, plastic or other composites. Clearly, this is a good technology for prototyping and small-batch manufacturing but it still has a ways to go before it becomes as ubiquitous as the paper-printer is today.
There are plenty of naysayers who doubt that this will ever be a replacement for cheap household items or mass production. But then again, I still remember spirit duplicators (“ditto machines”) when I was going to grade school in the 1970s, so it’s not hard to imagine that 3-D printing could follow a similar trajectory from expensive and slow to nearly-disposable.
DDD looks like a developmental stage firm and in many ways it still is, but unlike others, it has profits and is investing rapidly to stay ahead of the competition – and it had better. Since the beginning of this year, DDD has been dropping as investors worry about the impact of tightening margins and the entrance of Hewlett-Packard (HPQ) into the 3-D space.
However, the question we think should be asked is not whether competitors will move into the industry, which is more of a vote of confidence than anything else. Our biggest question is whether growth in the industry and DDD’s first mover advantage will make them attractive to investors again in the short term.
DDD is guiding higher in 2014 and 2015 in the topline and it has begun to guide a little higher on the bottom line again. For a company focused on reinvesting for growth, a small dip in margins last year should not have been a surprise. Cutting prices on lower-end machines to get them into the hands of more hobbyists and small businesses; investing in new development; and working with Google (GOOG) on a joint venture are all expensive in the short term, but likely to provide a lot of value in the long-term. However, investors don’t like lower profits in a cyclical like this and they discounted the shares.
It’s not just buyers who cooled off since January – shorts have been building very large positions. Short interest on the stock (the % of floating shares held short) has reached 34%, and the short coverage ratio (shares held short ÷ Average daily volume) is almost 7-days.
There is some justification for this bearishness. Besides the previously mentioned decline in profit expectations, cyclical stocks have been hit hard so far this year as the bull market got a little ‘toppy.’
However, a large short interest ratio on a profitable stock that is sitting at support is not the worst news for traders willing to take a risk. This can trigger a short-squeeze that initiates a new trend to the upside. This is very similar to the same situation we saw in DDD last September.
A short squeeze occurs when a heavily shorted stock starts to rise (usually due to a news event) which motivates short traders to cover their position by buying the stock back. That buying drives the price higher, which attracts more buyers and drives more shorts to cover. That cycle can quickly feedback into itself and start a new bullish rally. For example, Volkswagen was briefly the most valuable company in the world in 2008 due to a dramatic short squeeze.
Short squeezes are usually triggered by some kind of news event. An earnings release, product announcement or analyst conference could all serve as a catalyst for a short squeeze. We think this is a good time to take a risk on DDD because the court will be hosting its own analyst day on June 10, which could be the trigger we are looking for. The company needs to justify its use of proceeds from the fundraising it announced last month and we expect they have something good to share.
The Bottom Line
We can’t predict whether the company is going to be able to drive margin and growth expectations enough in the short term to get back to $100 per share – no one can. However, as with any trade, it comes down to a risk/reward analysis.
Let’s assume that the chance for a short-covering rally triggered by the analyst conference next week is 50%. Even those odds would be attractive if the expected upside is larger than the expected downside here at support. That is our argument in favor of the stock. DDD is fairly priced where it is, which means support should hold or limit the downside. However, the upside is nearly unlimited and it is working hard to earn back its investors in 2014.
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