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The American Manufacturing Renaissance
On Tuesday, President Biden visited a Javelin missile facility in Alabama.
Ordinarily, a visit to a Lockheed (NYSE:LMT) plant would make Page Six news at best. Presidents from Franklin Roosevelt to Donald Trump have long used visits to shore up constituent support; it’s nearly impossible to visit New England without spotting a sign announcing that “George Washington Slept Here.”
But this week’s visit was particularly remarkable.
The high-profile tour was an attempt to press Congress into approving his proposed $33 billion assistance package for Ukraine — twice as much as the U.S. Department of Justice (DoJ) receives for law enforcement every year and three times more than America spends on non-military defense.
The sudden scramble for funding is understandable. Russia’s invasion of Ukraine has united Americans of all political stripes. Across the Atlantic, even a fractious Europe has found unity in fighting against a common threat; in February, Germany committed EUR 100 billion towards its defense fund.
Such massive spending however, also comes with practical hurdles. Each Javelin missile contains around 250 microprocessors — a headache made worse by global chip shortages. And America has already sent more than 5,500 Javelin systems to Ukraine; Lockheed can build just 2,100 missiles per year at its current facilities.
To fund the American manufacturing renaissance, the president surely has more factory tour photo ops in his future.
Nevertheless, U.S. companies are also doing their part to pull themselves up by the proverbial bootstraps. Corporate capital expenditure jumped 14% to $7.2 trillion in 2021. And security repurchases of nonfinancial businesses — a sure sign of belt-tightening — is two-thirds lower today than in 2016.
Today, we’re going to look at a second-order winner benefiting from these tailwinds:
Desktop Metal (NYSE:DM).
The Second-Order Winners of American Manufacturing
Before we consider Desktop Metal, let’s revisit the concept of second-order investing.
Second-order companies are those that benefit from the knock-on effects of first-order winners. Investors might consider Lockheed’s Javelin program as a first-order winner of U.S. rearmament, while their microprocessor suppliers are second-order ones.
And investors ought to favor these second-order winners.
Consider energy stocks. The early winners of February’s oil spike were first-order exploration and production (E&P) bets like Indonesia Energy (NYSEAMERICAN:INDO) and Houston American Energy (NYSEAMERICAN:HUSA), where oil prices dictate asset values.
The correlation, however, cuts both ways. INDO and HUSA have fallen 70% and 63% since March’s oil peak, respectively.
Meanwhile, second-order bets featured in the Moonshot Investor like Summit Midstream (NYSE:SMLP) and Martin Midstream (NASDAQ:MMLP) are driven by oil and gas demand — a far easier factor to predict. If North American rig counts are going up today, pipelines will naturally see increased demand six months from now as wells get completed. SMLP and MMLP are both up 35% since March.
The same pattern is now emerging in U.S. manufacturing.
But what of second-order bets? As the Javelin missile shortage shows, there are more pieces to the U.S. manufacturing puzzle than meets the eye.
And that’s where Desktop Metal comes in.
The Best 3D Printing Company on Earth
Desktop Metal is a 3D printing firm based in Massachusetts that focuses on (surprise!) metal-based printing industrial uses. Their product lineup spans high-speed mass production printers to smaller systems for rapid prototyping.
In other words, this isn’t your hobbyist 3D printing firm. Instead, Desktop Metal is helping automakers manufacture car parts… sports companies design golf clubs… and skydivers create carbon-fiber camera mounts.
And it’s growing fast.
Despite missing earnings expectations in Q3 and Q4 last year, DM still grew almost 7x year-on-year. Analysts expect the firm to add another 130% in 2022, compared to a -3% decline in rival 3D Systems (NYSE:DDD).
There are three key reasons for the outperformance.
First, Desktop Metal has focused on metal and carbon fiber — materials that are harder for current-day technologies to form. Unlike plastics, metals are relatively expensive to injection mold. The slow speed of metal-based CNC machining makes it impractical for mass production, while stamping and forging processes struggle to produce complex parts.
The lack of suitable alternatives has provided Desktop Metal an easier path to growth. Analysts expect the firm to eclipse 3D Systems and Stratasys (NASDAQ:SSYS) by 2025.
Second, DM has a well-functioning sales team, especially for a startup. Marketing costs have risen at less than half the rate of revenue growth — an unusual feat for such a fast-growing firm. The same Wall Street analysts expect selling and marketing expenses to expand at just one-third of revenue growth.
Finally, Desktop Metal’s R&D team has wisely focused on production speed — a significant hurdle to 3D printing costs. The company has made headway in technologies like digital light processing (DLP) that can print entire layers rather than tracing pieces at a single energy point. And its P-50 system can now print up to 12,000 cubic centimeters per hour, making it a viable alternative to casting for smaller components.
What’s DM Worth?
Like any high-growth company, however, valuing Desktop Metal is challenging even for experienced analysts. The company’s rapid 2021 ascent came with a $155 million cash burn, suggesting that DM could potentially run out of cash before reaching scale. Investors should mentally prepare for a secondary offering.
Expectations are also sky-high for the young startup. Wall Street’s $7 price target assumes the company grows another 6x over three years — a feat that few billion dollar companies ever achieve. This pace would rival Amazon’s (NASDAQ:AMZN) growth in 1997 and Netflix’s (NASDAQ:NFLX) in 2002.
Finally, there are sector-specific issues. The 3D printing industry is a relatively narrow moat industry where competing firms have long struggled to turn profits. And in an ironic twist, Desktop Metal itself has suffered manufacturing supply chain issues from China.
Yet by other measure Desktop Metal is a powerful bet on the future of American manufacturing. A 2020 Gartner survey found that one-third of supply chain leaders had already moved their business out of China or planned to by 2023. And businesses returning to the U.S. will be searching for efficiencies to offset the loss of cheap foreign labor.
That could make Desktop Metals worth billions.
In these all-or-nothing cases, I favor a probabilistic approach to valuation.
Using consensus estimates, a 2-stage DCF model suggests prices should rise to $6.60, an 80% upside. Raising the perpetual growth rate to 7.5% increases DM’s value to $33.60, while a corporate failure might value the firm closer to a $1.50 buyout price.
Assigning a 60%-20%-20% chance to each outcome places a $11 value on the firm, a price not far from its $10 SPAC listing.
The firm’s insiders certainly seem on board with that logic. In March, CEO Ric Fulop added more than a half-million dollars to his current stake around the $4 level; he now owns 20 million shares in the firm. And just one director has used a Rule 10b5-1 trading plan to reduce their holdings this year.
Though Desktop Metal remains a risky bet, its superior technologies, quality sales teams and good management make it a Moonshot bet to consider.
Can 3D Printing Solve America’s Labor Shortage?
In January, Habitat for Humanity unveiled its first-ever 3D printed home. The 1,200 square-foot house in Williamsburg, Virginia, was a marvel for the nonprofit — construction costs were supposedly 15% less than for a traditionally-framed house.
For decades, homebuilders have jumped from one labor-saving technique to the next. Sears sold around 70,000 home building kits in the early 20th century, and developers turned to mass production in the 1950s to house the millions of GIs returning from war. Today, companies like Clayton Homes can assemble factory-built modular homes in as little as three weeks.
When you’re building something the size of a house, it’s hard to outsource production overseas and ship it back in 40-foot containers.
As tensions between the U.S. and China heat up, American manufacturers are also starting to consider how they can also apply similar techniques. A survey by tech vendor Capterra found that 79% of HR leaders are now dedicating either a “moderate” or “significant” portion of their spending on training and development.
In 2018, a paper by the non-partisan think tank RAND Corporation warned how 3D printing could “weaken international connections currently sustained by complex, multi-country supply chains.”
As America seeks greater supply-chain independence, those negatives will quickly become unexpected benefits.
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On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.