An Industry on the Rise with Numerous Fundamental Questions

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Last Friday shares of photonics-based solutions company Coherent (NASDAQ: COHR) traded higher by almost 11% after reporting earnings. As a result, numerous stocks that manufacture and develop similar products also traded higher. However, the question is whether or not this industry is growing and if it’s time to buy.

Coherent Earnings and Valuation

Coherent’s earnings weren’t anything special. The company’s revenue was actually lower 2.5% compared to last year, but the company did improve its margins by 100 basis points over last quarter to a gross margin of 42.6%. However, the market expected certain macro challenges because of Europe; therefore it was the rise in gross margins that was impressive to investors. The stock now trades with a price/sales of 1.60 and a forward P/E ratio of 15.18, which means the company is fairly valued.

The stock trades in an industry that is not sexy to the investor’s eye by any means. It’s not a stock that will ever trade at 40 times to 50 times earnings, as companies in the space manufacture lasers for various uses. Coherent is engaged in the scientific research and commercial space, which makes the bulk of its business that much more unattractive, and difficult to understand.

A Look at Industry Peers

Judging by Coherent’s earnings and its valuation, I think the reaction was warranted and appropriate. The company did guide for Q2 revenue between $193 million and $203 million, which was above the consensus of $192.7 million. As a result, the guidance could be a good indication that demand is increasing for the entire industry, which may explain the rise for other stocks in the space.

IPG Photonics (NASDAQ: IPGP) is my favorite company in the laser development industry. The company develops and manufactures fiber lasers, fiber amplifiers, and diode lasers, making it somewhat different from Coherent. The stock traded higher by 2.16% on Friday and is now flirting with new highs. It too is growing margins but is also involved in an industry that is producing revenue growth. With that being said, it’s also trading at 6.4 times its total sales for the last 12 months, which is about four times more expensive than Coherent.

IPG Photonics has industry-best margins and is expected to grow its revenue by low double digits in 2013. Therefore, despite my belief that it’s the best company in the space, with the most upside, it may be a little too expensive for the value investor. On the other hand, Newport (NASDAQ: NEWP) faces decreased margins, moderate revenue growth, and is cheap by all metrics, making it the best value in the space.

Newport is almost the complete opposite of IPG Photonics, and operates with a more diversified business. The company provides a portfolio of products to customers in various end markets, such as scientific research, microelectronics, aerospace, defense, security, and life/health sciences among others. It’s this diversification that gives the company upside but also leads it to struggle, as certain markets are weaker than others. If, in fact, the global market is growing then Newport could be the company that benefits.

Conclusion

Upon looking at each of these three companies in the laser/photonics business, I conclude that all are valued appropriately, and could rise with continued growth in the global market. Coherent is valued fairly but faces fundamental growth concerns; IPG Photonics is the most expensive but is growing the fastest; and Newport is the cheapest but is also heavily reliant on global economic strength in a wide range of industries. With that being said, investors must be aware that a photonics company is only as strong as its weakest link, and in the global economy there are many unstable and weak links (such as in Europe).

Another potential problem is the issue of weakness in certain industrial marketplaces, such as in healthcare and automation. A laser company relies on the need for replacement parts and demand within these end markets and industries, yet several are not seeing any level of demand increase with the global economy. With that being said, fiber lasers are still cheap to operate and more efficient than other alternatives. Therefore, I suggest investors take more time to look through the various companies and determine which segments are growing and which companies might see the greatest demand.

This is not a one-size-fits-all space. Investors must assess each company and know the strengths and weaknesses of their products. I am not saying that the space is not worthy of an investment, but investors should be careful, and should not attribute Coherent’s strong quarter and its increased guidance as an industry wide sign of strength.   


BrianNichols has no position in any stocks mentioned. The Motley Fool recommends IPG Photonics. The Motley Fool owns shares of IPG Photonics. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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