Why IPGP will Slice the Competition

By Mohamed Mounir - June 1, 2012 | Tickers: COHR, IPGP, RSTI | 0 Comments

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What do you get when you combine high profit margins, disruptive innovation, YoY revenue and earnings growth, and a small cap valuation (almost under $2 Billion)? The answer is a potential multibagger. 

All these qualities are displayed by a company called IPG Photonics (NASDAQ: IPGP) . IPG Photonics is the leading maker of fiber lasers

The Product

A Fiber Laser is in layman terms a laser which is made to travel through a flexible transparent fiber made of glass called an optical fiber. Optical fibers have a lot of different applications which include transmitting digital information over long distances. That means its likely that the information that’s popping on your screen right now has probably passed through an optic fiber along the way. A bunch of Optical fibers are shown in this image:

 

Anyhow back to lasers, fiber lasers have a lot of advantages over other types of lasers including

• Compact size
• High Output Power
• Reliability
• High Optical Quality

 Not only are Fiber Lasers superior to other lasers in terms of applications, but they also reduce costs for operators.

Here is a comparison between CO2 lasers and Fiber Lasers in terms of energy efficiency and cutting speed: 

Graph Source: Salvagnini Italia s.p.a., November 2009

Figure 1 Energy Consumption Fiber Vs CO2 kW/hr

Figure 2 Linear Cutting Speed m/min

From the above charts it’s clear that fiber lasers offer an advantage over the more common CO2 lasers offered by competitors such as Rofin-Sinar Technologies (NASDAQ: RSTI) and Coherent Inc. (NASDAQ: COHR) 

Growth Prospects

So what is the Market share of fiber lasers compared to the total source laser market? Here are both the historical and projected sales for each:

Graph Source: Laser Focus World Optech Consulting and IPGP Estimates

Figure 3: Sales of Total Lasers vs Fiber Lasers ($ Millions)

As you can see fiber lasers have some catching up to do. IPG Photonics is the dominant fiber laser producer in the world so this gives it a great opportunity for growth. IPGP made 91% of its revenues in 2011 through fiber lasers so much of the company’s future growth prospects depends on the growth of the fiber lasers market.

The likelihood of that happening is pretty high, last year fiber lasers grew faster than ever at a rate of almost 60% as fiber lasers began to take significant market share in welding and cutting form CO2 lasers.

Not to mention that there could be new applications for lasers on the horizon just as using lasers to drill oil and gas wells and for 3D Prototyping and for medical applications such as skin rejuvination. The company also intends to enter in the future the $8 Billion laser systems market instead of just producing the laser source.

Leveraged Business Model

What I really like about IPGP is it's margins. The company had 54.2% and a 55.8% gross margins and 37% and 36.7% operating margins in 2011 and Q1 2012 respectively. The reason for these stellar margins is vertical integration. In 2004 the company started producing it's own diodes instead of outsourcing. As the company produced more and more chips year after year this lead to a substantial decrease in the diode cost per watt from $80 in 2003 to under $3 in 2012. The more chips the company produces the lower its cost per unit will be.

When a company has low variable costs and high fixed costs it is said to have what is called Operating Leverage. If demand is high and the company produces and sells more products it will translate into a higher net profit per unit sold, so a larger percentage of revenues is translated into profits meaning that net profits grows faster than revenues. To illustarte this point IPGP's revenues increased by 58% in 2011 from $299 million in 2010 to $474 million, but net profit increased by 120% from $54 million in 2010 to $117 million in 2011.  However the downside to this is that if there is a slowdown in demand the company will suffer greater losses due to the fact that many of its costs are fixed and can’t be reduced in the event of a slowdown.

Proven Performance

However, the company has a strong balance sheet and a proven business model to whither any storms ahead. The company grew it’s revenues and profits in the last 5 years and 2007 to 2012 couldn’t be in any way described as years of prosperity; marred by a sub mortgage crises, financial meltdown, balance sheet recession, a slow recovery, fears of a double dip recession, and last and we all hope the least Euro Zone worries and austerity measures. The company was even in the black for 2009, the worst year for financial results! I don’t believe the next 5 years will be as bad as the last 5 were and I do believe that manufacturing and the market of fiber lasers will grow as the decade progresses.

Bottom Line:

IPG Photonics is a disruptive innovator, first mover and a top dog of its industry being the dominant and most profitable laser company. It has a superior product, very good growth prospects, high margins, a business model benefited by operational leverage, and great historical performance. I am very Bullish on IPGP and I will definitely be adding it to my portfolio in the near future.

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