Laser-Like Focus on Market Beating Returns
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As an investor that subscribes to the Peter Lynch philosophy of investing in straightforward, easy to understand businesses, a fiber laser company like IPG Photonics doesn’t leap to mind. However, you don’t need a PhD in Laser Engineering to understand that IPG Photonics (NASDAQ: IPGP) is a disruptive brand. In simple terms, a fiber laser is a precisely focused, intense light beam (photons), approximately the diameter of a human hair. Lasers have been broadly adopted for various manufacturing applications, especially cutting, welding, and engraving. IPG Photonics’ fiber lasers have been rapidly gaining market share over the last several years in a growing market.
Lasers are utilized in increasingly diverse areas including the manufacturing of mobile handsets from companies like Apple, blades by Gillette, to vehicles by Daimler. Fiber lasers are more precise, portable, and cost-effective (use less electricity) than crystal and carbon dioxide based lasers. While the technology is complex, the investment is less so. IPG Photonics is a pioneer in the design and fabrication of fiber lasers. Their products include low, mid, and high-powered lasers that supply over 300 diverse customers and end-markets, including general manufacturing, automotive, heavy industry (drilling), aerospace, consumer products, semiconductor, military, electronics, and medical devices. 80% of their business is international with 38% of their business from Europe, so the stock is often volatile, and susceptible to negative headline news about the global economy. Revenues from China have tripled over the last 3 years, although growth slowed in Q3 2012. Europe makes up a large percentage of revenues, but in Q3 Europe, along with the U.S., represented their strongest markets. IPG Photonics recently reported strong Q3 earnings, but cautiously guided lower on Q4 earnings citing seasonality and global macroeconomic concerns, causing a 12% drop in the stock. While it has rebounded a bit, it still trades below its growth rate.
More than 85% of IPG Photonics is concentrated in high-powered lasers for material processing, with a strong concentration coming from automobile manufacturing. However, the company is continually expanding applications, and driving growth. Furthermore, IPG Photonics has a significant patent portfolio, and uses their vertical integration as a competitive advantage. They design and manufacture all components including proprietary diodes for the laser, and the optical fiber for the delivery system, which provides better control over cost, quality, the economies of scale, and thus, allows them provide better service and value to customers. Additionally, vertical integration allows a level of customization for clients that a competitor like Coherent cannot provide as they focus more on the specific components of lasers rather than the whole product chain.
The long-term opportunity in IPG Photonics is in their R&D and resultant expansion of applications, especially medical and consumer electronics with their nascent ultra-short pulse laser technology, which allows very precise micro cutting applications. They compete head-to-head with Coherent (NASDAQ: COHR) and Rofin-Sinar (NASDAQ: RSTI) in the medical sector. While Rofin-Sinar offers a vertically integrated solution like IPG Photonics, Coherent focuses more on the laser components. By offering a more complete solution, and the strength of their brand, IPG Photonics should be able to take market share. Combine that with their continued rapid growth in materials processing in what can only be considered a global economic landscape that is currently less than robust. Any improvement in the global economy will benefit IPG Photonics.
Through 2007-2011, IPG Photonics experienced 5 year compound annual growth in revenues of 27%. While the company struggled in the recession due to their exposure to manufacturing, they grew revenues 59% (YOY) in 2011 to $474.5 million driven by materials processing. Gross margins grew from 49% to 54%. While growth has slowed in 2012, it remains above 20%, recently reporting 21% revenue growth and 29% net income growth in the third quarter with core strength in their materials processing segment and 50% growth in pulse lasers in the electronics market.
At $53.99 per share, IPG Photonics trades below its long-term growth rate, with a PEG Ratio of .90 on 5 year projected earnings. It is also notable that IPG Photonics has continued to strengthen their balance sheet, generating $38 million in cash in the third quarter ending the quarter with a very strong balance sheet of 372.6 million in cash. With growth margins of 59%, and operating margins of approximately 39%, IPG Photonics operates efficiently while still investing in the future.
IPG Photonics is an investment in technology that streamlines, and enables advancements in a broad swath of the manufacturing industry including high growth areas medical and electronic devices. While they are exposed to a slowdown in the global economy, the company is a growth company trading as value stock. Furthermore, they offer a unique value proposition due to lower operating cost, precision, and their unique customization ability. The company trades below their long-term growth rate, and the seasoned management has been smart about allocating capital and strengthening their balance sheet, which should help weather any short-term global growth worries. The recent knee-jerk market reaction to conservative guidance by IPG Photonics management is an opportunity for those with a laser-like, long-term focus on market beating returns.
James Fantaci owns shares of IPGP. Please follow James on twitter to keep abreast of future Foolish articles. The Motley Fool owns shares of Apple, IPG Photonics, and Rofin-Sinar Technologies. Motley Fool newsletter services recommend Apple, IPG Photonics, and Rofin-Sinar Technologies. 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.If you have questions about this post or the Fool’s blog network, click here for information.