When I last visited Rofin-Sinar Technologies (RSTI), I thought that the valuation held some appeal for long-term investors, but that there were some meaningful operating/execution risks in the meantime and that I preferred fiber laser specialist IPG Photonics (IPGP). That call has worked out pretty well, as IPGP is up more than 15% from that article, while Rofin-Sinar has fallen about 6%.
Rofin-Sinar is definitely seeing some pressures in its business today, as semiconductor, electronics, PV, and medical markets have fallen off. It is also not obvious to me that the company is making as much progress as it needs to in closing the gap with IPG Photonics. All of that said, the valuation is getting less demanding and if management can rebuild margins back to past levels the shares could do well from here.
Unimpressive Results Across The Board
There are not all that many positive things to say about Rofin-Sinar's fiscal first quarter results. Revenue fell 15% on a 27% decline in laser unit sales, with Marking/Micro sales down 27% on weak consumer electronics, semiconductors, and solar and Macro up just 1% on strength in machine tools. Component sales were down 4%.
Margins were not strong either. Gross margin fell more than a point, and operating income fell by more than 70%. SG&A expenses were almost flat with the year-ago period, but this is a business where gross margin makes a big difference as the company consistently spends considerable sums (high single digit percentages of revenue) on R&D.
Orders ticked up just 2%, and management lowered revenue guidance for the second quarter about 8% relative to the prior sell-side estimate. Autos were consistent as a percentage of sales, as auto OEMs have cut back on spending. Machine tools as a percentage of revenue increased significantly (from 30% to 40%), while the contribution from semiconductor markets fell almost by half.
The Neighbors Are Doing Better
Adding a little extra sting to the Rofin-Sinar results is the relative performance of its competitors. Coherent (COHR) echoed weakness in electronics (advanced packaging), but revenue rose 6% and orders were up 14%.
IPG Photonics also performed notably better. Revenue at IPG Photonics rose 14% and with Rofin-Sinar disclosing fiber laser sales of $17 million, it doesn't sound like the latter has managed to close the gap with IPG in this fast-growing laser market.
Fiber Still A Priority
So far, every new iteration of fiber laser systems has brought increased capabilities in terms of their ability to handle thicker materials and operate more quickly. This is leading to significant uptake in markets like automobile OEMs (particularly in China) where Rofin-Sinar has long had a strong presence with its CO2 lasers. Electronics manufacturers are also starting to adopt them in larger numbers, as are machine tool manufacturers.
With fiber lasers offering significant operating cost advantages (about one-third the cost on a per-hour basis) and smaller/lighter factory floor footprints, Rofin-Sinar cannot afford to let IPG Photonics continue to dominate this market. The company is responding, moving into production on 200W and 1.5KW fiber laser modules, but there is still a long way to go before the company is self-sufficient and truly competitive with internal diode sourcing (a key cost factor in fiber lasers).
Cyclical Or Structural?
On one hand, it's tempting to excuse Rofin-Sinar's issues as just part of the challenges the go with a company supplying capital equipment to cyclical, economically-sensitive industries like autos, semiconductors, and machine tools. Likewise, Europe is roughly half of the company's sales base and has yet to recover to the same extent as North America.
I believe that, but only to a point. Other machinery and equipment manufacturers with significant exposure to Europe have seen better recoveries in revenue and margins, and there is the fiber laser elephant in the room. I believe that Rofin-Sinar's R&D investments will help the company over the long-term, but there is only so long that the market will wait for better results.
I am looking for markets like semiconductors and medical devices to improve, and I'm likewise expecting better demand for machine tools in Europe. Coupled with what should be an improving fiber laser business, that leads me to a long-term revenue growth estimate of more than 5% for Rofin-Sinar, with a FCF growth target of 7%. I don't believe that Rofin-Sinar will get back into the high teens with operating margins, but I do believe low-to-mid teens are possible. Likewise, I do expect Rofin-Sinar to start gaining share in fiber lasers over the next three years and a failure to do so will make that 5% revenue growth target null and void.
The Bottom Line
I'm hopeful that Rofin-Sinar is muddling through a cyclical trough, but hope is not a particularly good investing strategy. My discounted cash flow model suggests a fair value of more than $27 today, subject to those aforementioned risks about mix and competitiveness in the fast-growing fiber laser market.
With the company having seen 14% sequential order growth and other laser companies reporting improving conditions, I think aggressive investors may want to take a closer look at Rofin-Sinar. While there is a risk that Rofin-Sinar's time at the top of the industrial laser market is moving toward twilight, I'm not quite willing to throw in the towel just yet.