II-VI Incorporated (NASDAQ:IIVI) reported results for the fourth quarter of 2014 (SEC filing, earnings call, press release). Revenues increased 22% Y/Y to $187.9M. Revenues resulting from the company's acquisitions completed during fiscal year 2014 were $39.5M and $115.2M for the fourth quarter and fiscal year, respectively. Bookings increased 33% Y/Y to $193.3M million. Organic bookings were up 3% Y/Y. Quarterly diluted EPS was $0.20 versus $0.22 a year ago. For the fiscal year EPS was $0.60 compared to $0.90 a year ago. The revenues from the integrated businesses increased 8% Y/Y. However, the businesses acquired from Oclaro (NASDAQ:OCLR) continue to be a drag on sales growth and earnings. Although the management is not satisfied with the performance of these businesses, the segment showed 8% Q/Q sales improvement, so they seem to be stabilizing. The company's new $50M share repurchase program is designed to "at least partially offset the dilutive effect of the issuance of shares from the Company's current [share-based compensation program]." For Q3 of 2014, IIVI forecasts revenues between $170M and $185M and EPS in the range of $0.14 to $0.20 per share-diluted. This represents a ~18% Y/Y sales growth including the acquisitions, and a ~13% EPS growth for the mid-range $0.17. Given how large the acquisitions were, the growth is rather unimpressive.
As I advised in the conclusion of my original thesis, "most of this growth is already priced in and the 16% upside comes with a downside risk of up to 60%. Investors are advised to dollar-cost-average the purchases or wait for a pullback to achieve a better risk-to-reward setup." By adhering to strict risk-reward discipline advised in the thesis, investors could have avoided a large part of the ~25% stock price drop that came as I correctly feared. In a separate thesis on Oclaro, I correctly noted that IIVI overpaid for the acquisitions of Oclaro's assets as they were barely break-even businesses which turned out to be a drag on IIVI's subsequent performance and contributed to IIVI's share price fall. As I mentioned: "By negotiating the two divestitures [that IIVI bought], Oclaro has pulled off a masterpiece... It also managed to sell barely breaking-even or money-losing business units for a relatively high price-to sales ratio, compared to other businesses in the industry."
But on a positive note, IIVI's stock weakness now offers a more attractive entry point. Therefore, I now initiate a long thesis with a target price of $18 within two years, offering a total upside of ~25%. However, IIVI is still a risky proposition. Investors should fully hedge the downside, for example with put options with a strike price ~15% below the purchase price. IIVI is one of my lower-conviction stock recommendations due to numerous issues, including potential troubles related to past or future acquisitions and relatively high management compensation.
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