Here is a company that I recently placed onto my watchlist. From the way the company and stock price have been on fire, I am not sure when it will come down in price to a point where I can pull the trigger.
Straight to business. IPG Photonics is a maker of fiber lasers which are used in a wide variety of industries for welding, cutting, drilling and etching.
See the video demonstrations of IPG Photonics lasers and their competitor Trumpf.
IPG Photonics Spider Graph
- Management: B
- Growth: A
- Moat: A
- Risk: B-
- Valuation: C
- Overall: B+
The company was founded in 1990 by the current CEO, Mr Gapontsev, whose entire career has been focused on the study of lasers. He holds a PHD and was previously the senior scientist at the Soviet Academy back when the Soviet Union existed. His life story is amazing itself.
Gapontsev’s family was evacuated to the Ural mountains in the darkest days of World War Two, relocating to the Ukraine after his father was freed from a Nazi-run POW camp and then raised in the Soviet Union. Educated as a researcher in lasers, Gapontsev launched his own laser business with the fall of the Soviet empire, only to move it to Germany and then rural Oxford, Massachusetts in the late 1990s when doing business in Russia became untenable. – Forbes
Here are additional points related to the company management.
- Executive team all have extensive history and experience in the laser industry. Look at their resumes.
- CEO owns 19.9% of the common stock under his name, but if you include holdings via his trust and other associated companies, he owns roughly 42% of the company. Seeing as how Gapontsev is in his seventies, how the company operates after his departure will be interesting.
- Total executive compensation was 1.5% of total revenue in 2010. Very good because they thrashed their performance goals.
- Mostly all option exercises or selling. No open market buys and admittedly who would make open market purchases when the team is receiving options for meeting performance objects and the stock price rocketing up. Selling and option exercises are expected.
Growth is where IPGP shines. As the world continues to advance and new technologies come to fruition, the use of lasers is gaining traction in all industries. Nowadays, big companies no longer manually weld, cut and drill. Everything is automated via robotic lasering.
IPGP pioneered fiber laser technology but the technology itself is still very young. Fiber lasers are only beginning to replace the existing gas (Co2) and YAG lasers that are common today.
Some additional points that show why IPGP has lots of room for growth.
- Fiber lasers are cheaper than gas and YAG lasers. The huge benefit is that little to no maintenance is required. The size is also smaller which is why companies have been adopting the lasers in droves.
- Current backlog shows a huge increase in confirmed sales compared to prior year.
- Fiber lasers are not just limited for use in one industry. Lasers are used by many industries including material processing for general manufacturing, automotive, aerospace, consumer and semiconductors. It is also used in the communications industry and medical usage.
From what I’ve read about the company so far, IPGP is very innovative and creative in the way they do business. They do not just stay idle and wait for customers to adopt their products. Instead, they try to break normal convention of how lasers can be used, and market their products to disrupt markets.
Strategic Advantage or Moat
The main strategic advantage IPGP has over its competitors is their ability to produce everything in house. This means that they have tight control over quality and component supplies. IPGP refers to it as a complete vertical integration and includes making everything from semiconductors, amplifiers, manufacturing tools, components, software and every technique they use.
Vertical integration also means a reduction in component and final product cost, better access to critical components and rapid development of technology and new products. Doing everything in house leads to excellent margins.
Another great advantage IPGP has over competitors is the fact that the CEO pioneered fiber lasers. IPGP is the one with the know how and trade secrets to innovate and stay ahead of the competition while the rest of the competition are followers. The hundreds of patents also help to increase the moat.
Finally, IPGP is not just centered on US sales. It has a diversified customer base. North America makes up 20.6% of sales, Europe is 37.6%, Asia and Australia is 41.3%.
Now that companies are willing to replace their existing lasers with fiber lasers, other laser manufacturers have taken notice and are coming out with their own fiber laser products.
However, according to price specs and people familiar with the product, IPGP is ahead of the competition in terms of product quality and price.
This article lists some public competitors which you could further research. In my view, IPGP is head and shoulders above the competition.
Of course there are risks.
- CEO is 72 years old. It has been his vision and expertise that has driven this company forward. Will the company be able to continue its surge without him?
- Business is cyclical. Relies on capital expenditure by companies to make sales. In 2009, IPGP saw a big drop of 20% in revenue compared to an increase of 60% in revenue in a better economy.
- Laser prices are going down as competitors bring their product to market. There is a high chance that margins will decrease from today’s level.
- High fixed cost due to in house development. If capacity is not utilized, margins will compress as evident in 2009.
- Since the entire manufacturing process is done in house, IPGP has a limited number of suppliers for some required components and raw materials. Loss of a single supplier could disrupt the entire manufacturing process.
- Subject to litigation. Already involved in several lawsuits where IPGP was alleged of infringing on competitor patents. IPGP won however.
- 37.6% of sales come from Europe. Continued uncertainty across Europe and the world will seriously affect the company.
- CEO controls 42% of the company. Buyouts, mergers will easily be blocked.
IPGP has to looked at from a growth point of view. Standard value metrics will likely deem the company to be way overvalued.
Take a look at FCF and you will see that it is positive, but because most of the capex is due to growth, FCF will surely increase over the next few years once the growth drivers are set into place.
Compare FCF to owner earnings and you will see that the “real earnings” look much better. This is just one quick method to get an idea of the capex related to growth.
Additional points are as follows:
- Breakdown of inventory shows a huge jump in raw materials and works in progress. IPGP is working to fill orders.
- Company has huge margins and it has continued to increase. In 2004, gross margin was 42%. TTM is 60% but my estimate is that it will likely decrease with increased competition.
- With all the orders IPGP has been receiving, net margin is 25%. During a recession, it was down to 3%. This is a huge difference. If possible, it is best to wait for a full blown recession before buying IPGP unless you are certain that the economy will continue to improve.
- ROIC is around 12% which is average. On the other hand, CROIC is horribly low at a meager 1-2%.
Rather than try to determine the value, better to try to figure what the market is implying for growth stocks using the intrinsic value spreadsheets.
- Reverse DCF with $90m FCF and 12% discount rate shows 23% growth rate.
- A discount rate of 9% shows 18% growth rate.
- Reverse Graham method using the current EPS of $2.42 implies a growth rate of 16%.
- The EPV far exceeds the asset reproduction which implies that a moat does exist.
Two main catalysts come to mind.
- Improvement in world economy
- Greater adoption of fiber lasers across wider industries and newer applications
IPGP is a fast growing company positioned attractively as it is the leader of fiber lasers. Fiber lasers are being sold to numerous different industries utilized in a variety of ways.
Being first to market along with being able to manufacture everything in house is leading to strong margins and sales across the world.
I have to take a closer look at valuation, but IPGP is definitely worth putting on my watchlist.