IPG Photonics Corporation: Recovery Or More Downside Ahead

May 13, 2022 11:41 AM ETIPG Photonics Corporation (IPGP)3 Comments1 Like
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Summary

  • IPGP surprised by growing sales and profits in Q1 when they were expected to shrink and it had some other encouraging news to share.
  • The market reacted well to the latest updates from IPGP, but it seems to have had a change of heart, possibly for good reasons.
  • The stock has reached a support level that has been in place for years, although the trend is still pointing down.
  • There’s progress, but whether IPGP continues to do so is in doubt, which means going long could turn out to be rewarding or costly.

cnc laser machinery for metal cutting.

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IPG Photonics Corporation (NASDAQ:IPGP) pulled a rabbit out of a hat with its Q1 report. The worst was expected with IPGP facing a number of headwinds, but the Q1 numbers were much better than expected, giving rise to speculation that IPGP may have turned the corner. However, there is reason to believe IPGP may not have seen the last of the headwinds that have given it problems. Why will be covered next.

IPGP sprints past the forecast

Not much was expected from IPGP heading into the Q1 report. IPGP had guided for revenue of $320-350M and EPS of $0.85-1.15, but the top and the bottom line blew past expectations. IPGP grew instead of contracting. Q1 revenue increased by 7% YoY to $370M and EPS increased by 4% YoY to $1.31. Growth was driven by products for emerging applications, which reached 36% of revenue.

Still, margins declined YoY, although they improved QoQ. It's also worth noting that earnings growth had some help with a foreign exchange gain of $6M. In addition, EPS growth benefited from share buybacks. IPGP spent $79M to buy back 600,000 shares, which is the most ever. IPGP expects buying to continue in Q2. The table below shows the numbers for Q1 FY2022.

(GAAP)

Q1 FY2022

Q4 FY2021

Q1 FY2021

QoQ

YoY

Revenue

$369.979M

$364.467M

$345.585M

1.51%

7.06%

Gross margin

46.4%

45.5%

47.5%

90bps

(110bps)

Operating margin

25.2%

23.3%

25.7%

190bps

(50bps)

Operating income

$93.143M

$84.803M

$88.842M

9.83%

4.84%

Net income (attributable to IPGP)

$69.572M

$65.087M

$68.127M

6.89%

2.12%

EPS

$1.31

$1.21

$1.26

8.26%

3.97%

Source: IPGP Form 8-K

Guidance calls for Q2 revenue of $355-385M, a decline of 0.46% YoY at the midpoint. The forecast expects EPS of $0.95-1.25, a decline of 14.7% YoY at the midpoint. These numbers are worse than before, but IPGP may just be cautious with its forecast, similar to how the Q1 numbers ended up being much better than predicted.

(GAAP)

Q2 FY2022 (guidance)

Q2 FY2021

YoY (midpoint)

Revenue

$355-385M

$371.7M

(0.46%)

EPS

$0.95-1.25

$1.29

(14.73%)

Some positives and negatives from the Q1 report

IPGP was able to beat thanks to strong performances from almost all regions, including the U.S., Japan and Europe in particular. The latter stood out with a YoY increase of 27%. Even China was better than before. China still declined by 7% YoY in Q1, but that was better than the 20% decline in Q4. As a result, non-China revenue increased as a proportion of total revenue, which is something IPGP has been aiming for. China's share fell from 40% to 35% YoY, which means non-China revenue was 65%.

On the other hand, IPGP believes about 10% of Europe's growth was due to the pulling forward of demand. Even so, 17% growth is still a very good number. From the Q1 earnings call:

"Sales increased 27% in the region, as a result of higher demand across many different applications, including cutting, welding, cleaning, solar cell manufacturing and advanced applications. We believe that about 10 percentage points of this growth was attributed to pull forward of demand from the second quarter as customers were securing supply."

A transcript of the Q1 FY2022 earnings call can be found here.

However, there were some less positive developments. As shown earlier, Q1 margins declined with higher transportation costs, higher cost of goods and higher inventory reserves all having a negative impact. Moreover, there is reason to believe the decline in margins is set to continue. IPGP has a large manufacturing presence in Russia and recent geopolitical events have taken a toll on the company.

In order to hedge against possible supply chain disruptions due to sanctions and other spillover effects, IPGP has adopted a multi-pronged approach to the problem. First, IPGP increased its inventories. Second, IPGP is in the process of reducing production in Russia, including halting new investments. At the same time, IPGP is increasing the share of production in the U.S. and Europe by upgrading production facilities and adding additional employees.

Finally, IPGP is bringing in third-party suppliers to get around possible trade barriers. These measures should help reduce the possible fallout from the situation in Russia, although they will still take time and come at a cost. This being the case, margins are likely to contract in the coming quarters as a consequence.

The market has second thoughts about IPGP

The market's initial reaction to the big earnings beat from IPGP was very positive. The stock gained 18% at one point, but it ended the day with more modest gains of 8%. The intraday highs put the stock in a position to briefly peak above the downtrend that has been in place since the start of 2022, but the stock failed to follow up. The downtrend remains in place. The stock has since given back most of the post-earnings gains and it is basically back to where it was pre-earnings.

IPGP chart

Source: finviz.com

Note how in the chart above the stock has lost huge chunks of its value, starting from when the stock collapsed in August of last year for reasons discussed in an earlier article. In 2022 alone, IPGP is down 41% YTD. Still, there are signs IPGP may be close to bottoming. The stock has outperformed recently. While tech stocks have sold off in the last few days, IPGP's losses were much more modest. For instance, IPGP lost only 0.2% on Monday, the day the Nasdaq lost over 4%.

It's also worth mentioning that the region around $100 has served as a pivot point on multiple occasions going all the way back to 2015. It's a place where the stock has reversed course after finding support, but also resistance. The stock's decline has decelerated, suggesting some level of support. If support holds, going long at this point could pay off handsomely, especially in the long run, with the stock close to a support level that should be sturdy based on past history.

Having said that, the trend is still pointing down. The stock needs to reverse course soon because if it does not stay above say $95 or so, it's almost certainly heading for the next support level, possibly around $80. In addition, if the stock gets there, the region around $100 becomes resistance and overcoming it will be a challenge if past behavior is any indication.

IPGP is much cheaper than it used to be

The stock has been in decline for quite some time. As a consequence, IPGP is trading at multiples that are way below where they have been in recent years. For instance, IPGP has an enterprise value of $3.86B thanks to its cash hoard of $1.4B, which is equal to 8.5 times EBITDA on a trailing basis and 8.7 times EBITDA on a forward basis. Both are roughly 50% below the 5-year average. If someone was looking for IPGP, but was turned off by multiples, then now may be a good time to dip your toes into the water. The table below shows the multiples IPGP trades at.

IPGP

Market cap

$5.24B

Enterprise value

$3.86B

Revenue ("ttm")

$1,485.3M

EBITDA

$454.4M

Trailing P/E

19.39

Forward P/E

20.69

PEG

0.42

P/S

3.62

P/B

1.96

EV/sales

2.60

Trailing EV/EBITDA

8.50

Forward EV/EBITDA

8.73

Source: Seeking Alpha

Investor takeaways

IPGP has been dealing with headwinds for several quarters now. Sales are falling in China, IPGP's biggest market by far. Problems in your number one market will invariably impact the quarterly results and that has certainly been the case for IPGP. IPGP was expected to report another bad quarter, but IPGP was able to surprise with Q1 earnings that were much better than expected, although it had some help with foreign currency gains and record share buybacks a factor.

Nevertheless, the fact remains there were a number of positive developments in Q1. New products have gotten a good reception from the market. All major sales regions came in better than expected. The U.S. and Japan made solid contributions, but it was Europe that was the big difference, although partially as a result of the pulling forward of future demand. IPGP is trying to reduce its reliance on China and if recent performance out of Europe and other sales regions continues, IPGP may just get it done. The Q1 report was good enough to cause some to think that IPGP may have finally turned it around.

However, it may be too early to tell if IPGP is indeed on the road to recovery. Europe outperformed and China was not as bad as feared, but whether they continue to do so remains to be seen with both economies showing signs of weakening. In fact, the global economy as a whole is likely to slow down with inflation running high and economies tightening their belts, which does not bode well for the industrial demand that IPGP caters to.

The fact that the market reversed course after an initial rally suggests that it too has doubts about the sustainability of IPGP's most recent quarterly performance, especially in Europe due to recent geopolitical events. In any case, margins and therefore earnings are very likely to come under pressure due to the need to make changes to the existing supply chain involving Russia.

A previous article suggested that the stock was likely heading for $100, give or take, an area which has often served as major support and resistance. Getting there would also be a 100% retracement of the move upwards starting from the low in March 2020. As it turned out, this proved to be correct as that is where the stock is at the moment. The fact that the stock bounced at around this price point is an encouraging sign that support is making its presence felt. On the other hand, support may not hold in the future. The stock could go lower. The trend suggest it will.

The Q1 report was a positive sign, but I remain neutral on IPGP. It's just way too early to tell if IPGP has indeed turned the corner or whether there are more setbacks in store. Recent geopolitical events give reason to be doubtful, especially with IPGP's large presence in Russia. IPGP needs to show that the positives from the Q1 report can be sustained and not a fluke. While multiples have gone down, there is room for them to go even lower. IPGP is still not a screaming buy with multiples where they are.

Europe and other regions performed well in Q1, but there is reason to believe their economies are heading for turbulence for a multitude of reasons, rising inflation being one of them. If, for instance, Europe falters due to a bad economy and China declines due to COVID-19 lockdowns, something that could very well happen, IPGP is unlikely to escape the fallout.

The charts suggest the stock remains in a downtrend. IPGP tried to break out of the downtrend that has been in place for all of 2022 with its Q1 report, but the breakout was rejected, suggesting overcoming resistance won't be easy. There may come a time for long IPGP, but with all of the above is mind, now does not look like it.

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