IPGP - IPG Photonics: Just Going Through The Motions

2023-11-10 05:41:50 ET

Summary

• IPGP has seen its stock bounce in recent days, and while this could continue with the stock price below $100, a sustained rally will be difficult to accomplish.
• The latest report came in mixed with guidance weaker than expected, but the outlook managed to offset it with the promise of improvement.
• The top and the bottom line at IPGP have been under pressure for years and this could continue with all the root causes still present.
• IPGP is worth considering as a short-term play, but the argument becomes more difficult as a long-term play.

The Q3 FY2023 report from IPG Photonics Corporation (IPGP) arrived just in time on October 31 to stem the slide in the stock. The stock was in the midst of a major decline that wiped out all of IPGP's 2023 gains and then some, but the latest report helped enable a turnaround, although other factors played a role also. However, while a short-term rally is possible, a sustained rally is likely not in the offering as IPGP has yet to find the solution to its core problems. Why will be covered next.

IPGP bounces in familiar territory

A previous article from last August theorized why there was reason to believe lower stock prices were very likely in the pipeline. So even though the stock had bounced after a major drop, which might have caused some to believe the worst had passed, the article nonetheless cautioned against getting in on IPGP. IPGP was rated a hold accordingly, which turned out to be warranted with the stock resuming its slide in September and October as shown below.

The stock kept sliding until it hit a 2023 and 52-weeks low of $83.00 on October 31, but that was as far as it got. It's worth mentioning that the bounce coincided with a rally in the stock market, which tends to lift all stocks to some extent. The stock was also oversold after falling for months and was due for a bounce for that reason alone.

Still, the arrival of the Q3 report on that same day did not hurt, although it could have if the report did not offset the bad with the good. Nevertheless, IPGP has underperformed with the stock down 3% YTD in a year which has been pretty good for stocks in general. The SPDR S&P500 ETF ( SPY ), for instance, has gained 14.3% YTD in comparison.

The last four months or so have not been great for IPGP. Not with the stock losing 35.3% of its value after reaching the 2023 high of $141.85 as recently as July 13, the culmination of a rally that started with the November 2022 low of $79.88. It's also worth noting that while the stock came close, the stock did not complete a 100% retracement of the preceding uptrend, starting with the November 2022 low of $79.88 and ending with the July 2023 high of $141.85.

There are no guarantees, but the stock could go lower to complete the retracement. So while the stock has put in a strong bounce post-earnings, a trip down to lower levels might still be in store. If the stock is to continue higher, it will likely have to overcome resistance that lies ahead. The first resistance level is probably at $94.50 or so, not far from where the stock is right now at $91.81. If the stock manages to clear the first hurdle, the next hurdles to overcome are around $103.55 and $110.87.

The Q3 FY2023 report came in mixed

As mentioned earlier, the rally of the last few days coincided with the arrival of the latest earnings report. However, this Q3 FY2023 report came in mixed. On the one hand, Q3 EPS of $1.16 surpassed expectations by $0.14, but Q4 guidance called for a sequential decline in revenue instead of the sequential increase expected.

The consensus expected Q4 revenue of $316M, but guidance calls for Q4 revenue of $270-300M, a decline of 5.4% QoQ and 14.5% YoY at the midpoint. The forecasts sees EPS of $0.85-1.10, which is much better than a year ago, but keep in mind that Q4 FY2022 was weighed down by a number of charges, including a $79M impairment charge and a $74M inventory provision charge, which led to a net loss of $92.9M or $1.91 per share in Q4 FY2022.

Source: IPGP Form 8-K

The table below shows how the numbers have tended to slide in general. Revenue, for instance, declined YoY for the fifth consecutive quarter. Note that Q3 FY2022 was boosted by a $21.7M or $0.32 per share gain related to a divestiture, which reduced operating expenses and thus increased EPS in that quarter, skewing the quarterly comparisons with Q3 FY2023.

Contrary to some expectations, IPGP opted to spend $46M on share repurchases in Q3, which reduced the weighted-average of shares outstanding to 47,388K. Nevertheless, IPGP has cut back on stock buybacks. IPGP, for instance, spent $500M on stock buybacks in 2022, a major reason why IPGP's cash reserves have come down from where they used to be. The flip side of less buybacks is that cash reserves have stabilized and are no longer dropping like before. IPGP is sitting on cash, cash equivalents and short-term investments of $1,133.5M with no debt as of Q3, up from $1,096.4M in Q2.

Management added some color to the Q3 results. In general, IPGP is dealing with weak demand. Book-to-bill, for instance, was below one, a sign of weak demand. From the Q3 earnings call;

"Third quarter book-to-bill was below 1 with macroeconomic uncertainty resulting in a project delays and reduced orders in all major manufacturing regions. Leading manufacturing indicators in Europe are trending to the lowest level since the 2008 recession."

A transcript of the Q3 FY2023 earnings call can be found here .

On the other hand, IPGP countered the weaker-than-expected guidance with an outlook that suggested an improvement in demand is to be expected.

"Although we have limited visibility into orders beyond fourth quarter, we continue to believe the battery investment in China should restart in 2024 as electric vehicle sales continue to increase. Investments in battery capacity outside of China is in the early stages and should increase in the next several years as well.

We also expect some benefits from government spending and onshoring activities to benefit industrial activity in the U.S."

Consensus estimates are banking on it. The consensus is that IPGP will finish FY2023 with GAAP EPS of $4.64 on revenue of $1.28B, but this is expected to increase to $5.10 on revenue of $1.37B in FY2024. In comparison, IPGP earned $2.16 on revenue of $1.43B in FY2022 and $5.16 on revenue of $1.46B in FY2021. Keep in mind FY2022 EPS was negatively affected by charges as mentioned earlier.

Why IPGP could be considered a speculative play

While revenue and earnings may improve somewhat in the coming quarters, it's worth pointing out that growth has been hard to come by for IPGP in the last 5 years or so. Revenue, for instance, has been rather flattish in FY2017-2022. EPS too has generally declined, down from the peak of $7.38 in FY2018. On the other hand, the asking price for IPGP has come down from where it used to be.

The table below shows how multiples are generally below where they have tended to be on average in the last five years. Forward EV/EBITDA, for instance, is in the single digits at 9.7. Note that the trailing GAAP P/E is weighed down by the $1.91 loss in Q4 FY2022, which was caused by various charges.

Source: Seeking Alpha

An argument can also be made that IPGP is currently trading below fair value. True, fair value is highly subjective and the forward projections required may turn out to be incorrect. Nevertheless, if using the discounted cash flow method, and if we assume free cash flow grows from $234M to $336M in the next five years on revenue of $2B and with a discount rate of 8.85%, then it can be argued that fair value for IPGP is around $100-101. This is above the current price of $91.81. It could also help explain why the stock tends to trade back into the triple digits whenever it falls below $100 or so.

Investor takeaways

IPGP has not done all that well lately, and really for much of 2023, but a powerful stock market rally and a timely earnings report had enough to propel the stock upwards. It also came on the heels of a long decline, which meant the stock was oversold and due for a bounce. While guidance was on the soft side, the rest of the report contained enough to keep alive the prospect of better numbers in the near future.

The stock is currently trading below $100. In recent years, whenever the stock price fell below triple digits, the stock did not take long to trade back above the $100 level. IPGP fell below $100 in August, so some may want to play a return to the triple digits in short term. There are multiple methods used to calculate fair value, but at least one method suggests the stock price should be closer to $100. Multiples for IPGP are also lower than the average in recent years.

Nothing is set in stone, but speculators may want to bet on IPGP trading higher due to the above. However, while there's a case to be made for IPGP as a short-term play, this becomes harder to do for the longer term. IPGP continues to struggle with demand issues. Book-to-bill, for instance, was once again below one.

The latest report suggests IPGP has yet to find a real solution. IPGP is trying to offset the pressure on the bottom line with various measures, including stock buybacks, cutting back on expenses and the introduction of new products, but while some progress has been made, the overall situations has not really changed for the better.

Keep in mind that sales and profits at IPGP have been under pressure for years. Revenue, for instance, has shrunk by 2.37% on average for the last five years. EPS has been even worse. GAAP EPS peaked at $7.38 in FY2018 after rising year after year, but since then, EPS has fallen by 24%, on average, per year.

Remember that this could have been even worse if IPGP had not spent hundreds of millions to buy back shares to prop up EPS. Some market segments are doing better and emerging products are showing growth, but overall, IPGP is a company whose business is flat at best or, worse, in decline and this has been the case for years.

The lack of demand is caused by a number of reasons. China has arguably been the biggest factor contributing to the weakness since China remains IPGP's biggest market at 29% YTD and the struggles there are driven by several factors, including local competition. Another is that industrial growth is no longer as strong as in past years. The various issues related to the economy are also present in North America and Europe in particular.

Furthermore, there is reason to believe weak economic conditions is likely to give IPGP problems for the foreseeable future. In fact, an argument can be made that while IPGP, or its stock to be exact, could rally temporarily, a sustained rally will be difficult to accomplish as long as it is unable to grow the business due to soft demand in general.

I am neutral on IPGP, Some may want to consider IPGP as a short-term play by betting that the stock will stick to historical patterns and trade back into the triple digits. On the other hand, those who are are looking at IPGP more as a long-term play may want to take note of the underlying issues that have caused earnings to shrink for years.

Earnings are going down and while the newer products have been well received, they have yet to change the overall trajectory of where earnings are heading. All the factors that have led to this remain and while IPGP is working on the problem, IPGP has yet to find the solution to get out of its predicament. As long as this holds true, earnings are likely to remain under pressure the way they have for years. It will be hard for IPGP, or any other stock for that matter, to keep rallying while this is the case.

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