IPG Photonics ( Nasdaq - IPGP ) -- New Applications Drive Growth

IPGP Photonics (IPGP $70.00) is the leading manufacturer of lasers that use fiber optics to deliver the beam.  Older technologies rely on CO-2 and YAG crystals.  Those technologies dominated the $4.5 billion industry four years ago.  IPG had been developing its systems for a decade prior to that, achieving success in niche markets that appreciated its smaller form factor and more precise tuning.  In 2011 the company was able to match its competitors selling prices, precipitating an explosive sales acceleration.  Costs have continued to decline, allowing fiber to establish a dominant position in several key industry segments.  Additional parts of the industry now are adopting fiber, as well.  IPG also is elbowing out non-laser technologies in a growing range of manufacturing operations.  Competitors are attempting to replicate IPG's success.  But the company has such a lead with key components and system integration know-how that those offerings are barely competitive in the low end.  And the company still remains largely without direct competition in the high power segment, the most profitable part of the business.

New applications are expanding IPG's horizons.  Cutting metal has been the largest sales driver to date.  Welding now is becoming a major contributor, as well.  A variety of fancier uses is emerging to provide further leverage.  Those include oil drilling, 3-D printing, brazing, coating, and engraving.  Non-manufacturing applications represent only 5% of sales currently.  But those are poised to expand over the next few years, as well, particularly in semiconductor processing, medical applications, and telecommunications.

Demand is strongest in Europe and Asia, especially China.  The U.S. accounts for approximately 10% of sales.  Core applications in both of those international regions continue to perform well despite reports of macro-economic problems.  New products are reinforcing that expansion.  Cash flow is positive, fueled by pretax margins that routinely exceed 35%.  That allows IPG to respond quickly and effectively when competitive threats develop.  Over the past year upstart producers in China cut into IPG's low end marking business.  The company engineered a low cost line of its own, with regular margins, that turned back the tide.  Traditional laser manufacturers have been attempting to break into the fiber business.  They've succeeded to a degree with specialized products sold to longstanding customers.  Margins are believed to be tight on those units, though.  And IPG stands ready to make selective price cuts if it becomes necessary to turn the screws.

We estimate 2014 sales will advance 17% to $760 million.  Earnings appear on track to rise 22% to $3.85 a share.  Margins probably will benefit 1.0% this year from favorable currency moves.  Much of the company's production is based in Europe.  The euro's decline is lowering costs.  Next year sales could improve 15% to $875 million to support a 12% gain in earnings to $4.30 a share.  Our estimates assume margins return to normal.  IPG has a $500 million war chest that might be deployed for acquisitions.  The company has been unable to find what it wants to date.  It's been looking for a while now, so a purchase in the laser segment has become increasingly less likely.  But a move into a related business remains a possibility.  3-D manufacturing, for instance, might provide a high rate of return on the surplus cash now being generated by the fiber laser business.  If nothing emerges, a stock repurchase or dividend program could be established.

( Click on Table to Enlarge )

IPG Photonics ( Nasdaq - IPGP ) -- Margins Compress

IPG Photonics reported excellent on target Q4 results.  Performance was affected by the punk macro economic backdrop.  European business was especially slow.  Despite that sales achieved our estimate, improving 17% to $145.0 million.  Earnings were a nickel above our projection at $.69 a share (+3%).  Manufacturing margins declined to 51% compared to 53% in the year ago quarter.  IPG Photonics aims for a range of 50%-55%.  Product mix was the main factor behind the decline.  Competition began to emerge for the first time, moreover.  IPG Photonics created the high power fiber laser industry.  Other laser producers have a background in Yag crystal and CO-2 gas systems.  Fiber units eclipsed the older technologies in 2011 and have been gaining market share ever since.  Competitors have been racing to develop fiber systems of their own.  IPG Photonics remains far ahead in terms of overall price performance.  But competitors have zeroed in on some niche markets.  And while their production costs are substantially higher for now they are pricing aggressively to gain a foothold in the business.

Large scale users continue to rely on IPG Photonics.  New applications are being developed, moreover.  So even if competitors take slices of the company's existing markets overall volume is poised to keep rising.  The fiber category is likely to capture a larger portion of the overall laser industry in future years, as well.  Margins probably will come down a little bit as IPG Photonics enters new areas and competition exerts a modest degree of pressure on the more straighforward parts of the business.  But profitability is poised to stay high as IPG Photonics sustains its industry leading technology.

Our 2013 forecast assumes more economic weakness.  If demand picks up a significantly better showing could develop.  For now we estimate sales will climb 15%-20% to $650-$675 million to provide income of $3.15-$3.35 a share.  Longer term growth might be amplified with acquisitions.

( Click on Table to Enlarge )