IPG Photonics (IPGP) is one of those rare companies that is at the forefront of groundbreaking technology. IPGP is focused on fiber lasers, as laid out in its annual report:
Although low-power fiber lasers were introduced four decades ago, their recent adoption has been driven primarily by our improvements in their output power levels and cost as well as their superior performance and lower cost of ownership compared with conventional lasers.
Superior performance, lower cost, ease of use, compact size, and choice of wavelengths and precise control of beam are all advantages of fiber lasers over conventional gas and crystal lasers. In addition to its many existing uses, IPGP is positioned at the forefront of nanotechnology applications which need precise manufacturing capability.
The story behind the laser company is an interesting one. Valentin Gapontsev founded the company in 1990 and is currently CEO. He is an expert in laser technology, with the following background before founding IPGP:
Prior to that time, he served as senior scientist in laser material physics and head of the laboratory at the Soviet Academy of Science’s Institute of Radio Engineering and Electronics in Moscow. He has over thirty years of academic research experience in the fields of solid state laser materials, laser spectroscopy and non-radiative energy transfer between rare earth ions and is the author of many scientific publications and several international patents. Dr. Gapontsev holds a Ph.D. in Physics from the Moscow Institute of Physics and Technology.
He has significant skin in the game, as he owns more than 33% of the company (worth around $1.7 billion). The top three executives on the management team have been with company since 2000, and IPGP is headquartered in Oxford, Massachusetts.
One other possible competitive advantage for IPGP is its vertical integration in terms of parts and the design process. That allows IPGP to control the manufacturing process from start to finish.
Generally, we do not sell our proprietary components to third parties in significant quantities. Using our technology platform, we configure standard products based upon each customer’s specifications.
Moreover, IPGP has expanded into a wide array of industries. Here are some of the applications of its fiber lasers:
As the business expands, IPGP also benefits from its support services business, which will be a major source of future revenue growth on a larger installed customer base.
Financially, sales and earnings have grown in each of the past 5 years, an indication of the secular uptrend for fiber laser demand. Gapontsev is clearly a manager more focused on the details of the business than financial engineering, as IPGP has a very clean balance sheet with minimal debt and simple, straightforward line items. Operating free cash flow is very closely correlated to net income growth, meaning a simple Price-to-earnings valuation is reasonable. At a P/E of 25x, IPGP looks fairly valued given average annual EPS growth of 25% over the past 3 years.
Given the company’s historical success, the bull case is easy to make. What are some of the risks?
First, IPGP is the first to admit that it does have significant cyclical business exposure:
For example, our sales decreased by 25% in the materials processing market in 2009 as a result of the global economic recession.
Second, the company has a high fixed cost base:
We have a high fixed cost base due to our vertically integrated business model, including the fact that approximately 79% of our approximately 2,800 employees as of December 31, 2013 were employed in our manufacturing operations.
Third, founder and CEO Gapontsev is 75, and many of the other key executives are over the age of 60.
Fourth, IPGP is dependent on the replacement cycle for lasers, but that’s likely still in the early stages:
To date, a significant portion of our revenue growth has been derived from sales of fiber lasers primarily for applications where CO2 and YAG lasers historically have been used.
Fifth, significant competition in both conventional lasers and fiber lasers, though IPGP’s product and technical lead in fiber lasers seems substantial.
Finally, 30% of its sales are to China, and another 10% to Russia, which could be considered a short-term risk, and possibly a long-term positive.
As a stock, IPGP was actually quite stagnant over the past 2 years until the breakout above $80 in early February:
The options market in IPGP is relatively illiquid, with no line of over 500 contracts of open interest. However, this is an interesting stock in a budding sector that could be attractive on a pullback to the breakout area near $80-$85.