Fiber laser manufacturer IPG Photonics (NASDAQ:IPGP) missed analysts' expectations in Q2 FY2023, with revenue down 9.83% year on year to $340 million. IPG Photonics made a GAAP profit of $62.3 million, improving from its profit of $57.3 million in the same quarter last year.
IPG Photonics (IPGP) Q2 FY2023 Highlights:
- Revenue: $340 million vs analyst estimates of $346.2 million (1.79% miss)
- EPS: $1.31 vs analyst estimates of $1.24 (5.65% beat)
- Revenue Guidance for Q3 2023 is $315 million at the midpoint, below analyst estimates of $358.9 million
- Free Cash Flow of $40.9 million, up from $3.88 million in the previous quarter
- Inventory Days Outstanding: 233, up from 230 in the previous quarter
- Gross Margin (GAAP): 43.4%, down from 45.7% in the same quarter last year
Both a designer and manufacturer of most of its products, IPG Photonics (NASDAQ:IPGP) is a provider of high-performance fiber lasers that are used for cutting, welding and processing raw materials.
IPG Photonics was founded in 1990 by Valentin Gapontsev, a Russian physicist. Gapontsev pioneered a proprietary all-fiber technology platform for fiber lasers and amplifiers. IPG went public in 2007 and was included in the S&P 500 in 2018.
A laser converts electrical energy to optical energy that can be focused and shaped, creating a concentrated beam that causes materials to melt, vaporize or otherwise change their character. In materials processing, lasers are gaining market share from traditional machine tools (e.g. saws, presses) because of the greater precision, processing speeds, and flexibility.
Semiconductor manufacturers employ lasers for key steps such as lithography (3D relief images on the substrate) and annealing (heating wafers to change electrical properties). With regards to annealing, for example, IPG Photonics’ lasers can create extremely localized heating with fine depth penetration control and precise positioning; this allows target structures to be heated without affecting other surrounding heat-sensitive materials. The company also offers complementary products used with IPG’s lasers such as optical cables and beam switches to deliver and apply the lasers. Other than semiconductor applications, the most common uses for IPG’s products are industrial cutting/welding, 3D printing, and marking/engraving.
Competitors offering laser products for materials processing include Coherent (NASDAQ:COHR), Laserline, Lumentum (NASDAQ:LITE), and Maxphotonics.Sales Growth
IPG Photonics's revenue growth over the last three years has been unimpressive, averaging 6.17% annually. This quarter, its revenue declined from $377 million in the same quarter last year to $340 million. Semiconductors are a cyclical industry, and long-term investors should be prepared for periods of high growth followed by periods of revenue contractions (which can sometimes offer opportune times to buy).
IPG Photonics had a difficult quarter as revenue dropped 9.83% year on year, missing analysts' estimates by 1.79%. This could mean that the current downcycle is deepening.
IPG Photonics may be headed for an upturn. Although the company is guiding for a year-on-year revenue decline of 9.74% next quarter, analysts are expecting revenue to grow 9.15% over the next 12 months.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) is an important metric for chipmakers, as it reflects a business' capital intensity and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise, the company may have to downsize production.
This quarter, IPG Photonics's DIO came in at 233, which is 20 days above its five-year average, suggesting that the company's inventory has grown to higher levels than we've seen in the past.
Pricing Power
In the semiconductor industry, a company's gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor. IPG Photonics's gross profit margin, which shows how much money the company gets to keep after paying key materials, input, and manufacturing costs, came in at 43.4% in Q2, down 2.3 percentage points year on year.
IPG Photonics's gross margins have been trending down over the last 12 months, averaging 36.8%. This weakness isn't great as IPG Photonics's margins are already far below other semiconductor companies and suggest shrinking pricing power and loose cost controls.
Profitability
IPG Photonics reported an operating margin of 23.5% in Q2, down 7.9 percentage points year on year. Operating margins are one of the best measures of profitability because they tell us how much money a company takes home after manufacturing its products, marketing and selling them, and, importantly, keeping them relevant through research and development.
IPG Photonics's operating margins have been trending down over the last year, averaging 15.4%. This is a bad sign for IPG Photonics, whose margins are already among the lowest for semiconductors. The company will have to improve its relatively inefficient operating model.
Earnings, Cash & Competitive Moat
Analysts covering IPG Photonics expect earnings per share to grow 26.9% over the next 12 months, although estimates will likely change after earnings.
Although earnings are important, we believe cash is king because you can't use accounting profits to pay the bills. IPG Photonics's free cash flow came in at $40.9 million in Q2, down 7% year on year.
As you can see above, IPG Photonics produced free cash flow of just $112.1 million in the last year, resulting in a measly 8.16% free cash flow margin. IPG Photonics will need to improve its free cash flow conversion if it wants to stay competitive.
IPG Photonics's average return on invested capital (ROIC) of just 17.2% over the last 5 years is fairly low compared to other semiconductor companies. This underperformance suggests that the company tied up a lot of capital to achieve grow or maintain profits.
Key Takeaways from IPG Photonics's Q2 Results
With a market capitalization of $6.22 billion, IPG Photonics is among smaller companies, but its $1.1 billion cash balance and positive free cash flow over the last 12 months give us confidence that it has the resources needed to pursue a high-growth business strategy.
We struggled to find many strong positives in these results. On the other hand, its underwhelming revenue guidance for next quarter was disappointing and it missed Wall Street's revenue growth expectations. Overall, this was a mediocre quarter for IPG Photonics. The company is down 1.45% on the results and currently trades at $129.58 per share.
Is Now The Time?
When considering an investment in IPG Photonics, investors should take into account its valuation and business qualities as well as what's happened in the latest quarter. We cheer for everyone who's making the lives of others easier through technology but in the case of IPG Photonics, we'll be cheering from the sidelines. Its revenue growth has been weak, and analysts expect growth rates to deteriorate from there. On top of that, unfortunately its gross margin indicate some combination of pricing pressures or rising production costs and operating margins reveal subpar cost controls compared to other semiconductor businesses.
IPG Photonics's price-to-earnings ratio based on the next 12 months is 22.8x. While we have no doubt one can find things to like about the company, and the price is not completely unreasonable, we think that at the moment there might be better opportunities in the market.
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