Why IPG Photonics Hasn’t Held Onto Gains This Year

Less than two weeks ago, we crossed the halfway point for 2012. Checking and worrying about your stocks on a daily basis is never a good idea -- but it’s worth checking in with your holdings every six months or so.

When it comes to manufacturing stocks, optimism has been held in check by worries of slowing global demand. Below, I’ll explain why IPG Photonics (Nasdaq: IPGP), which is at the cutting edge of fiber-optic lasers, is no exception to this trend. The company has continued to produce encouraging results, but the market keeps shrugging these numbers off.  Before diving in, though, let’s take a look at how IPG has fared versus the S&P 500 in 2012.

IPGP Total Return Price data by YCharts

As you can see, the stock is still beating the S&P 500 this year,  which is great. But it’s down 30% since mid-February, and the company has given the market pretty great results in the interim.  Let’s look at some metrics to better figure out why this is the case.
 

Source: SEC filings, Yahoo! Finance.

Though IPG may look a little expensive on a cash flow basis, this is largely because the company is fully integrated, and there are large capital expenditures involved as it tries to expand capacity to meet demand.

The most important thing to know about IPG is that its fiber-optic technology is changing the world of lasers, which historically used carbon-based machines produced by the likes of Rofin-Sinar Technologies (Nasdaq: RSTI) and Coherent (Nasdaq: COHR). Though they started out being less powerful and efficient, fiber-optic lasers have made staggering advances that have completely disrupted the industry.

The company actually got out to a quick start in 2012. not because of an earnings release, but due to a presentation at an investor conference that convinced others that the stock was underpriced relative to its potential.

IPG also impressed investors when it came out with first quarter earnings in May.  Not only did profit increase at a faster pace than impressive revenue growth, but the company gave a rosy outlook moving forward.

So why is the company down? Though IPG was the first-mover in the industry, Newport Corporation (Nasdaq: NEWP) and JDS Uniphase (Nasdaq: JDSU) have entered the fray with fiber-optic lasers of their own. But this alone doesn’t account for the stock’s fall since February.

It has to do with the company’s unique business model, and how it interacts with macroeconomic shifts.  Because it’s a vertically integrated company -- it manufactures all the parts used in its lasers, instead of buying them from someone else -- IPG does very well in boom times, but can struggle when the economy heads south. 

About 84% of IPG’s revenues come from companies using the lasers for materials processing. This means that lasers are used for cutting and welding of large sheets of metal for manufacturing. The auto industry production line would be a perfect example of how the lasers are used.

But these businesses are highly sensitive to economic cycles. With three big uncertainties looming over the global market, investors just haven’t been willing to put their faith behind the company. Personally, I think long-term investors shouldn’t heed such worries, and I’ve backed that sentiment up in both my personal portfolio, and on my All-Star CAPS profile.

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