After an auspicious beginning, 2018 ended on a sour note for IPG Photonics (NASDAQ:IPGP). The maker of industrial lasers signaled in July that the growing trade war between the U.S. and China and softening demand in Europe would take a toll on its third-quarter results. This news rattled investors, sending the stock slumping by more than 25%.
Things were even worse than feared, as the company missed expectations for the third quarter as well as its own tepid guidance, resulting in further declines. The trade war is no closer to being resolved, which will likely affect IPG when the company reports the financial results of its fourth quarter before the market open on Tuesday, Feb. 12.
Let's recap the results of last quarter as well as recent trade developments to see if it provides any insight into what investors can expect when IPG reports earnings.
A worse-than-expected performance
For the third quarter, IPG Photonics reported revenue of $356 million, a decline of 9% year over year, missing the low end of the company's revised guidance. The pain continued all the way to the bottom line, where operating income of $124 million fell 23%, resulting in earnings per share of $1.84, down 13%. Both numbers fell far short of analysts' consensus estimates.
The company continued to see strong sales in North America, growing by 29% year over year there, but that was more than offset by softness in China and Europe, where sales fell by 9% and 25%, respectively.
Dr. Valentin Gapontsev, IPG Photonics' Chief Executive Officer said, "Global macroeconomic and geopolitical headwinds have persisted into the fourth quarter ... and we expect currency headwinds to be greater in the fourth quarter than in the third quarter." To give that some perspective, foreign currency exchange rates knocked more than $5 million off the top line compared to the company's expectations.
What's causing the slowdown
IPG believes the trade war is having a negative impact on demand for IPGP's industrial lasers, particularly since China is a major customer. The biggest contributor to that is the declining value of the Chinese currency compared to the U.S. dollar. Unfortunately, that may be extending to Europe. During the conference call discussing the results, Gapontsev said, "We believe tariff and trade-related headwinds were the primary driver of weaker than expected performance for our business in China and Europe." He went on to say that uncertainty caused by a "softening macroeconomic climate" in those major markets was causing customers to delay purchases of IPG's lasers.
Then there are concerns about tariffs. In July 2018, the U.S. imposed $250 billion in tariffs, while China has responded with $110 billion of its own. The U.S. initially planned to increase the rate of tariffs from 10% to 25% on $200 billion worth of Chinese goods effective Jan. 1, but it has since delayed implementation until March 1 in order to give leaders further opportunity to reach an agreement.
Fortunately, IPG is somewhat insulated from these dueling tariffs, as the company has facilities in Germany it can use to manufacture lasers for the Chinese market, thereby avoiding some of the negative impact.
What the quarter may hold
For the fourth quarter, IPG has forecast revenue in a range of between $300 million to $330 million. If the company meets this goal, it would represent a decline of between 9% and 17% year over year -- and even that's not a given. The company is expecting earnings per share to come in a range of $1.30 to $1.50, which would represent an increase of 35% to 56% compared to the prior-year quarter -- but that requires context.
In fourth-quarter 2017, a one-time tax charge reduced IPG's earnings per share by $0.90. Adjusting for that anomaly results in earnings per share that will fall between 19% and 30% compared to the year-ago quarter.
There isn't any indication that the trade war will end anytime soon, and IPG has been clear that the situation will likely continue to affect sales in China and Europe. Obviously, the company has no control over geopolitical issues or the economy, and investors should keep this in mind and resist making rash decisions.
We'll know more when IPG reports earnings before the market open on Feb. 12.