IPG Photonics: The Possibility Of A Further Decline Cannot Be Excluded (NASDAQ:IPGP)

IPG Photonics Corporation (NASDAQ:IPGP), a leading manufacturer of fiber lasers, fell to new lows in August, adding to already substantial losses in the preceding months, but the stock has shown signs of recovery lately. However, it would not be prudent to assume the headwinds that led to the decline in the stock have gone away, just because the stock has stopped falling and may be in the process of bouncing. In fact, the possibility the stock has not seen the lows for 2024 cannot be dismissed. Why will be covered next.

Why IPGP has fallen through support

A past article from November 2023 believed that IPGP was worth considering as a short-term play, but making a case for IPGP as a long-term play was harder to do because of all the challenges confronting IPGP, challenges for which IPGP has yet to find a solution. For instance, while the outlook from IPGP included the promise of improvement, there was no denying the top and the bottom line at IPGP have been under pressure for years for a multitude of reasons, particularly in China. IPGP was thus rated a hold.

The chart above shows how the stock managed to rally towards the end of 2023, only to reverse course and decline to new lows in 2024. Note how for months IPGP was held aloft with the stock bouncing whenever it was in position of falling below $80 or so. Examples include the April 2024 low of $80.33, the June 2024 low of $80.27 and the July 2024 low of $79.80.

This is reminiscent of what happened as far back as November 2022 when the stock rebounded to go on a rally after the November 2022 low of $79.88. Just $0.08 separate the November 2022 low of $79.88 and the July 2024 low of $79.80, even though they are 20 months apart. Yet for all these months, the stock stayed above the $80 price point, brief dips notwithstanding.

This points to the presence of fairly strong support in the $80 region, taking into account the length of time support held its ground and the number of failed attempts to break through. However, whatever support was present failed in August 2024 because the stock broke through after two years. This after many previous attempts to break below failed, resulting in a bounce in the stock whenever this happened.

Will what used to be support become resistance for IPGP?

These latest moves are significant for a few reasons. The stock peaked in January 2021 with a high of $262.55, but then trended lower until the middle of 2022. From then on, the stock went basically sideways, with support in the aforementioned region. As such, an argument could be made in favor of long IPGP, with the charts switching from something decidedly bearish to something more neutral.

The chart below shows how the stock was contained between two trendlines for years. You had an upper descending trendline and a lower horizontal trendline, which means the two were converging on one another. This meant the stock would have to break through one of the trendlines at some point, since it would eventually run out of room. This is what happened in August 2024.

As long as the lower trendline held, the possibility existed the stock could break through the upper trendline. This would be seen as a bullish move. However, it was the upper trendlines that outlasted the lower trendline with a break below the latter. This move can be seen as bearish for a number of reasons.

First, losing support that held for as long as it did significantly weakens the case to be bullish, since one can no longer point to the presence of support like before. Secondly, the chart patterns turn more bearish with lower highs and lower lows, a trend that favors lower stock prices. True, trends do not last forever, but it is not something one should ignore.

Third, what used to be support tends to become resistance and vice versa. Support was fairly strong, which is what propped up the stock for as long as it did. The reverse is likely to be true also. If what used to be support becomes resistance, then the stock is not likely to have an easy time overcoming resistance, just as it was not easy to break through support. If resistance is in place in the $80 region where support used to be, then the path of least resistance is for the stock to head lower until the next line of support.

Is there something that could drive the stock to new lows in 2024?

The drop below support in the $80 region happened on August 1. The decline in the stock continued in the days thereafter until the stock hit a low of $65.03 on August 12, but it moved higher since, if slowly. This decline in August occurred for a number of reasons. It happened against a backdrop of a stock market selloff for a number of reasons, including tensions in the Middle East. IPGP got pulled along.

Still, while it can be said that the drop below support was the result of factors outside of IPGP’s control, it is worth noting that the stock fell prior to all of this happening. What brought the stock close to the point of losing support in the $80 region was the release of the Q2 FY2024 report. The stock dropped because the most recent earnings report was a letdown in a number of ways.

For instance, the consensus expected guidance to aim for GAAP EPS of $0.80 on revenue of $283M in Q3 FY2024, but IPGP is calling for $0.00-0.30 on revenue of $210-240M, a pretty big miss. Keep in mind this comes on the heels of nine consecutive contractions in quarterly revenue, starting in Q2 FY2022, which would make Q3 FY2024 the tenth consecutive quarter revenue has shrunk YoY at IPGP. IPGP has problems that go a long way back.

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Source: IPGP Form 8-K

The preceding or Q2 FY2024 quarter was also worse than expected. IPGP earned $0.45, $0.06 less than expected, on revenue of $257.6M. If not for stock buybacks, EPS could have been even worse. IPGP finished Q2 FY2024 with cash, cash equivalents and short-term investments of $1,063.8M and no debt on the balance sheet. Book-to-bill was below one. The table below shows the numbers for Q2 FY2024.

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Source: IPGP Form 8-K

The outlook has deteriorated for IPGP

Prior to the latest updates, IPGP suggested a stronger second half was possible. For instance, book-to-bill in the second-to-last report or the Q1 FY2024 report rose to above one, up from below one in the preceding quarter, suggesting an improvement in demand. This seemed to affirm IPGP’s assessment at the start of FY2024 that growth was achievable in the second half of FY2024, putting an end to the recent contraction. From the Q4 FY2023 earnings call:

“I think the first half of the year will continue to be, or will be, will be very challenged. But I’d like to target and we are targeting maybe some moderate growth on a year-over-year basis in the second half of the year.

clearly, given the weakness we had in the second half of last year, that shouldn’t be too difficult to do if we see even a basic recovery and things. But I think it would be good to get back into some growth on a year-over-year basis. And that’s certainly what we’re trying to target.”

Source: IPGP Q4 FY2023 earnings call

But not only did book-to-bill deteriorate back to below one in Q2 FY2024, IPGP sees a recovery no sooner than sometime in 2025 at the earliest. From the Q2 FY2024 earnings call:

“We’re seeing more stable demand sequentially in China, but macroeconomic uncertainty is still negatively impacting demand across general industrial markets and applications in Europe and North America. While we believe strongly in the future of EVs, the well-publicized slowdown in EV adoption in Europe and US has prompted several customers to delay further investment in battery capacity around the world. Our prior expectation for a rebound in demand in the second half seems less likely to materialize, and we currently are not expecting to see a meaningful recovery in our laser sales until sometime in 2025.”

Source: IPGP Q2 FY2024 earnings call

Could the numbers get worse for IPGP?

The latest guidance was much worse than expected, but it is possible that the worst is yet to come. Q3 FY2024 is still expected to post a profit, or break even at the low end of guidance, but if Q4 FY2024 gets worse and IPGP posts a loss, then that might be enough to drive the stock lower on the back of deteriorating results.

A book-to-bill below one does not bode well for the next report, which is supposed to include Q4 FY2024 guidance. In addition, there is reason to believe IPGP could experience a further contraction in demand in the main sales regions of China, Europe and the U.S. China was tops with a contribution of a quarter of total revenue, which was relatively flat QoQ, but this is down from the over 50% where it used to be.

IPGP has had more success with new products in China, but the Chinese market seems to be in a structural decline with IPGP ceding market share to local players, especially when it comes to applications like cutting. IPGP still gets about 5% from that market, so in theory the decrease in China sales could have further to go.

Europe also seems to be nowhere close to bottoming. Industry is contracting in Europe, Germany in particular, due to structural problems, especially the high cost of energy. Similar to China, the problem in Europe can also be seen as a long-term, structural problem for IPGP, which cannot be resolved easily, and certainly not in the short term.

The U.S. has been a somewhat better market for IPGP than the other two recently, although it still contracted in the latest quarter, but this market could also deteriorate. While there is no disagreement as to whether the U.S. is heading towards a recession, the recent signaling by the Fed that the time has come to cut interest rates could be seen as a sign the Fed believes stimulus in the form of looser monetary policy is needed to combat a slowing down in the economy. If the economy slows to the point of perhaps a recession, then that is almost certain to negatively affect industrial demand and, by extension, the need for industrial lasers from IPGP.

Investor takeaways

IPGP has been a victim of circumstances in a tough August, which pulled down the stock through support on the way to new lows, but the stock has recovered to some extent lately. IPGP is also cheaper in some ways than it has been in a long time. For instance, IPGP is valued at about 1.4 times book value with a market cap of $3B, half of where it has been on average in the past five years.

The above, in combination with IPGP’s leading position as a supplier of fiber lasers, which are finding use in a growing number of applications, makes IPGP a stock worth looking into. However, there is a reason why the stock price has fallen, along with multiples like price-to-book. IPGP continues to see its sales and profits shrink, with the latest quarterly guidance calling for the tenth consecutive contraction in the top line and the bottom line may only break even at the low end of Q3 FY2024 guidance.

If this continues, IPGP could guide for a loss in its next quarterly report. The state of the two most important markets are such that the problems there are structural in kind, with no immediate solutions. A further drop in demand in China and Europe could see Q4 FY2024 continue the streak IPGP finds itself in. That could drive the stock lower.

The charts suggest lower stock prices are a real possibility. The stock lost support that had kept it aloft for a long time, which suggests getting back above where support used to be could be difficult. IPGP is more likely to have an easier time going down than going up due to resistance blocking the way higher. In contrast, it is not clear if or where support will be on the way lower. The stock has gradually moved lower since the peak in 2021 and there is nothing to suggest that pattern is about to come to an end.

It may be tempting to try to go for a continued bounce in the stock, but I am neutral on IPGP. There is reason to believe the bottom is not yet in. IPGP has essentially been going down in several ways, and IPGP has yet to show it has found a way to reverse that trend. As long as this is the case, putting money into IPGP is most likely not worth the risk.