Breaking up is hard to do. The longer one holds a stock, the stronger the emotional attachment can become. A cold, Vulcan-like look is required at incoming information to ensure that logic trumps emotion. Recent conference calls have undone an investing thesis I held in one stock, while redoubling my faith in another.
It’s not you; it’s me
First, my break up. I recently sold Simpson Manufacturing Co, Inc. (NYSE:SSD), and it hurt. My thesis was that it commanded huge margins on their specialty product, and that picture is crumbling. The company’s wood connectors, which are cleverly designed lengths of steel and brackets that hold your house together, are best in class, especially in areas with seismic activity (Simpson is based in Northern California). Simpson reigned as undisputed heavyweight champion.
However, it appears that macro factors are taking a toll on its ability to hold fast on margins; Lowe’s Companies, Inc. (NYSE:LOW) doesn’t carry Simpson Manufacturing Co, Inc. (NYSE:SSD)’s product any more due to a disagreement on pricing. Simpson has to resist price cuts at all costs: In effect their brand is on the line, since their main strategy is not to allow its connectors to be commoditized. A competitor is now trying to claim more market share with low pricing, while Simpson Manufacturing Co, Inc. (NYSE:SSD) is holding fast to its prices and emphasizing the quality and service support behind its product. So while still a near-monopoly, the signs of Simpson facing a possible pricing war unnerve me.
Simpson Manufacturing Co, Inc. (NYSE:SSD) is a great company and will continue to grow and innovate. But with margin erosion and market share issues lurking, currently I don’t see that the shares will be any more profitable than an index fund for the foreseeable future.
I want to take this to the next level
Another company, IPG Photonics Corporation (NASDAQ:IPGP), had a conference call that reinforced my investment thesis, and if management can be taken at their word, its moat is as wide as ever. It makes industrial lasers. On the earnings call, management made it clear they are leaps and bounds ahead of the competition in the core competency- fiber lasers used mainly for material processing, and they’ve just landed a huge contract with a major auto manufacturer. The adoption of its products are ramping up, and it has plenty of runway to go. The company has additional initiatives underway (such as softening rock under the drill bit to make drilling for oil and gas faster and cheaper) that I hope succeed, but my investing thesis rests on the proven track record of the core product for existing applications.
Some gems from the call include this one, on taking market share:
“There is no weakness in China. China is a very strong performer. [Anyone] who references fiber laser sales being weak due to the macro side, the underlying issue is they are not winning against IPG Photonics Corporation (NASDAQ:IPGP).”
And this, on how its vertical integration is allowing the company to sell a finished product that is not only superior, but also cheaper than the competition:
” . . . our cost of manufacturing these lasers now is getting to be lower than what the competition may be paying for diodes in the marketplace, the complete fully loaded cost of manufacturing.”
IPG Photonics Corporation (NASDAQ:IPGP) had slightly lower margins YoY, but management clarified that this was because they constantly seek lower costs for customers as they work to lower manufacturing costs, which in turn should accelerate uptake of its product. The company also gives volume discounts for very large orders. IPG Photonics has only been in my portfolio for a couple years, and I want to make it a more serious relationship, with more money and a longer term perspective.
Pick a number
As always, once a company is identified, valuation is the back half of the decision to invest, and can be the harder part of the equation. IPG Photonics Corporation (NASDAQ:IPGP) has a tad pricey 20 times trailing P/E, but it has other compelling metrics, like a 25% Return on Equity, 17% Earnings Growth YoY, about $350 million in cash, and 18% insider ownership.
Compare this with competitor Rofin-Sinar Technologies (NASDAQ:RSTI)‘s ROE of 7% and earnings growth of negative 8%, or Coherent, Inc. (NASDAQ:COHR) with an ROE of 9% and earnings growth of negative 7%. While these companies have different strengths, fiber lasers are making some of these competitors’ technologies distinctly obsolete. It should be no surprise that these competitors highly tout the development of fiber laser products in their annual letters. Fiber lasers are taking market share in a widening array of existing and greenfield markets, and as far as I can tell, the competition is playing catch-up in terms that can be measured in years, not months.
The article Earnings Calls Checkup: One Thesis Undone, Another Going Strong originally appeared on Fool.com and is written by Anthony Reilley.
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