nLIGHT: The Rally Stops In Familiar Territory (NASDAQ:LASR)

nLIGHT, Inc. (NASDAQ:LASR) has been red-hot in the last six weeks or so. The stock was until fairly recently on pace to end 2023 with sizable losses, but a number of tailwinds popped up in time to give LASR enough of a boost to alter the trajectory. The stock has pulled itself out of negative territory for the year and by doing so has put itself in a position to end the year 2023 with solid gains after a late turnaround. In addition, the rally raises hopes that LASR may finally be getting itself out of the hole it fell into after the stock peaked in 2021. Why will be covered next?

LASR has rallied

As recently as late October, it looked like LASR was going to end 2023 with the stock in the red. The stock hit a 52-week low of $8.13 on October 31, which put LASR down 19.8% for the year at that point. However, the stock rallied from then on until it hit a high of $15.00 on December 14, which means LASR gained 84.5% in about six weeks to turn things around.

The low of $8.13 is actually the lowest the stock has gone for since LASR became a publicly traded company in April 2018. LASR actually trades below its IPO price of $16 a share and that’s after the recent rally pushed the stock price up. The chart below shows why LASR has not been a great stock to hold on to for the most part.

The stock reached a peak of $46.45 in February 2021, but it’s been a gradual decline since then, although the pace of the decline has slowed down more recently. The stock closed at $13.87 on December 15 after falling by 5.3% on Friday, which means that even though the stock is up 36.8% YTD, which gives LASR a market cap of $647.5M, LASR is now worth less than a third of what it went for at the peak.

With the stock down big, some might be interested in LASR for that reason alone. The rally in recent weeks is likely to cause some to wonder whether the rally has any legs to it or whether the drop on Friday is a harbinger of things to come. There are no guarantees, but it’s possible LASR may finally be getting itself out of the rut it has been in for the last few years.

On the other hand, it’s worth mentioning that the stock seems to have encountered resistance, which it will need to overcome if it is to continue the rally of recent weeks. Note how in the chart below the stock topped out in the $15-16 region, which is the same region where it proceeded to reverse course back in June/July. Similar to back then, the stock retreated after coming into contact with the $15-16 region.

The rally in the last six weeks or so is no doubt impressive, but it’s not something LASR has not done before. Something similar happened as recently as last May. That rally eventually fizzled out after the stock was unable to overcome resistance in the aforementioned $15-16 region. This could happen again and the stock could repeat what it did before now that the stock came into contact with the $15-16 region.

It’s also worth mentioning that fair value could be in the $15-16 region, which may be why the stock has problems getting past this region. Fair value is subjective, but if we assume revenue grows at an estimated CAGR of 5% over the next ten years, not that different from the 6% LASR averaged in FY2018-2022, causing free cash flow to grow by 71.2%, then fair value is about $15.96 with a discount rate of 12% according to the discounted cash flow method.

Longs may therefore want to consider locking in profits after the rally of the last few weeks with this in mind. The stock has come a long way in a short amount of time and resistance is in the way. A move lower would not be so unusual under these conditions. If resistance is not broken, a trip back to the $8-9 region is a possibility, especially if that is where support lies.

Why LASR started to rally?

As mentioned before, up until quite recently, the stock was on pace to end 2023 with losses. This turnaround in the last few weeks was made possible by a couple of reasons. For starters, the rally benefited from a powerful rally in the stock market, starting in November, which helped LASR because a rising tide lifted all boats.

Furthermore, note how in the previous chart the stock shifted into higher gear on November 27 with a gain of 13.7%. This did not happen for no reason. LASR announced on November 27 that it had been awarded a $34.5M contract by the U.S. Department of Defense for the delivery of a high energy laser. This contract followed another one on November 2 from the DoD, which increased the value of an existing contract from $86M to $171M. Both were well received by the market.

The November 2 contract update helped counter the mixed results of the Q3 FY2023 report, which was released on the same day. LASR beat estimates for the top line, but it also fell short on the bottom line. The consensus expected a non-GAAP loss of $0.08 per share on revenue of $49.3M, but LASR reported a non-GAAP loss of $0.10 and revenue of $50.6M, a decline of 15.7% YoY.

In terms of GAAP, LASR reported a loss of $11.9M or $0.26 per share. The main difference between the GAAP and non-GAAP results is that the latter excludes stock compensation expense in the amount of $6.6M. Adjusted EBITDA was minus $1.9M. LASR finished with cash, cash equivalents and investments of $111.8M with no debt. The table below shows the numbers for Q3 FY2023.

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Source: LASR Form 8-K

Guidance calls for Q4 FY2023 revenue of $45-50M, a decline of 16.2% YoY at the midpoint. The forecast sees adjusted EBITDA of minus $2.0-5.0M. With the latest guidance, LASR is estimated to post a non-GAAP loss of $0.14 in Q4. FY2023 is estimated to conclude with a non-GAAP loss of $0.30 on revenue of $206M. In comparison, LASR ended FY2022 with a loss of $0.50 on revenue of $242.1M. The top line has shrunk, but LASR has been able to improve the bottom line with lower losses through various measures, including cost cutting.

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Source: LASR Form 8-K

LASR is undergoing a transition

The numbers have declined in the last several years and China has played a large part in this happening. In Q3 FY2023, revenue from China fell 50% YoY, but in the rest of the world 13%. This pushed China’s contribution to just 5% of total revenue in Q3 and 6% in Q1-Q3. This is way below where it used to be. For instance, China contributed 46% in Q2 FY2018 and as recently as Q1 FY2022, China was in the double digits with 11%.

The drop in China has been negated to a certain extent by growth in the U.S., particularly from the defense sector. Defense accounted for 41% of revenue in the first three quarters of FY2023, more than double the 18% five years ago in FY2018. Higher exposure to defense spending should make LASR less prone to the ups and downs associated with the business cycle. On the other hand, it’s worth mentioning that U.S. defense spending is unlikely to see much growth in the future, which could limit growth at LASR compared to growth driven by say consumer/corporate spending.

It’s also worth mentioning that the headwinds that originated in China, and which were mostly confined to that market, may be starting to pick up in markets outside of China. Manufacturers of fiber lasers in China, which have gained market share inside China, are offering their products at lower prices in other markets, in direct competition with those from LASR. This could turn into something more potent down the line. From the Q3 earnings call:

In cutting, revenue from customers outside of China increased year over year as we continue to increase sales over high power, all fiber programmable technology to key strategic customers. We continue to demonstrate the flexibility of our programmable fiber lasers and believe that the market for high-value applications remains well-suited for continued growth.

At the same time, we have started to see domestic Chinese laser manufacturers who are offering non-programmable commodity fiber lasers take a more aggressive pricing approach outside of China. “

A transcript of the Q3 FY2023 earnings call can be found here.

Investor takeaways

I am neutral on LASR. LASR is making some progress in overcoming the headwinds that have put pressure on the top and the bottom line. LASR has been able to make up for a shrinking market in China by growing the defense market. Two major contract wins in November played a big role in the stock rally of the last six weeks or so.

LASR is still a company in the red, but losses have been reduced. On paper, with China making up 5% of revenue, China should be less of a headwind than in the past when China contributed close to half. If LASR can continue to grow the non-China business, China could conceivably become a non-issue at some point.

This does depend on Chinese manufacturers not gaining too much traction outside of China because if they do, the headwinds originating in China could spread to other regions, which could make it more difficult for LASR to return to profit. The defense segment should be immune to Chinese competition since that market demands U.S. suppliers, but it’s not impossible for the competition from China to make headway in other markets. This is an issue that needs further watching.

Nonetheless, while LASR is making progress, the time may not yet be right for long LASR, especially since LASR does not have a great track record in terms of rewarding the longs. While a breakthrough is not out of the question, the odds favor a move lower in the near term after the huge stock rally in a short amount of time. The chart patterns also suggest the stock is likely to retrace some of the gains in the last few weeks.

The stock seems to be leaning towards sideways action, something that has been the case since last year. Speculators may want to bet on the stock heading back to the $8-9 region. This is where support is likely to be present, which would make for a good entry point. Nothing is set in stone, but with everything above in mind, the stock is most likely heading lower.