Saturday, June 11, 2011

Cognex Offers Growth but Lacks Visibility



Cognex $CGNX is a world leading company in the field of machine vision systems. As such, this makes this stock a direct play on growth in Global Investment in Machinery and Equipment (IME). Cognex sells machines that ‘see’ and help measure and quantify factory automation processes. Whilst, Cognex is a play on this kind of capital spending, it does have a few key industry verticals which can cause performance to be lumpy.
Cognex splits its company into three separate divisions
  • Factory Automation-(70% of sales) of which Auto production is a key vertical, Solar is a strong growth area
  • Semiconductor and Electronics Capital Equipment (SEMI) (17% of sales)
  • Surface Inspection (13% of sales)
By far the most important is Factory Automation which is also the fastest growing and with the highest gross margins of around 80% The other two divisions have gross margins of around 50% and due to these factors and, according to the conference call, Cognex appear to believe that they can continue to achieve overall gross margins of 72-75%

Cognex End Markets
Frankly, Cognex has had very favourable tailwinds over the last two years which has made growth look artificially strong. The last recession was characterised by a severe cutback in IME and Cognex suffered accordingly. However, with the recovery investment has flowed back and the low base effects have created very strong looking growth for Cognex. Some details here on trading history here...

$1000s2006200720082009201020112012
Revenue238,318225,683242,680175,727290,691319,450360,510
growth-5.3%7.5%-27.6%65.4%9.9%12.9%
Gross Profit173,480161,333174,253119,340213,130234,796264,975
gross margin73%71%72%68%73%74%74%
Op Profit44,47328,13625,104-12,66875,17376,66886,522
margin18.7%12.5%10.3%-7.2%25.9%24.0%24.0%

The slowdown from 2008-09 is demonstrative of the cyclical nature of Cognex’s end markets. However it is worth reflecting on the weakness in 2007. This was largely a consequence of a combination of factors including weakness in the semiconductor industry; an over reliance on the weakening North American auto production; low penetration within factory automation in Japan and some administrative difficulties within the North American sales operation.
Cognex addressed these problems buy increasing diversification in end markets and by shifting the sales focus to the types of countries (China/India/Korea ec) that are expanding automated production. As for the semiconductor industry, around ten years ago 66% of Cognex revenue was generated by this industry but now it is less than a third. Cognex mainly sells into the semiconductor equipment manufacturers that integrate Cognex solutions into their products. The US sales operation was restructured and finally, Cognex formed a partnership with Mitsubishi in order to generate accelerate longer term sales in Japan.

Future Prospects
Cognex’s revenues will be largely tied to global IME, their success in introducing the new Dataman product (they aim for a run rate of $10m by the end of year, but are ahead of expectations) and in increasing the number of customers that utilise vision machine solutions. For example, Cognex is targeting the Life Sciences industry for long term growth. This sort of growth will take time as Cognex integrates with OEM with this type of solution.
Thinking shorter term, Japan automotive comprises less than 1% of Cognex sales, and it is hard to see too much disruption from Japan factory automation beyond a quarter or two. Longer term the Mitsubishi partnership should help Cognex in Japan and also in China, where Mitsubishi has a strong sales infradtructure. In the recent results Cognex claimed that the key factory automation market was actually getting stronger. Surface inspection revenues tend to be lumpy from quarter to quarter, and semiconductor revenues were exceeding expectations.

Cognex Evaluation
Cognex has a strong balance sheet with $316.4m in cash and investments on the balance sheet. At a current price of $33.22 the market cap is $1.36bn and the Enterprise Value is therefore $1.17bn. It is a conservatively run company that has consistently generated strong cash flows.

$1000s20062007200820092010
Free Cash Flow44,25543,83852,2956,81770,491
%Revenues18.6%19.4%21.5%3.9%24.2%

On the other hand, revenues can be lumpy and earnings visibility is not great. The stock fell 10% after a disappointing forecast at the Q4 2010 results, yet they exceeded them in Q1 2011 and the Cognex share price soared. Buying Cognex is a tad tricky because we are in a period where manufacturing growth is moderating, so expectations need to be not unduly optimistic.
Nevertheless, on balance, I think Cognex has good long term prospects and analyst forecasts have it on an EPS of $1.49 and $1.77 for 2011 and 2012 respectively.  Whilst this seems expensive on a PE ratio basis, Cognex generates strong cash flows and has 23% of its market cap in cash and investments. I think it is better priced at $37 which gives 10% upside from the current price of $33.22. I picked some up.