Fastenal Confirms US Construction Acitivity is Solid

Fastenal $FAST gave earnings and demonstrated good growth. The Fastenal story is a good one and stock investors can find a detailed write up and earnings analysis of the company’s fundamental evaluation in the link at the bottom. However, for now the important thing to takeaway from Fastenal’s earnings report is that-if the US was in isolation- a double dip recession looks unlikely. Fastenal is a good company to look at because it sells the kinds of fasteners and hardware equipment that are used in construction activity.

The best way to conclude this from the results is to look at the sales figures for stores that have been open for more than five years. These stores tend to be more cyclical in their revenues because they are more mature in their market share within their local markets. Here are the numbers for revenue growth…

	Jan.	Feb.	Mar.	Apr.	May	June	July	Aug.	Sept.	Oct.	Nov.	Dec.
2011	15.3%	17.9%	19.2%	19.1%	17.9%	18.2%	17.3%	15.2%	14.5%
2010	-2.1%	-0.5%	7.4%	14.9%	17.3%	16.2%	19.8%	18.2%	18.9%	17.9%	13.2%	16.0%
2009	-12.4%	-14.3%	-21.5%	-25.2%	-25.2%	-26.3%	-26.6%	-24.7%	-24.2%	-21.7%	-15.0%	-12.1%

…and it is clear that US construction activity hasn’t fallen off a cliff just yet!

Further Reading

http://earningsview.blogspot.com/2011/01/fastenal-set-for-good-growth-but-what.html

Alcoa Kicks off Earnings Season With Weakness

Alcoa $AA gave results and its always interesting to look at them and do some equity research analysis because it is a bellwether for the upcoming US earnings season. Alcoa is also a key cyclical stock that gave good forward guidance as to where the economy is headed. No need to dwell too long on the earnings because most investors will know that they missed –already reduced- analyst EPS forecasts. Alcoa reported 15c in EPS against a forecast of 22c. The commentary on the conference call also confirmed the weakness in the global economy and, interestingly, seemed to confirm that this mainly caused by corporation holding back expenditure in the face of macro economic uncertainty.

Alcoa Earnings

 The macro issues will be put aside for the moment, but for now, it’s useful to look at what was said about Alcoa’s end markets. The following table is derived from the presentation and indicates year-on-year growth by semester and region. The regional split is not available for aerospace and industrial gas turbines.

	N America	Europe	China	Global
Aerospace				-4%     12%
Automotive	4%       0%	14%       -16%	2 %        2%	-4%        4%
Heavy Truck Trailer	28%    23%	14%       -11%	5%     -24%	10%     -14%
Beverage Can	0%     -2 to -3%	6%         2-3%	10-15%  15-20%	2-3%    2-3%
Commercial Cons	-9%    -3 to -4%	-4%     -2 to -4%	10-12%	1-3%
Industrial Gas Turbine				5-10%

So what are the key takeaways and conclusions from Alcoa’s earning report?

• Europe is weak across the board and this is a consequence of macro economic uncertainty
• Aerospace looks strong going forward as commercial jet deliveries are forecast to grow at 9% CAGR until 2014
• European automotive looks like it is falling off a cliff but global growth is accelerating thanks to China automotive sector
• Industrial turbine growth remains solid
• Beverage looks attractive because global growth looks solid and their appears to be a structural story in China as the consumer shifts to using cans

Given these factors, any stock that is a user of aluminum and has it as a major part of its fixed costs could see margin expansion and increased profitability if their end markets hold up. So for example, beverage can manufacturers like Rexam, Crown Holdings $CCK or Ball Corp $BLL could do well. Rexam tends to hedge a lot so it might not be the best stock to play this theme but the other two are worth a look provided their emerging market exposure is good. Similarly, aerospace manufacturers and suppliers to Boeing and Airbus could also see margin expansion.

Of course, all of this is predicated on continued weakness in aluminum prices…

…and given slowing global growth, this could be a safe assumption. The one area of circumspection in Alcoa’s report related to China and commercial construction. If the likes of Jim Chanos are right in their bearish predictions of a major slowdown in China’s residential and commercial construction market then things could get nasty for Alcoa.

Alcoa Reports Slowing Growth in Europe

Another key conclusion from this report is how badly Europe is faring. This will particularly affect Germany because it is heavily exposed to heavy machinery Capex. Indeed, the Dax has performed very badly this year and, it is safe to conclude that a satisfactory resolution to the Euro zone debt crisis is very much in their interest.

As the Alcoa CEO, Klaus Kleinfeld said in the conference call..

I guess that's all the time we have today. Let me sum it up. I mean, we've seen strength in many of our markets despite the sharp slowdown in Europe that hurt our sequential results. And I'm, as I just said, more concerned about the lack of confidence than about market fundamentals. It almost looks like the world is worrying itself into another recession and that should not be allowed to happen.
I think the problems that we have today, I mean, around Europe and some of the discussions here, I think are all problems that can be solved. And I hope the solutions get accelerated and we'll be able to restore confidence. Confidence, I said many times, is the air, the oxygen that every economy needs to grow.

…it really is all about returning confidence to the markets.

Source:

Alcoa Earnings Presentation

Sonosite Delivers Revenues and Earnings Below Estimates

Ultrasound manufacturer Sonosite $SONO gave results which were below analyst forecasts and also below the company’s internal forecasts. Although this is a disappointment, it is not as bad as it superficially appears and looks to be part of the usual ‘variance’ that happens with fast growing companies. Nevertheless, I would expect the stock to be marked down.

Firstly, turning to the results

• Rev 72.7m vs. 73.8m forecast
• EPS of -8c vs. 10c forecast
• Full year guidance maintained as per conference call

In other words this is a 17c miss on earnings and revenues were light. This is not a good headline but delving deeper into the results and conference call, it looks like this is more to do with a timing of orders than any protracted weakness.

Sonosite’s Missing Orders

Essentially, the management is saying that there were $4-5m in orders in Q2 which were delayed and are due to be rolled over in the next quarter. Now, if I had a dime for every time I’ve heard that sales that hadn’t been booked were just about to ‘come in’ I’d probably have enough to make up Sonosite’s shortfall myself! The market will approach the issue with the same level of skepticism. As for the earnings shortfall, this is explained by the fact that Sonosite has over 70% gross margin, a few million lost in sales will drop through heavily into the bottom line. Had the orders come in, then Sonosite would have handily beaten estimates.

Skepticism aside and having listened to the conference call, I thought that Sonosite were very specific about these orders and were quite willing to put credibility on the line in outlining their belief that they were part of a non systemic and incongruent sequence of events. For example, 25% of the shortfall was due to VisualSonics (VSI) and this amounts to just three orders. Moreover, most of the shortfall has subsequently come in and only $300k has ‘evaporated’. According to the management, if there was a systemic weakness, it was to be found in the UK. In addition, guidance has been kept the same for the full year, so clearly they are expecting to beat pre-existing forecasts for the next quarter.

Sonosite’s Opportunities in the Second Half

The results in the first half were categorized by an increase in R & D costs and SG & A which saw total Operating Expenses rise to 66.2% of sales from 64% last year. This increase in expenses is largely due to integrating Visual Sonics and too the launch of new products as part of the three year strategic plan. Indeed, the management concluded the conference call by pointing out that margin improvements were due to take place in the second half.

One cause for concern is the rising working capital requirements. This is natural in a business that is about to accelerate revenues, but as shipments were lighter than expected in the quarter, Sonosite saw inventories rise. In conclusion, if there is a pronounced correction on the back of this result than a decent buying opportunity could be being created. GE $GE gave results recently and reported good growth in compact ultrasound shares and with Sonosite affirming that it had -at least- retained market share in the US, this looks like a timing of orders issue rather than a cause for sustained weakness.

Anite Signals Strong Growth for 4G and LTE Spending

Ixia $XXIA and Spirent $SPT investors got an early read across from wireless and handset testing company Anite $AIE. Anite’s gave a final results statement and gave the stock market an update on how 4G and LTE deployment is taking place.  In summary on their wireless division,

‘2011 saw improved financial performance within the Wireless division, driven by both customer spending recovery and organic business growth. We believe the recovery phase is complete and that its 2012 results will be driven by business growth alone. Wireless is better positioned to take advantage of its existing and new markets than in the past and we believe that the LTE opportunity is also likely to be deeper and longer lasting than previous technologies.’

In addition, Anite talked of increased investment in 2G and 3G products as well as LTE. This augers well for the likes of Alcatel, Spirent and Ixia.

However, the key to longer term growth is the demand pull from the use of smart phones with data demanding functionality. This is particularly relevant when IP and video data is increasingly being used because it is bandwidth intensive. Naturally, this puts pressure on the network operators and handset manufacturers and testing solution providers will benefit if their customers are under pressure to invest in new technologies.

Interestingly, Anite mentioned that the demand for legacy systems has..

‘proved more sustained than expected and we continue to invest in this area.  However our main focus is currently on LTE, although the pace of change is accelerating and we are already planning for the next generation.’

Growth in the Wireless Market

 Anite referred to the longer term demand drivers here

‘Sales of smartphones are expected to grow 61% year-on-year- making the market ever more complex. While there is little growth in voice and text in developed markets, mobile data traffic is expected to grow by 6.3 exabytes (1 billion gigabytes) a month by 2015, a 25-fold increase over 2010^’

Industry Handset Production Forecast (m)	2010	2015
2G GSM	700	300
3G (WCDMA)	400	950
LTE	0	75

LTE is being deployed quicker than 3G ever was, simply because the adoption of smart phones is driving the need for a network upgrade. This is distinct from the early 2000’s when 3G was rolled out before the handset technology existed to take advantage of the network. It really is different this time.

In general, this is a very positive update and augers well for Ixia, Spirent and Alcatel. There doesn’t appear to be any slowdown in network upgrades and legacy system sales are holding up well.

FedEx Bullish Conference Call and Growth Forecasts

FedEx gave $FDX gave Q4 results and the stock markets cheered them by sending FedEx stock 2.6% higher. Essentialy, FedEx is a cyclical company and rather like its rival UPS $UPS it should be seen as a play on global growth. Indeed, this issue was articulated in more detail in this linked article which should search as a good reference point.

In summary, both FedEx and UPS are not investments I would make right now. This is not a negative call on global growth, rather, an expression of my view that there are better value plays which will give directional exposure to global growth. In addition, I believe there are better growth plays which can generate superior returns to buying either of these stocks. Neither have the 'outer' of a takeover, nor great cash flow yields with which to pay high dividends. UPS is currently yielding around 3% but that it is not particularly attractive.

More interesting, is to compare what FedEx where saying about the global economy and compare it with Ben Bernanke's statement today. I'll come back to this point later.

Growth Prospects?

For both FedEx and UPS, there appear to be some upside prospects, at least if FedEx's conference call is to be believed. I will summarize some of the key 'take-aways' from the conference call below.

• Near term ecoomic weakness caused by previously high energy costs and the disaster in Japan
• A stronger second half as consumption picks up and energy costs fall
• Growth to be continued to be led by industrial expansion
• Growth in Asia/Pacific and China seen as showing continuing strength and the current environment described as being 'very positive'
• Currently low Inventory/Sales ratio in the supply chain are seen as boding well for future growth

Both companies should see the benefit from lower energy costs in their margins and also in their revenue numbers as high energy and food costs act as a kind of 'tax' on discretionary spending.


Comparing FedEx with the Fed?

No not Roger Federer, but Ben Bernanke. In the conference call, FedEx gave some specific US GDP growth forecasts which will be interesting to compare with the recent downward revisions to GDP  forecasts by the Federal Reserve.

US GDP Forecast	Q2 2011	Q3 2011	Q4 2011	2011	2012
Federal Reserve January				3.4-3.9%
Federal Reserve April				3-1-3.3%	3.5-4.2%
Federal Reserve Revised				2.7-2.9%	3.3-3.7%
FedEx Forecast	1.9%	3.5%	3.4%	2.5%	3.0%

Interestingly, the FedEx forecasts are somewhat weaker than the Federal Reserve forecasts, even with the lowering of the numbers by the latter. However, they are both indicating stronger growth in the second half and in particular with consumption spending coming back. I consider these strong indicators for stock pickers to take advantage of.

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...

$1000s	2006	2007	2008	2009	2010	2011	2012
Revenue	238,318	225,683	242,680	175,727	290,691	319,450	360,510
growth		-5.3%	7.5%	-27.6%	65.4%	9.9%	12.9%
Gross Profit	173,480	161,333	174,253	119,340	213,130	234,796	264,975
gross margin	73%	71%	72%	68%	73%	74%	74%
Op Profit	44,473	28,136	25,104	-12,668	75,173	76,668	86,522
margin	18.7%	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.

$1000s	2006	2007	2008	2009	2010
Free Cash Flow	44,255	43,838	52,295	6,817	70,491
%Revenues	18.6%	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.