Thursday, May 9, 2013

Cognex Offers Good Upside From a Recovering Economy

It’s been a fascinating –if at times confusing-earnings season for the industrials. In the good old days all an investor needed to do was look at the ISM manufacturing index and generally expect his stock to trade in the direction of its trends. Not anymore. In this disjointed recovery all industrial sectors are equal, but some are more equal than others. The question is does your stock have exposure to the flourishers or the survivors in the sector? Such thoughts came to mind when looking at Cognex’s (NASDAQ: CGNX) latest results.

Cognex Seeing Better Days

For those who don’t know the company well, I have a primer article on it linked here. Its long term prospects are attractive. It is inevitable that manufacturing (particularly within emerging markets) will become automated and with that the need for monitoring robotic processes will increase. The future looks bright for Cognex. Moreover it is managing to diversify its revenues by increasing the amount of its non-cyclical end markets in areas like food & beverage and packaging.

All of this fine for the long term but what of its near term prospects? In short I think Cognex is well placed within its end markets and is starting to see better days in some of its key industry verticals. It suffered last year as industries like consumer electronics and semiconductors (they are highly correlated) were affected. Moreover it has faced some geographic issues with weakness in Europe and the secular trend of manufacturing moving from Japan (a market where Cognex is strong) to other Asian countries.

What Happened in Q1 For Cognex and how Does this Relate to Industrials?

A breakdown of revenues in Q1.

Starting with the most cyclical part of its revenues there is some evidence that semiconductors and consumer electronics (the latter also accounts for demand within factory automation) have passed a trough. Cognex noted that semiconductor revenues increased year on year and sequentially for the first time in two years but were cautious over pronouncing a recovery because of the relatively small amount of customers that it has.

Elsewhere Intel’s (NASDAQ: INTC) recent results weren’t great, but the good news is that it seems to have stopped lowering revenue forecasts and forecast that its gross margins are about to trough. Historically, its share price has trended in the direction of its gross margins and while things don’t look great right now (particularly with the PC market) the industry is highly cyclical and can turn around pretty quick. While Intel faces challenges from the changes in computing devices, all Cognex really cares about is being in the production plants irrespective of what the devices the chips end up in. In summary, 2013 does look like it will a better year for the semiconductor industry

Turning to Cognex’s biggest revenue driver (factory automation) there were some good signs here too. Unusually it reported a sequential increase of 2% in revenues from Q4 to Q1, when the norm is for a decline. It is hard to pin this on any one event but I think we have to recognize-as discussed above- that industrial sector is growing at uneven rates. Indeed looking back at Alcoa’s recent results we can see that the automotive (a key area of strength for Cognex) and aerospace sectors are doing well while packaging is seeing solid, if unspectacular, growth. It was a similar story with PPG Industries recent results too although PPG was also helped by its US residential housing exposure. If you are selling into the right sectors within manufacturing you did okay, if not times were tough. PPG is always going to be a cyclical play buy I think its end market focus means it can grow faster than the market.

This theme was also repeated in Fastenal (NASDAQ: FAST) and MSC Industrial's recent results. Fastenal has more exposure too automotive and aerospace and it reported relatively better numbers than MSC did within metalwork. My take on these ideas is that aerospace is a long cycle industry and customers can’t just halt or slowdown production for customers. Moreover industries like automotive and residential housing are driven by consumer demand which is relatively less affected by immediate political concerns than say corporate inventory building.

Moreover let’s recall that the automotive industry leads the way with just-in-time production so there is less ‘time’ for manufacturers to temporarily halt inventory purchases. I think Fastenal and MSC’s end demand will come back this year but it is subject to short term pessimism.

Where Next For Cognex?

If you are bullish on the global economy and industrial output then you should like the look of Cogex for the long term. Not only is manufacturing becoming more automated but Cognex is trying to expand the industry verticals that it sells into. For example, it has its products in trials with logistics companies. The shift in manufacturing from Japan to China is an issue but I note Chinese factory automation sales were 23% and it still has a lot to play for with automotive in China. Moreover it is realizing new products aimed at the high volume lower priced market place.

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