Wednesday, November 6, 2013

Cognex is a Great Way to Invest in Factory Automation

For the third quarter in a row, vision machine company Cognex (NASDAQ: CGNX  ) delivered satisfying earnings, confirming that its strategy remains on track. Now that the market's pushed its stock up 68% so far this year, let's look at its business trends, and assess whether the stock can still go even higher.

Cognex fires on all cylindersCognex's machine vision systems help manufacturers to monitor automated production processes. It reports revenue in three different markets, with the growth opportunity mainly coming from its factory automation segment, which provides around 80% of current revenue.

Its web and surface inspection segment (14% of revenue) also contributed handsomely. It reported a yearly increase of 9% in the quarter, and Cognex cited the aluminum market (particularly with automotive) in China as one main source of growth.

In fact, if you look over what Alcoa (NYSE: AA  ) forecast for end demand growth, many of the key markets that Cognex wants to target in China are doing well. Alcoa increased its expectation for end demand from the Chinese automotive market, which is likely to reflect positively on Cognex's future expectations in surface inspection.

The last segment is its semiconductor and electronics equipment market (6% of revenue). Unfortunately, this area of sales decreased 17% in the quarter, as the semiconductor industry's difficulties continue.

Factory automation is the key
Cognex has been firing on all cylinders with the factory automation market this year. Broadly speaking, its aims at the start of the year for this sector were were:

  • Start commercializing revenue from the package-shipping companies that have been trialing its ID products

  • Develop sales in China

  • Open up markets for its products in new industries, and therefore diversify factory automation's revenue streams

So far the scorecard on these objectives is exemplary. With regard to logistics, Cognex declared in its conference call that "The Americas also set a new quarterly revenue record, helped by large ID product orders for logistics applications in distribution centers."

Indeed, the Q3 numbers contained $3 million of revenue from orders made in the quarter by a retailer ($600,000) and a "parcel delivery business" ($2.5 million). Happily, these sorts of orders will likely lead to repeat orders in the future.  Moreover, Cognex has five to 10 "very large global players" in logistics that are evaluating its ID products right now, and 20 more retailers and other companies looking at it.

Indeed, its ID product revenue grew by 45% in the quarter to $25.5 million, and now represents 35% of its total factory automation revenues.

Source: Company presentations and author's estimates.

As the chart indicates, Cognex is managing to expand its non-ID product revenue as well. And there is evidence that it's successfully developing markets in new industries. For example, the automotive sector previously made up 25% of its factory automation revenue, but it was only up "in the low to mid-single digits" in the quarter. Furthermore, its strongest-performing markets (aside from logistics and distribution) in the quarter were in areas like consumer products, life sciences, and medical devices.

Finally, its China revenue grew 28% to reach $10 million in the quarter, or around 11% of total company revenue.

Elsewhere, there are indications that spending remains solid in the sector.  Danaher's (NYSE: DHR  ) product-ID-based revenues were flat in the quarter, but this was partly due to coming up against a large one-off order last year. The underlying picture is far stronger. For example, Danaher's Videojet is a leading manufacturer of coding and marking solutions, while its X-Rite color measurement products are used across many of the same end markets that Cognex sells into. Both saw sales rise in the mid-single digits -- a good indication that Cognex's customers are continuing to invest .

Where next for Cognex?
The industry backdrop is positive, with Alcoa and Danaher confirming that there is growth in Cognex's key sectors. Moreover, Cognex is achieving its main objectives, and it will only take a few large orders from some logistics companies in order to see analysts scurrying to raise estimates.

However, on a forward P/E ratio of nearly 33 times forecast 2014 earnings, the stock is probably going to need earnings upgrades in order to move higher. It's a great company, and its outlook is definitively getting better, but it makes sense to wait for a dip here

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