Agilent's Growth is Driven by Strong End Markets

Agilent $A is a pure analytical and electronic measurement company that provides solutions to diversified sectors involved in industrial output. I like this stock because it combines diversified cyclical growth and a secular growth story that is dependent upon new product development and regulatory and legislative drivers.

Agilent has been very active in research and development over the last few years and is starting to see the benefits of this. Furthermore, this transformation has seen the company shift from relying on over 40% of its revenues from the semiconductor industry towards becoming a truly diversified company. It is highly cash generative and promises strong growth.  It's time to take a closer look.

Agilent's Profit and Revenue Drivers

The three main divisions of Agilent are broken up as follows

Agilent	2010 Rev (bn)	2010 Op Margin	Growth Rates	Market Size (bn)
Electronic	2.8	16%	4-5%	12
Chemical	1.2	23%	5-6%	10
Life Sciences	1.5	15%	5-7%	19

In addition, Agilent sees its end markets as growing at 5-7% over the long term but the opportunity looks larger in the markets (particularly life sciences) where Agilent has the chance to expand market share. This doesn’t come without risk because the academic and governmental markets (not for profit) within life sciences could come under funding pressure going forward. However, this makes up only 8% of total revenues with the ‘for profit’ sector (biotech/pharma co’s) making up 14% of revenues. In addition, within life sciences, Agilent is seeing strong growth from the shift towards generics and biologic. Furthermore, Agilent is wel placed to benefit from the movement towards Ultra High Pressure Liquid Chromatography (UHPLC) from High Pressure Liquid Chromatography (HPLC).

Agilent is well diversified with the largest single segment (industrial, computing and semiconductors) only making up 21% of current revenues. The second largest segment is communications which is driven by technological change and LTE rollout as well as China’s 3G expansion. Agilent looks well placed in many markets.

Emerging Market’s are Key to Agilent’s Growth

Agilent are well placed in emerging markets and all three of the divisions are seeing an increase in the share of their revenues coming from Emerging Markets. In addition, Agilent’s strong market position in Electronic Measurement Group (EMG) puts them in good stead as manufacturing production shifts increasingly out to Emerging Markets like India, China etc. The return in investment is higher in EMG than in the other two divisions but Agilent is more established in this sector.

It is a similar story with the Chemical Measurement Group whereby there is strong growth from Asia. In addition, global trends are towards increased awareness of food safety and environmental awareness, which is all positive for measurement solutions like Agilent.

Somewhat surprisingly, Agilent is also seeing strong growth in Life Science’s group from Asia and this division appears to be the most exciting for Agilent overall. In essence, it is an opportunity that is categorised by the chance to grab market share in a fast growing (probably around GDP+3%) sector which is driven by proprietary technological change.

Agilent Stock Evaluation

Agilent currently trades at around $51.66 which gives it a market capitalisation of around $18bn and $17.3bn in Enterprise Value. The company is highly cash generative with diversified revenue streams and has invested impressively in R & D over the last few years. I like the diversification and the opportunities for upside potential given the tendency for greater quality control in increasingly complex manufacturing and research processes.

Analysts have forecasts of $2.88 and $3.28 for the year to Oct 11 and 12 respectively from $2.00 in 2010.  However, as ever, this doesn’t tell the full story. Free cash flow generation over the last three years has been $600m, $280m and $497m respectively and I think it is reasonable to expect around $900m for the year to Oct 2011. This puts Agilent on a FCF/EV of around 5.2% and that is too cheap for a company growing earnings in the mid teens.

I bought some with a target price of $58.

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.

Robert Half Set to Continue Gains?

Robert Half International RHI is an interesting stock to look at because its earnings and –more importantly- its share price drivers and prospects tend to reflect macro-economic concerns rather micro. It is a very cyclical stock. Analysts waste a lot of time trying to analyze the finer detail of Robert Half’s numbers and execution, but in reality it is the employment environment that governs its prospects.

Having noted that, it is worth noting that this doesn’t preclude individual company analysis of Robert Half. Rather, it means that an analysis should focus on the macro-economic direction (employment gains) and then appraise prospects based on the performance of their execution. For example, the following data is a good example of how cyclical this stock is.

The first column represents a metric to analyze the turning point in Robert Half fortunes. The quarterly revenue is divided by the rolling yearly revenue. The second column is the quarterly Gross Margin. The third is the private non-farm payroll net 3-month, taken from the Bureau of Labor Statistics.

The green number represent bottoms or troughs, whereby the direction afterwards is upwards. Similarly, the red numbers are tops or peaks.

	Quarter Rev as percentage of Rolling Year Revenue	Quarter GM	Private Non-Farm Payrolls 3 Month Net
2000	0.00%	42.83%	649
q2	0.00%	43.13%	311
q3	0.00%	42.92%	440
q4	26.15%	43.11%	289
2001	25.82%	43.24%	-126
q2	23.44%	42.04%	-645
q3	21.71%	40.13%	-634
q4	20.82%	39.61%	-908
2002	21.28%	39.47%	-379
q2	23.34%	38.70%	-165
q3	25.03%	36.18%	-165
q4	25.12%	35.79%	-64
2003	24.78%	35.85%	-309
q2	25.16%	36.73%	-53
q3	25.88%	37.34%	188
q4	26.21%	37.21%	303
2004	27.59%	37.74%	489
q2	28.73%	39.71%	628
q3	29.03%	39.87%	294
q4	28.19%	40.21%	489
2005	26.80%	40.75%	471
q2	26.79%	41.18%	752
q3	27.03%	41.06%	545
q4	26.50%	41.47%	542
2006	26.87%	41.66%	869
q2	26.70%	42.57%	262
q3	26.76%	42.06%	336
q4	26.42%	42.55%	384
2007	26.33%	42.00%	478
q2	26.52%	42.88%	234
q3	26.29%	42.48%	-108
q4	26.26%	42.92%	185
2008	25.68%	41.68%	-155
q2	25.25%	42.19%	-644
q3	24.03%	41.65%	-1060
q4	21.51%	40.65%	-1948
2009	19.61%	35.67%	-2257
q2	20.14%	35.34%	-1435
q3	22.07%	36.70%	-698
q4	24.28%	37.77%	-270
2010	24.98%	36.51%	236
q2	25.90%	37.69%	353
q3	26.70%	37.82%	372

Source: Robert Half,Bureau of Labor Studies, Earnings View


The key is to note how closely correlated Robert Half's cyclical fortunes trough with a bottom in private non-farm payrolls. However, it is worth noting that Gross Margins continued to rise, right up til the employment market turned with the recession in 2008. In fact Robert Half's share price did well (although there was some stock specific weakness in mid 2006) right up until the start of 2007.

All of which indicates that there is probably more to run from Robert Half in terms of Gross Margins, share price and profits. However, it appears that Robert Half's share price is far more dictated by the direction of employment gains/losses than an underlying current profitably. If you think the economy will continue to improve in 2011 and payroll gains will remain positive than RHI has further to run.