Investors had a roughly six-week window of opportunity earlier this year to buy Cognex (CGNX) at what I think is a good price relative to the company’s financial prospects. Since then, the shares have not only participated in the post-panic recovery, but also picked up some momentum as a reshoring play. The company posting a stronger than expected first quarter and management sounding fairly bullish on the company’s recovery prospects after COVID-19 has only added to that momentum.
I’m skeptical regarding the reshoring angle, but I am still very bullish about the long-term prospects of Cognex and its machine vision technology as an enabling technology for further automation of factories, warehouses, and logistics chains. Valuation has moved back to what is more typical for high-quality industrial companies, making this more of a hold in my mind than a buy.
Better Than Expected Results Against A Sharply Lowered Bar
It’s true that Cognex beat revenue expectations by 8% in the first quarter and beat operating income expectations by 75% (about $0.05/share). It’s also true that expectations were significantly higher three months ago and Cognex’s performance was well off those estimates. While analysts may have overestimated the near-term impact on Cognex’s business from COVID-19, the downturn is most definitely coming.
Revenue declined 4% for the quarter, which isn’t a bad result relative to what other industrials have been posting so far, and is actually pretty good relative to many reports in the factory automation foodchain (several robotics businesses, for instance, have seen double-digit declines in revenue this quarter). Cognex saw significant weakness among its auto customers, with the COVID-19 outbreak exacerbating what was already a tough market. Logistics was also impacted, though not to the same extent, and consumer electronics was a source of growth in the quarter, as well as some smaller end-markets.
Despite the (slightly) weaker revenue, gross margin improved more than two points on a richer mix driven by the higher mix of sales to the consumer electronics end-market. Operating income declined 31%, though, as the company continues to invest considerable sums in R&D in areas like software development and deep learning. With that, operating margin declined by almost five points but this was a better result than the Street expected.
Absent Guidance, Investors Are Left To Sort Through The Tea Leaves
Management is typically relatively reticent with details about the business, and given the uncertainties around the COVID-19 guidance, they’re joining with most other companies and pulling guidance. Given the circumstances, that’s reasonable.
Cognex management did confirm that the near-term outlook for the auto market had deteriorated significantly, and that’s a message that has been echoed throughout the multi-industrial space (Rockwell (ROK) being a rare exception on company-specific drivers like battery assembly projects). Based on my read of the auto market, I would basically agree with management’s outlook that the auto MRO business should recover relatively quickly and that the outlook for strategic capex (investing in equipment to support new hybrid/EV lines) is also strong once we get through the worst of the COVID-19 impact. I’m not sure I’m quite as bearish as management about the prospects for capex reinvestment into existing plants, though management may well have been talking very specifically about the demand for their products (it was unclear to me on the call).
Consumer electronics is a surprisingly difficult market right now, with management indicating that they don’t have the level of visibility into full-year demand that they’d normally have by now. They don’t seem to be alone here. Fanuc (OTCPK:FANUY) management said they’d been fielding a lot of inquires from consumer electronics companies for their Robomachine products (machinery that is largely used to make smartphone cases), but weren’t getting the expected levels of actual orders yet. Given how chip and chip equipment companies have been talking about 5G phone-related demand, I think this is a “when, not if” situation, but there’s still substantial uncertainty.
Logistics could end up being the strongest driver for Cognex in 2020. That assumes that COVID-19-related shutdowns end and logistics systems get back to more normal operating conditions – you can’t really upgrade your facilities if technicians are staying home and/or if your entire chain is under severe stress. I’d also note a wide spread of opinions on this end-market right now. ABB (ABB) cited it as one of the stronger markets, but Jungheinrich (OTC:JGHHY) recently issued pretty sobering guidance, though that company is much more leveraged to conditions in Europe and Cognex management said that they don’t see “many bright spots” in Europe now.
The Outlook
As a key enabling technology to automation, both in factories and logistics chains, I view machine vision as one of the most attractive long-term industrial sectors. I’m not as bullish on the prospects of reshoring becoming a major driver (companies shifting manufacturing back to their domestic markets), mostly because I don’t see many companies in Cognex’s core markets needing (or wanting) to do that, or at least not to an extent that would really move the needle on Cognex’s revenue prospects.
With Cognex already seeing a significant step down in revenue last year, I think Cognex should still see some year-over-year revenue growth this year even with the COVID-19 downturn. I expect the auto market to recover relatively quickly, and I likewise expect those electronics orders to materialize. While my expectations for 2020 are indeed lower than they were a quarter ago, I expect Cognex will get a lot of this back through “catch up spending” in later years, and my long-term expectation of low-teens revenue growth is basically unchanged.
So too with margins and cash flow. I expect a noticeable hit to operating margin in 2020, but I think the damage will be temporary and I believe Cognex can ramp its FCF margins into the 30%’s as it grows and better leverages its R&D spending.
The Bottom Line
Cognex trades at a level now where I expect a long-term annualized total return to shareholders on the low end of the high single-digits. That’s not bad or atypical for a quality industrial company, though it is a bit robust given where most industrials are trading now (though healthy earnings and as-expected outlooks for Q2 are boosting the sector). I’m pretty ambivalent about adding Cognex here, though I also realize that windows of opportunity to buy at better prices may be few and far between, particularly if investors get more comfortable with the idea that the worst of the COVID-19 impact is now in sight and understood.
Disclosure:I am/we are long ABB.I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
