Keyence Riding High As Automation Demand Is Set To Improve

Japan’s Keyence (OTCPK:KYCCF) is a remarkable company in many respects. In addition to strong positions in key enabling technology areas like machine vision, sensors, and control systems, Keyence has an exceptional margin structure, with outsourced manufacturing, an intense focus on innovation, and a strong marketing effort driving margins that are rarely seen outside of software in the industrial machinery space.

There are downsides and concerns to consider, though. Keyence offers precious little information to investors about its own operations, and most of what I know about the company comes from talking to and following its competitors. Keyence also seems to generate a remarkable level of sales growth for a company with such low R&D spending (around 3% of revenue), and that leads me to wonder if rivals like Cognex (CGNX) will ultimately out-innovate the company.

Valuation has never been simple when it comes to Keyence, and that’s even more true now after a strong run that has seen Keyence leave rivals like Cognex and Emerson (EMR) even further behind. Keyence is a rare asset with respect to metrics like margins and ROIC, and top-tier companies deserve a premium. Likewise, automation demand should continue to outgrow underlying industrial output. Still, with the company already trading at a 2x premium to more normal valuation standards, how much upside can investors really expect?

 

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Keyence Riding High As Automation Demand Is Set To Improve

Cognex Hammered On Ongoing Weakness In Core Markets

Wall Street is weird sometimes. Institutional investors spend remarkable amounts of time collecting data, and yet can still be flat-footed at surprising times. Given the slowdown in factory automation reported by companies like ABB (ABB), Rockwell (ROK), and Schneider (OTCPK:SBGSY), not to mention commentary on the auto and electronics markets from other automation providers like Yaskawa (OTCPK:YASKY) and Fanuc (OTCPK:FANUY), it should have been pretty clear that Cognex (CGNX) would see some real weakness here.

Granted, Cognex’s guide for a year-over-year decline in revenue in 2018 was surprising, so there’s certainly validity to being surprised by the magnitude of what’s going on at Cognex. What’s more, I think you can ask some very relevant questions about whether 2018/2019 is a dip in an otherwise strong investment cycle, or whether 2017/2018 was more of a “supercycle”-like plateau that gave investors a false sense of the near-term market opportunity for machine vision.

I’m still bullish on the machine vision opportunity and Cognex’s long-term opportunities, but guidance for 2020 later this year will be critical. In the high $40s Cognex isn’t a must-buy, and I previously said I was looking for a mid-$40s buy-in price before this revision, but it’s a tempting idea now.

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Cognex Hammered On Ongoing Weakness In Core Markets

Cognex Muddling Through Some Temporary Macro Challenges

I flagged Cognex (CGNX) back in early December as offering rare upside for a high-growth industrial, and though the shares had further to fall before bottoming on Christmas Eve, they’re still up about 20% since that early December article – outperforming its closest peer Keyence (OTCPK:KYCCF) and industrial stocks in general.

It’s a harder call to make now, though I still really like the machine vision space and continue to believe that Cognex has attractive addressable long-term growth opportunities in logistics, autos, and factory automation. I don’t believe my expectations of low double-digit revenue growth and mid-teens FCF growth over the next decade are conservative and I’m worried that there could still be another round of disappointment in consumer electronics and autos, though a negotiated trade agreement with China could brighten that outlook. I’d definitely look at Cognex again were it to pull back to mid-$40’s, but here it looks more like an attractive hold.

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Cognex Muddling Through Some Temporary Macro Challenges

Keyence's Diverse Business Model Continues To Deliver

From a quality perspective, it’s hard to find many better companies in the automation-enabling space than Japan’s Keyence (OTCPK:KYCCF) (6861.T). A strong player in machine vision, sensors, control systems, and other precision equipment, Keyence is not only a leader in attractive areas like 3D vision and product ID, but it has a long history of “self-obsoleting” and moving out of increasingly competitive markets that are no longer willing to pay for innovation before they become commoditized.

The only problem with Keyence is that its qualities are well-known and typically well-reflected in the share price. I thought the shares were an okay pick back in mid-2018 for longer-term investors wanting a dependable play on automation, but I didn’t think they were particularly undervalued, and the shares have mostly just kept pace with the broader industrial sector, while underperforming Cognex (CGNX) but outperforming a fair few Japanese automation names. I think this recent run in many automation names may be underplaying the risk of further macro deterioration, and while I’d still stand behind Keyence as a long-term holding, I’d wait in the hope of a cheaper entry price.

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Keyence's Diverse Business Model Continues To Deliver

Apple (And China) Taking Another Bite Out Of Cognex

Given the multiples and elevated growth expectations, I think you could argue that the market has actually been somewhat restrained in its negative reaction to Cognex’s (CGNX) challenging 2018 and a weaker outlook for 2019. Granted, the shares are down about a third over the past year (much worse than machine vision rival Keyence (OTCPK:KYCCF) ), but we’re still talking about a company trading at a forward EV/EBITDA in the low-to-mid 20’s.

I don’t think Cognex has necessarily seen the worst of the slowdown, and I do have some concerns that growth expectations and mulitples could have further to fall. By the same token, though, Cognex is a rare high-quality, high-growth asset in industrial automation and a significant player in a key enabling technology. Whether on its own or as part of a larger automation company, I believe Cognex’s business will be significantly larger 10 years from now, and that leads me to lean in favor of not getting too cute trying to time the bottom of this recent downturn.

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Apple (And China) Taking Another Bite Out Of Cognex

Fanuc Still Strong In Robots And Automation, But Trouble May Lie Ahead

I’ve never been quite as fond of Japan’s Fanuc (OTCPK:FANUY) (6954.T) as many readers seem to be, and over the last five years you could have done better with other automation names like Yaskawa (OTCPK:YASKY), Rockwell (ROK), Keyence (OTCPK:KYCCF), or HollySys (HOLI) (though the two-year comps are more forgiving to Fanuc). While Fanuc has done better than I’d expected over the last two years in terms of revenue growth, leveraging a strong rebound in machine tool and robomachinery orders, margins and FCF generation haven’t been all that impressive as business has skewed to lower-margin products.

Now there are macro clouds on the horizon. Weaker smartphone capex demands seem likely to pressure results in 2018 and we may be nearing the point of peak machine tool orders, setting the stage for what could be a nasty decline over the next few years. I do expect Fanuc to continue to see strong growth in robots and robotic components, but I’m just not excited about the valuation today given those challenges and potential risks.

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Fanuc Still Strong In Robots And Automation, But Trouble May Lie Ahead

Keyence Is A Key Enabler In Factory Automation

There are many moving parts to factory automation, figuratively and literally, but Keyence (OTCPK:KYCCF) (6861.T) is a key player in numerous high-value segments like sensors, control systems, measurement, and machine vision. With robotics quickly spreading beyond its traditional strongholds of auto and semiconductor assembly and into large, high-potential markets like consumer electronics, general industry, food/beverage/pharma, and logistics, Keyence has a large and growing market to serve with leading-edge products that are not only market leaders, but in many cases unique product offerings.

Keyence is priced like the leader it is, and investors may lament the lack of product/segment-level disclosure, not to mention the low (albeit consistent) volume for the ADRs. While concerns about smartphone-related capex spending and a potential slowdown in machine tool orders later this year are valid, this is a name to watch for investors who are not so value-sensitive and want to invest in gating technologies for factory and warehouse automation.

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Keyence Is A Key Enabler In Factory Automation

A Buyable Dip In Cognex?

Being a value-oriented investor who loves technology, particularly industrial technology, often has me feeling like a stranger in a strange land. There’s never any shortage of “you can’t worry about valuation; you just have to buy!” comments, and it can indeed be frustrating to watch the expensive shares of great companies get ever more expensive and float up and away like a kid’s balloon.

But with great valuation often comes great volatility, and that can work for patient investors. Cognex (CGNX) is back where it was when I last wrote about the company, but I believe the company is a little better today, even if its near-term revenue growth opportunities are not. Although the risk of further declines in consumer electronics can’t be ruled out, nor declines in auto spending or issues in China, the valuation now looks close to reasonable and that may be about the best you can hope for, though I’d note the shares are not cheap by most metrics.

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A Buyable Dip In Cognex?

At Cognex, The Electric Eye Is Green

If you love growth, you may well like Cognex (NASDAQ:CGNX). If you like growth at a reasonable valuation, this will be a more frustrating story for you. Cognex has established itself as a high-quality leader in the machine vision and product ID space, and high-quality companies deserve premiums, but the Street seems to be baking in an exceptional amount of growth into today's valuation.

I love the prospects for Cognex to introduce new products to expand its expecting opportunities, as well as its opportunities to leverage growth in areas like factory and warehouse automation, and I have little to complain about with respect to how management runs the business. If and when we get another of those market corrections that sweeps many babies out with the bathwater, this would definitely be a name to revisit.

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At Cognex, The Electric Eye Is Green