Cognex Languishing Through A Painful Reset Of A Major Growth Market

It would have been difficult to be more wrong about Cognex (NASDAQ:CGNX) than my call back in April that, despite challenges in the logistics market (warehouse automation), this machine vision company would still manage double-digit growth in 2022. In fact, Cognex is likely looking at not only a revenue decline in 2022, but quite possibly a decline in 2023 as well given weaker macro trends. With weaker end-market demand (and a fire at a manufacturing partner), Cognex is on pace for far less in terms of profitability and cash flow than I’d expected, and it may not be “business as usual” until 2024/2025.

Down about a third since my last ill-fated update, Cognex has been a notable laggard in an otherwise flattish market for other automation names like Datalogic (OTC:DLGCF), Fanuc (OTCPK:FANUY), Keyence (OTCPK:KYCCF), Rockwell (ROK), and Yaskawa (OTCPK:YASKY), though KION (OTCPK:KIGRY), another logistics-driven name, has been even weaker. While I do see long-term value in the name here, it’ll be difficult for sentiment to turn with logistics revenue likely down 20%-plus again in 2023, particularly if other end-markets weaken more than seems to be baked into sell-side expectations.

 

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Cognex Languishing Through A Painful Reset Of A Major Growth Market

Cognex Could Come Back To Life In 2022

The last six months or so have not been good ones for industrial stocks, and particularly higher-multiple growth stories. Within that limited context, then, Cognex (NASDAQ:CGNX) actually hasn't done so bad; the shares have lagged the broader industrial space by about 10% since my last update, but the shares have held up better than those of other high-multiple favorites like Fortive (FTV), IDEX (IEX), and Rockwell (ROK).

I do still have some modest concerns about a transition in how Cognex is viewed by the Street - less of a "pure" growth story and more of a "good growth… for an industrial" - but sentiment is difficult to predict, and I think Cognex still has a powerful tailwind from overall growth in automation adoption across multiple industrial end-markets. I'm also concerned that my double-digit growth projections are too aggressive, but again I see significant growth opportunity in existing served markets, growth in new markets, and opportunities to grow/acquire adjacent products and software.

Cognex isn't what I'd call "truly cheap", but I do see high-single-digit total annualized return potential at this level, and I think 2022 could be a better than expected year for growth, so I'm leaning more favorably on these shares even after the nearly 25% bounce of recent lows.

 

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Cognex Could Come Back To Life In 2022

Cognex Hits An Air Pocket And Analysts Start Caring About Multiples

 

Growth stock investing is a funny thing, and that’s probably why I don’t do a lot of it. When things are going great – robust beat-and-raises, sky’s-the-limit growth projections, and so on – analysts will bend over backwards to find creative ways to argue for a multiple that produces a price target at least 10% to 20% above the current price. But if the growth story hits a few bumps, even with no disruption to the long-term story, suddenly valuation matters again.

To be (somewhat) fair to analysts, they’re not the only ones – institutional and retail investors do the same. In any case, it’s looking like Cognex (CGNX) is going to see revenue flatten out a bit for two or three quarters, with some gross margin pressure from a major new customer and supply chain issues, and so the shares have flattened out a bit, “only” rising about 10% since my last update in March and lagging the broader industrial group and the S&P 500.

I’m still expecting high-teens growth over the next five years and longer-term growth closer to the mid-teens, as well as margin leverage, and I still view Cognex’s machine vision technology as a key enabling technology for automation. Multiples-based valuation was always tricky, but the prospective return as per discounted cash flow isn’t bad; in a sector with a lot of really expensive stocks with less exciting growth stories, Cognex looks relatively a little more interesting.

 

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Cognex Hits An Air Pocket And Analysts Start Caring About Multiples

Cognex Already Trading On Recovery Prospects

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.

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Cognex Already Trading On Recovery Prospects

In An Ugly Market, Cognex Looking Better

In writing on Cognex (CGNX) in the past, I’ve said that whatever circumstances it would take to make this leading machine vision company look undervalued, they would probably look pretty ugly. And here we are – whether Covid-19 is a valid reason for a widespread market sell-off or just an excuse for institutions to sell off expensive stocks, it has driven a lot of quality names to much more reasonable valuations.

Cognex certainly has near-term risk. Capex in the auto sector remains weak and Cognex management believes that both auto and consumer electronics capex may not rebound strongly in 2020. Economic concerns and the election cycle could likewise weigh on logistics capex investing. Longer term, Cognex now has a new rival to worry about, and so on. Point being, there’s always going to be a reason not to buy Cognex (or almost any stock, really), but I believe that this is a relatively rare chance to buy Cognex at a price that at least appears reasonable on a long-term basis.

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In An Ugly Market, Cognex Looking Better

The Market Seems Focused On Cognex's Long-Term Potential Over Short-Term Troubles

Institutional investors aren’t famous for their patience, and growth investors are typically even more unforgiving when their growth darlings come in a few ticks below expectations. And yet Cognex (CGNX), which posted over 20% year-over-year revenue contraction and once again guided down, is getting off relatively light, or at least in the immediate post-earnings period. 

Don’t get me wrong – I like Cognex and I think it’s one of the best plays on logistics automation and the “factory of the future” theme. I’m just surprised that the Street is still comfortable paying over 30x 2021 EBITDA during this cyclical downturn. I think the long-term potential return here is still okay, but I’d love a more pronounced “buy the dip” opportunity again.

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The Market Seems Focused On Cognex's Long-Term Potential Over Short-Term Troubles

Expectations For Cognex Could Be Washed Out, Though Multiples Are Still Robust

Machine vision specialist Cognex (CGNX) is still looking a little bleary-eyed, as the company is absorbing a rare one-two bunch of serious deterioration in its two largest markets (autos and consumer electronics). While the revisions to near-term growth expectations have been painful, it increasingly looks as though the stage is being set for easier comps in 2020 and beyond, and although I have my doubts about the consumer electronics business, I think the auto and factory automation end-markets will recover (while logistics continues to grow nicely).

Cognex isn't dirt cheap, but it still remains a favored name in discussions of "factory of the future" stocks, and the company's machine vision capabilities make it a fairly rare asset in industrial automation. While I do think Cognex's primary end-markets aren't likely to get much worse from here, a broader sell-off in the market (or increased risk aversion) could still shrink the multiple further. On the other hand, I don't expect Cognex to ever trade at a particularly wide discount to long-term fair value, and I wouldn't advise getting too clever about trying to call a bottom here.

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Expectations For Cognex Could Be Washed Out, Though Multiples Are Still Robust

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

Few Sour Notes For Honeywell

At the risk of drifting into the territory of a broken record, Honeywell’s (HON) performance continues to back up my view of the company as one of the best multi-industrials today. With Honeywell’s longer-cycle businesses hitting the sweet spots of their cycles, the company’s growth is finding another gear at a time when shorter-cycle results are likely to be choppier.

With its core businesses doing well (and with runways to do even better) and ample capacity to do more M&A, but no particular necessity, the only issue I have with Honeywell is, predictably enough, the price. It’s tough for me to push my valuation models beyond a fair value of $170 today, and I think Honeywell is now enjoying the status as a Wall Street darling and growth safe haven. Honeywell has earned this love and I wouldn’t advise stepping in front of this freight train, but it’s tougher to get excited about the returns on offer from this high level.

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Few Sour Notes For Honeywell

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

Yaskawa Electric's Earnings Report Underlines The Uncertainties In Automation

Investors looking to get a clear sense of the near-term direction of key automation segments like servomotors, drives, and robotics will need to wait a little longer, as Yaskawa Electric’s (OTCPK:YASKY) (6506.T) fiscal first quarter earnings report confirmed some worrying trends but also showed some better than expected strength in other areas.

Although Yaskawa shares are down another 10% from when I last wrote, I’m still not completely sold on the valuation argument at today’s price. This “lull” in smartphone-related capex could go on a little longer than expected, and I’m likewise concerned about the potential for weaker semiconductor, machine tool, and auto-related orders. Long term, I like Yaskawa’s position in both motion control and robotics, and the valuation is getting more interesting on an EV/EBITDA basis, but I’m inclined to stay on the sidelines here for now.

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Yaskawa Electric's Earnings Report Underlines The Uncertainties In Automation

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?

Datalogic Leveraging Its Product ID Know-How Into Larger, Faster-Growing Markets

Automation takes many forms, and product ID is arguably an under-appreciated part of the automation story. Italy's Datalogic SPA (OTC:DLGCF) (DAL.MI) is leveraging a strong foundation in retail data capture (scanners in particular) into new areas and gaining share in markets like manufacturing, logistics, and healthcare as more businesses turn to advanced identification technologies to improve production flows, improve accuracy/reduce errors, and lower overall operating costs.

Datalogic's ADRs are not especially liquid, but these shares are nevertheless worth a look as companies like Honeywell (HON) bring a higher profile to the opportunities to automate in areas like warehouses and logistics. With fragmented competition in the manufacturing and logistics spaces, I believe Datalogic could generate long-term revenue growth in the high single-digits with improving margins and perhaps attract the attention of larger players looking to bring more technology to factory floors and warehouses.

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Datalogic Leveraging Its Product ID Know-How Into Larger, Faster-Growing Markets

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