Hurco Closes The Fiscal Year Strong, But Not Quite In The Clear Yet

The industrial sector has been a more interesting place of late. While there are still troubling signs for 2023, including higher rates, contracting manufacturing PMI, and weakening business confidence, the market has been more willing to look for "buy the dip" opportunities and the sector has done well over the last three months. That said, there has still been a gap between the broader industrial space and sub-sectors like metalworking where there are still risks about short-cycle weakness and where Hurco (NASDAQ:HURC) has modestly underperformed the sector since my last update (up around 4% versus 11% for industrials) while beating the S&P 500 and other machine tool companies like DMG Mori (OTCPK:MRSKF) and Okuma (OTC:OKUMF) and metal tools company Kennametal (KMT).

Hurco's better-than-expected fourth quarter results are encouraging, but I'm not willing to sound the "all clear" at this point given increasing pressures on smaller manufacturers. That said, I do think the reshoring trend still has legs and I believe management has the company in good shape to weather whatever remains of this downturn. I do still see double-digit annualized return potential from here, but I would again remind investors of the risk of a worse-than-expected short-cycle slowdown in 2023, particularly with numerous quarterly reports and 2023 guidance calls on the way in this sector over the next six weeks.

 

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Hurco Closes The Fiscal Year Strong, But Not Quite In The Clear Yet

Hurco Treading Water As The Cycle Turns

The last few months have done little to dispel concerns that short-cycle industrial demand is slowing, and that certainly hasn't helped small machine tool manufacturer Hurco (NASDAQ:HURC). While the shares have held up okay relative to the broader industrial space and other shorter-cycle names like DMG Mori (OTCPK:MRSKF), Fastenal (FAST), Kennametal (KMT), and Sandvik (OTCPK:SDVKY) (though Kennametal has done better) since my last update, the reality is that the current outlook is not particularly strong for an already-overlooked short-cycle industrial.

In light of the last Hurco earnings report and reports from other companies and third-party information sources (like the Japanese Machine Tool Builders' Association or JMTBA), I've pulled forward my expectations for Hurco's cyclical correction. The shares do still look undervalued and positioned for a double-digit long-term annualized return, but it's hard to see investors getting excited about short-cycle names again until mid-2023 at best, as the rate cycle has yet to play out and inflation remains stubborn, while business confidence erodes.

 

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Hurco Treading Water As The Cycle Turns

Hurco Already Hit Hard In Anticipation Of Weaker Capex Spending

What I thought back in March may have just been a “pothole” for Hurco (NASDAQ:HURC) has started looking more like a sinkhole, as orders have turned down and investors have grown considerably more worried about the health of short-cycle industrial names, particularly those exposed to capital equipment budgets.

Time will tell if we get a true cyclical downturn in the next few quarters or whether this is a shorter “correction” in response to inflationary and labor pressures (not to mention the chaos created by the pandemic). In any event, it’s clear that short-cycle industrials are by and large not in favor right now, and while I do think Hurco’s valuation is too low now, the reality is that the market can often overcorrect and investors looking to take advantage of the pullback have to at least be aware of the risks of further declines before the outlook and sentiment stabilize.

 

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Hurco Already Hit Hard In Anticipation Of Weaker Capex Spending

Hurco Leveraging Improving Demand, But Orders Need To Be Watched

 

Hurco's (HURC) fiscal first quarter saw this small machine tool company continue to leverage a broad recovery in global manufacturing, but a sequential drop in orders is worth watching. The market has been growing increasingly concerned about the approaching end of this short-cycle recovery, and weak North American orders for Hurco are concerning. That said, there are a range of issues in the end-market that could explain some temporary weakness, so I'm reluctant to call an end to the cycle.

In the fairly short time since my last update, Hurco shares are up a bit, outperforming the wider industrial space and larger machine tool companies like DMG Mori and Okuma. Relative to that last update, I've pulled my expected cyclical peak and decline in a bit, as I'm increasingly concerned that the disruptions from Russia's invasion of Ukraine, particularly higher energy prices, could bring a swifter end to this up-cycle.

 

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Hurco Leveraging Improving Demand, But Orders Need To Be Watched

Hurco Still Unfollowed And Unloved, But Delivering On Improving End-Market Conditions

 

Owning stocks like Hurco (HURC) – small industrials with no institutional research coverage and too little daily volume to attract a lot of fund managers – can be a frustrating exercise in the best of times. These aren’t the “best of times”, though, as the Street continues to pull back from industrial names, and particularly those leveraged to capex equipment, on fears of peaking orders and margin pressures from supply chain challenges.

To be sure, I do have some concerns about how Hurco will navigate ongoing cost pressures – they’re not doing badly, but costs aren’t letting up. Likewise, orders are annualizing close to prior peaks, so further improvement may be a larger ask.

All of that said, I do still believe there is room for Hurco to log more growth in this cycle, not to mention leverage better volumes into better margins. If Hurco can couple low single-digit long-term revenue growth (in line with developed market capital investment) with modest long-term operating margin improvement, I believe these shares deserve to trade in the $40s, making them a name worth considering today for investors who can accept the risks that go with illiquid cyclical small-caps.

 

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Hurco Still Unfollowed And Unloved, But Delivering On Improving End-Market Conditions

Hurco Seeing Real Evidence Of The Turn

 

There have been some “fits and starts” to the post-pandemic recovery, including mixed trends on capital spending and manufacturing activity in some sectors, but with fiscal second quarter results in hand, Hurco’s (HURC) recovery seems to be solidly underway, and looking around the industry, I expect “recovery growth” over at least the next few quarters.

Hurco has lagged the broader industrial sector since my last update, but done a little better than my own “peer group” of metalworking-driven companies. The stronger evidence of recovery should be good for the stock from here, and I do believe the shares are undervalued below $40 in the near term (and priced for longer-term annualized returns in the double-digits), but this is an unfollowed, illiquid company, so investors need to understand the risk that this remains overlooked for an extended period of time.

 

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Hurco Seeing Real Evidence Of The Turn

Hurco Seeing A Quicker Pace Of Recovery, And Still Undervalued

A small player in the cyclical machine tool industry, Hurco (HURC) has not enjoyed the same rebound or love that other short-cycle names like Kennametal (KMT), Lincoln Electric (LECO), or Parker-Hannifin (PH) have seen, with the shares lagging the overall industrial sector by about 400bp over the past year and far wider gaps to those aforementioned three short-cycle industrials.

While Hurco is a tiny company with an uncovered stock, and the machine tool industry is facing some longer-term threats, I continue to believe that that performance gap is too wide. With the company seeing some stronger orders and the global economy likely to continue to normalize as vaccination rates increase, I believe Hurco is still positioned for a rebound year in 2021 and growth into 2022.

 

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Hurco Seeing A Quicker Pace Of Recovery, And Still Undervalued

With A Sequential Bounce In Orders, Hurco Shifts To A Cyclical Recovery Story

When I last wrote on Hurco (HURC), I said that, "trying to call a bottom in the machine tool space is a good way to look foolish", and so it proved to be, as the rebound I expected in the fiscal fourth quarter (ended October 31) didn't really materialize - orders did improve meaningfully on a sequential basis, but the sequential revenue recovery did not materialize. That said, trends across the machine tool space do seem to be improving, with auto demand stabilizing and some growth in areas like medical, semiconductor, and mold/die.

I'm expecting a couple of years of double-digit sales growth from Hurco as manufacturers in the U.S., Germany, Italy, and other countries see a rebound in demand, but I still only expect the company to outgrow developed country GDP by a very modest amount over the long term. Even so, single-digit FCF margins and a return to low double-digit EBITDA margins should argue for a stock price closer to $40, with a double-digit long-term annualized return opportunity at today's prices.

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With A Sequential Bounce In Orders, Hurco Shifts To A Cyclical Recovery Story

Hurco Seems To Have Reached Its Bottom, And Now On To The Recovery

Trying to call a bottom in the machine tool space is a good way to look foolish, but I think we're finally there - based not only on the commentary of companies like DMG Mori (OTCPK:MRSKY) and the results posted by Hurco (HURC) today but also looking at other trends and commentary in the industrial space. With this quarter, Hurco's orders have spent two quarters at close to 50% below the prior peak, and I believe the company will see sequential revenue growth in the next quarter and quite possibly a return to order growth.

Although this downturn has been brutal in its suddenness, which does create some challenges in managing costs, it hasn't been all that different in terms of magnitude relative to past downturns. Looking ahead, I expect healthy double-digit growth from Hurco over the next couple of years, with improving operating leverage as well. With the shares have meaningfully underperformed since my last update (when I turned neutral the near-term outlook), I think today's valuation offers an attractive upside to a short-cycle industrial recovery in 2021 at a very reasonable price.

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Hurco Seems To Have Reached Its Bottom, And Now On To The Recovery

Hurco Not Out Of The Woods, But Investors Already Thinking Recovery

Trading below book value when I last wrote about (and recommended) the stock, Hurco (HURC) shares are up about 30% since then - more or less keeping pace with the broader industrial sector. As expected, Hurco's financials are getting pummeled by the sharp business downturn instigated by COVId-19, but investors have already started bidding up industrial stocks in expectation of a V-shaped recovery in many manufacturing sub-sectors.

While I do think Hurco will recover and that the shares are still priced for a double-digit long-term total annualized return, I'm concerned that industrial stocks have come back too far too fast. Given incremental updates on manufacturing end-markets and companies cutting spending to bare bones, I think it'll be at least another quarter or two before Hurco starts seeing evidence of a turn, but I think some of the worst-case scenario risk is leaving the table. All in all, I think Hurco is worth owning here, but I think we may see another pullback before the dust settles.

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Hurco Not Out Of The Woods, But Investors Already Thinking Recovery

Hurco's Balance Sheet Will Carry It Through These New Headwinds

I had been more bearish, or at least more cautious, than a lot of analysts regarding the outlook for manufacturing stocks in 2020 given the still-weak underlying end-market trends and the prospects of election year disruptions, but I certainly didn’t have the huge Covid-19 impact in my models. With the pandemic impacting economic activity around the globe, investors find themselves in what is basically an “all bets are off” environment when it comes to manufacturing equipment companies like Hurco (HURC).

Hurco’s strong balance sheet is likely its best asset today, as the company’s strong net cash position will help it push on through this unexpected new headwind. Although a downturn on par with fiscal 2009 (when revenue dropped by more than half) isn’t my base-case assumption yet, the company could survive that and demand will eventually recover in key markets like Germany, the U.S., and Italy. I certainly can’t promise that there’s no more downside at this level, but Hurco has navigated tough times before and I expect it will do so again.

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Hurco's Balance Sheet Will Carry It Through These New Headwinds

Hurco Grinding Through The Machine Tool Downturn

Although the shares were down on the day of the announcement, I can't really say that Hurco's (HURC) fourth quarter earnings surprised me all that much. True, revenue and margins were a little worse than I expected, and so too with orders, but this is what downturns look like and I had written previously that I expected at least two more soft quarters as the company worked through this downturn.

Additive manufacturing remains a long-term threat to machine tool companies like Hurco and DMG Mori (OTCPK:MRSKY), but I still see enough demand to support low single-digit long-term growth in Hurco's core high-spec market. I expect revenue to decline for the full year next year, but I believe Hurco will start seeing a recovery in orders (in the first or second quarter of 2020) and I do believe that low single-digit long-term revenue growth, double-digit EBITDA growth, and long-term FCF margins in the mid-single-digits can support a double-digit annualized return from here.

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Hurco Grinding Through The Machine Tool Downturn

Hurco Now In The Teeth Of The Downturn

The fact that Hurco (HURC) is starting to see a sharp downturn in revenue really should be no surprise; orders went negative three quarters ago, and nothing in the global manufacturing economy has really gotten better since then. At this point, there is still a great deal of uncertainty over the shape of this downturn – will this growing “sluggishness” turn into an outright recession, or is this more of a lull in an otherwise healthy trend?

I’ve been of the opinion for about six months that there was more emerging weakness than commonly expected, and I do still see some downside risk to 2020 – particularly if the trade disputes between the U.S. and China and the U.S. and EU intensify. Specific to Hurco, management has been through this before and the company is in solid financial shape. The shares are undervalued now, but I still see some downside risk, mostly to perception/sentiment, in the industrial sector over the next couple of quarters, so investors looking at this name as an undervalued rebound play need to recognize the risk that the decline isn’t over yet.

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Hurco Now In The Teeth Of The Downturn

Hurco Now Definitely In The Down Cycle

There's really no more "if" or "I wonder" about Hurco (HURC) and what's going on in the machine tool cycle - Hurco's April quarter marked the third straight quarter of year-over-year declines in orders, and revenue comps should soon turn negative. Although I think Hurco is faring better than average so far, it's too soon to really tell, and I think investors should expect year-over-year declines in revenue for both this year and next, though I still expect a return to growth in 2021.

Buying into a downturn is tricky. I was pretty underwhelmed by the near-term potential of these shares back in March, and the shares have dropped about 10% since then - lagging not only industrials in general, but also other machine tool companies like DMG Mori (OTCPK:MRSKY) and Fanuc (OTCPK:FANUY). Although I do believe the shares are undervalued, I don't believe the market has really accepted the probability of a weaker-than-expected second half in the U.S. economy, and I see more downside risk for the shares and the market. With at least a couple more quarters of order correction likely, I think there's still risk here, even though longer-term investors may want to keep an eye out for good entry points.

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Hurco Now Definitely In The Down Cycle

Slowing Orders At Hurco A Growing Risk

I always considered a cyclical slowdown at Hurco (HURC) a “when, not if” proposition, and it seems like the when is an increasingly near-term concern. Fiscal first quarter results weren’t bad, but a third consecutive decline in orders shouldn’t be ignored, particularly when major players in the machine tool market are calling for a double-digit decline in orders in 2019 and European demand appears to be weakening.

Hurco remains undervalued relative to industrial sector norms, but I’m pretty cautious about the outlook for a host of industrial sectors, including “general manufacturing” and it’s tough to get ahead owning even undervalued stocks in a weak cycle for the sector. Consequently, while I still like Hurco as a business and the valuation doesn’t appear demanding, it’s tough to recommend the shares unless you have a fundamentally more bullish view on the prospects for the North American and EU economies over the next 12-24 months.

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Slowing Orders At Hurco A Growing Risk

Signs Of A Slowdown For Hurco Getting Harder To Ignore

The slowdown in industrial demand that the market has been pricing into stocks since mid-2018 seems to now be showing up in some of the numbers, as the December ISM new orders figure saw a double-digit drop and German factory orders just posted the biggest decline (a little over 4%) in six years. Japanese machine tool orders went negative earlier in the fall, and it is looking as though weakness in China has spread into Europe and may be starting to show in North America.

None of this is good for Hurco (HURC), but it’s not exactly unexpected, as the shares have fallen close to 20% in the last six months. That puts Hurco’s performance a little below the average industrial and in between larger competitors like DMG Mori (OTCPK:MRSKY) and Okuma (OTC:OKUMF), and valuation is already starting to anticipate some revenue and profit declines in the coming years.

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Signs Of A Slowdown For Hurco Getting Harder To Ignore

Hurco Keeps Delivering, But The Cycle Appears To Be Slowing

If fiscal third quarter results are a fair indication, it looks like my concerns about a slowdown in business at Hurco (HURC) ahead of a major fall tradeshow were misplaced. Although Hurco did see some sequential slowdown in orders, that’s not uncommon in the summer and the business overall seems to be in good shape, while industrial customers continue to look to add production capacity.

Experienced investors know that the good times for Hurco, DMG Mori (OTCPK:MRSKY), Milacron (MCRN) and other industrial equipment manufacturers won’t last forever, but this latest earnings cycle has offered more positive commentary compared to earlier this year and many manufacturers are bumping into capacity constraints. While global trade tensions are a threat, and I wouldn’t go too far out on a limb to chase Hurco, I don’t think the cycle is over just yet.

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Hurco Keeps Delivering, But The Cycle Appears To Be Slowing

Are Somewhat Sluggish Order Comps A Risk For Hurco?

These are good days for machine tool companies, as orders have recovered nicely both in North America and in Europe driven by expanding production and the placement of aging equipment. Hurco (HURC) benefiting from this growth as well, but I'm a little concerned that the company's growth seems to be lagging industry growth in key markets like the U.S. and Germany. It's not a reason to sell yet, and the company's margins are developing pretty well, but it merits watching as I don't believe the shares are dramatically undervalued today.

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Are Somewhat Sluggish Order Comps A Risk For Hurco?

Hurco Off To A Strong Start

Manufacturers continue to expand and upgrade their capital equipment, and that trend is benefiting small-cap machine tool manufacturer Hurco (HURC). As a company that makes things, Hurco is clearly very leveraged to the health of the global manufacturing economy, but particularly in Germany, the U.S., the U.K., France, and Italy. Although industrial production growth has slowed a bit recently, the overall trends remain healthy in the U.S. and Western Europe, and most industrial companies have guided toward a healthy 2018.

A bi-annual tradeshow in September of this year is likely to create some volatility in quarterly results (with orders slowing into the show, as many companies introduce new models/features at the show), but I expect that Hurco will generate double-digit revenue growth and at least come very close to double-digit operating margin. With the current share price still offering double-digit return potential, I don’t think it’s too late for the stock, but I do think the industrial recovery story is pretty mature at this point.

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Hurco Off To A Strong Start

DMG Mori Running On A Global Tool Recovery

Companies appear to be opening their wallets for capital investment once again, and that has been very good news for DMG Mori (OTCPK:MRSKY) ((6141.TO)). This Japanese (and German) leader in the machine tool space has seen its share price almost triple from its early 2016 lows and rise almost 80% in the last year as the company starts to leverage its strengths into an improving order cycle.

With 2017 being the first year of growth off a trough, DMG Mori ought to be looking forward to at least a few more years of solid order growth, fueled by underlying drivers that include a need to replace aging machinery, a need to automate to remain cost-competitive and deal with a skilled worker shortage, and new technologies. Even so, the strong run in the shares has already captured a sizable chunk of the value, and I would note that analysts don't seem ready to believe that this cycle will be as strong as past cycles.

DMG Mori is more richly-valued than Hurco (HURC) (which I own), and there are valid reasons why it should be - it's the largest player in the field, and it has exceptional scale and operating leverage, among other reasons. What's more, there would seem to be room for analysts to raise their expectations in the future if this cycle matches prior upswings. That said, a lot here is riding on the overall health and growth of global manufacturing, so the current spread between the share price and fair value isn't as robust as I'd like.

I would also warn U.S. investors that the ADRs for DMG Mori are not liquid at all. The Japanese shares, however, have no such problem and are a better option for those investors able and willing to go to the added trouble.

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DMG Mori Running On A Global Tool Recovery