CGNX - Cognex Struggling To Deliver As Logistics Spending Shrinks

Summary

• Cognex posted weaker-than-expected fourth quarter results, with revenue undermined by weaker logistics/warehouse demand and margins hurt by supply chain constraints.
• Management guided well below the Street for Q1'23, as Amazon cuts back significantly on its warehouse/fulfillment capex.
• Auto demand looks healthy on the back of BEV production growth, and markets like food/beverage, biopharma, and med-tech offer reasonable near-term growth.
• Automation can support double-digit long-term growth at Cognex, and the valuation does offer some upside, but this is a beaten-down growth stock that needs to perform to drive a rerating.

Machine vision remains a long-term growth market, but it doesn't automatically track that all machine vision players are going to see a smooth growth curve. A heavier reliance on ID products used in warehouse/logistics automation gave Cognex ( CGNX ) a great tailwind when Amazon ( AMZN ) was spending hand over fist on building and automating warehouses, but it's leading to a brutal hangover as Amazon pares back spending and other end-markets like autos and electronics can't fill the gap.

Since my last update , these shares have fallen about 6% and lagged the industrial sector, as well as rivals like Keyence ( KYCCF ).

As a practical matter, it's tough to recommend a growth stock that's looking at some sharp year-over-year quarterly revenue declines, and where there is still arguably downside risk to expectations for the second half of 2023. On the other hand, the Street has a way of looking past near-term troubles and Cognex stock should exit 2023 with year-over-year growth, as well as longer-term opportunities in multiple markets that can support double-digit long-term revenue growth. I'm still bullish on that long-term potential, but there is still above-average risk here now.

A Weak End To The Year

In contrast to a reporting cycle that has seen a lot of industrial companies post better-than-expected fourth quarter results and fairly benign guidance for 2023, Cognex came in weak and started off 2023 with a very weak guide for first quarter revenue. The primary driver - a very weak logistics/warehouse automation market - isn't surprising, though the magnitude does still seem to be surprising the Street.

Revenue rose 4% year over year and 17% quarter over quarter in constant currency terms, missing by almost 3% and certainly coming in well below the 10% or so growth that has been common this quarter. Management regrettably does not provide much information on an end-market basis, so all I can offer is some guesswork regarding the drivers.

Looking at the results from companies like Atlas Copco ( ATLKY ) and Rockwell ( ROK ), the auto market was likely strong this quarter, with OEMs ramping up capex to support battery electric vehicle launches in 2023; Atlas specifically called out healthy demand for machine vision systems at auto customers for BEV and battery assembly. Likewise, based on commentary from Atlas and Rockwell, as well as Nidec ( NJDCY ), demand in the semiconductor industry was likely healthy, while consumer electronics demand was likely up marginally.

Logistics was almost certainly weak. Rockwell saw a double-digit decline in its quarter from that end-market, and Honeywell ( HON ) posted a 6% decline in its Warehouse and Workflow Solutions business, with neither company likely as leveraged to Amazon as Cognex has been.

Moving further down the earnings report, gross margin declined 90bp yoy and 140bp qoq, missing by 70bp, as the company is still seeing elevated costs due to the fire earlier in the year and the need to turn to brokers to secure needed inputs. Operating income was flat, also a miss versus the Street, though operating margin did improve 50bp yoy to 23.6%.

Weaker Warehouse Spending Is A Tough Hurdle To Overcome

For most of Cognex's markets, operating conditions aren't actually all that bad. Consumer electronics isn't in great shape but should grow again in 2023 as most of the major markets (phones especially) are bottoming out. Semiconductor industry demand could be shakier, especially on the memory side, but capacity investments are still underway in logic. Other markets like food/beverage, medical, and pharma, should be healthy in 2023, particularly with the company actively working to expand these businesses with new customers.

I'm more bullish on the auto outlook for Cognex than I was before, as although overall build-rate volumes aren't looking that strong in 2023, there is definitely an ongoing investment cycle underway to support battery and BEV production, with BEV production volumes likely to double this year.

Logistics remains the chief issue for Cognex, and Amazon in particular. Amazon management has been pretty vocal and explicit about cutting warehouse and fulfillment capex in 2023, and that could mean a 50% or greater decline in spending this year, after a 30%-plus decline in 2022. Backing that up, Prologis ( PLD ) has been talking about a 50%-plus decline in warehouse development starts in 2023. While there is still growth in automation spending in the logistics space (Rockwell is expecting double-digit growth in FY'23), it's not with the systems and customers where Cognex is strongest.

The good news is that while I think it will take a couple of years for Amazon spending to reaccelerate, there are other growth opportunities out there. Food and beverage companies are investing significantly more resources into automation to offset labor challenges and improve production efficiency, and there are attractive growth opportunities in other end-markets like medical, biopharma, and consumer goods.

Longer term, I also see growth opportunities in 3D vision for inspection and in machine vision systems for robotics. Adoption of machine vision and robotics is still low in most industry end-markets, and ongoing investment in these systems should support double-digit long-term growth for Cognex, even if there will be meaningful year-to-year variability.

The Outlook

I was previously below the Street for my FY'23 revenue number (about $975 million), but have decided to trim that another 5% mostly just to cover downside risk in the logistics and consumer electronics spaces. I do expect a double-digit rebound in FY'24 (up 12%), but again I'm taking a more conservative stance on logistics/warehouse-driven spending. I do think there could be an upside from auto OEMs as they continue to ramp up BEV production, not to mention longer-term demand from commercial/heavy vehicle manufacturers as they offer new electrical models.

Long term, I'm looking for revenue growth of around 10%. I don't think that's necessarily a conservative number, but considering the sort of capex auto OEMs will need to support ongoing BEV production growth, not to mention growth in markets like food/beverage, electronics, biopharma, and logistics/warehouse (which, despite Amazon's spending is still not especially highly automated), I believe it's attainable.

I expect margins to be better in FY'23, but it will take a few years to get back to the highs driven by the strong logistics growth that Cognex saw in 2021. Long term, I expect free cash flow margin to approach 30%, particularly as the company benefits from a greater software mix, and I expect low double-digit FCF growth modestly ahead of underlying revenue growth.

The Bottom Line

Discounted cash flow still supports a fair value in the $50s, though margin/return-driven EV/EBITDA is not nearly so supportive. Weak near-term results are a headwind, as is the risk of an even worse valley in logistics revenue, but I expect Cognex to return to year-over-year growth in the second half of the year and the Street has a pattern of looking about six months beyond expected weakness.

It will take time for Cognex to work again, and there is still some risk of additional miss-and-lower quarters, but investors looking for a "scratch and dent" growth story where a return to growth can drive rerating should spend some time on due diligence for Cognex.

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