It’s been a tough stretch for Cognex (NASDAQ:CGNX) since my last update on the company, as this machine vision company has been hit hard by weak capex cycles across almost all of its major markets. Revenue has declined meaningfully, driven painful decremental margins and a significant reset to sell-side expectations.
Shares are down slightly from the time of that last article, underperforming the larger industrial sector by a wide margin, but Cognex’s performance hasn’t been much different than other companies leveraged to similar drivers and markets, including Daifuku (OTCPK:DFKCY), Jungheinrich, Keyence (OTCPK:KYCCF), Rockwell (ROK), and Zebra (ZBRA).
Valuing Cognex remains tricky. The company’s growth and margins can still support a fair value in the $50’s, but that assumes a strong rebound within the next few years, very healthy long-term revenue growth (in the low double-digits), and a strong margin recovery. Those are all possible, but have to be weighed against risks like further near-term erosion in key markets like autos and a longer-term risk that the market isn’t as underpenetrated as previously thought.
Cognex’s End-Markets Are Scrambled
The last year was a rough one for Cognex, with markets representing two-thirds of revenue down year over year in the high teens, led by a very sharp drop in consumer electronics.
This year is shaping up to be no less challenging, albeit with a few bright spots (or at least brightening as of midyear).
Auto remains in rough shape, with weaker sales and more pressure from investors leading auto OEMs to cut back on their capex spending. Electric vehicle sales have been particularly disappointing, leading to meaningful cutbacks in capex for these lines, but it’s not as if the companies are raising their capex for traditional powertrain assembly lines by an offsetting amount – more or less they have the capex they need in place for that, and they’ve been incorporating machine vision for some time. Although I’m still generally bullish on EVs, it could take a little time for this market to become a positive tailwind again.
Logistics, too, is a rough space. As expected when I last wrote about Cognex, warehouse construction has fallen off sharply, with construction starts down 40% in 2023 and continuing to fall in 2024. Amazon (AMZN), previously a major customer for Cognex, has basically stayed on “pause” while digesting a huge prior capex expansion project, though Cognex did describe the business as “stable” in Q1’24, with specific strategic projects driving year-over-year growth. I think there’s room here to grow off of reset base, and further reshoring activity should be a positive long-term driver, but I expected a more measured pace of investment as the market recovers.
Consumer electronics remains a tough market, and I’m not really seeing anything that points to a big near-term rebound. I don’t see a particular driver for a new surge in smartphone volumes, and other drivers like OLED TVs just aren’t big enough to really move the needle.
Management hasn’t gone into detail on its medical market exposure, but I know lab automation spending has slowed some, and biopharma companies have definitely slammed the brakes on capex. Likewise with consumer packaging, where the industry is digesting capex bought to handle the surge of demand that followed the pandemic.
The one bright spot would seem to be in semiconductors. This has never been an especially large market (I don’t think it has exceeded 10% in a given year), but growth is growth and with fab construction in good shape, this is a positive driver.
How Quickly Can New Market Opportunities Develop?
One of the challenges for Cognex, at least in the near term, is developing new markets for its machine vision products. The company’s Emerging Customer Initiative is meant to do just that by expanding the salesforce to reach new and/or under-penetrated customers and expanding the product portfolio to include technologies like edge AI that improve ease of use and product flexibility (the company just released its first AI-enabled 3D vision system).
Bulls will argue that this is a sound management strategy to expand served addressable markets and find new opportunities in other manufacturing sub-sectors. After all, more and more industries have been adopting automation in the face of skilled labor shortages and that is likely to accelerate with even more reshoring activity in the U.S., and companies like Rockwell have been explicitly targeting customers in markets that haven’t traditionally been big users of automation.
Bears will argue that they’re doing this because all of the low-hanging fruit on the tree has already been picked and eaten, and it’s going to take a lot more effort to push automation into sectors that haven’t yet adopted it. In other words, automation companies are trying to find new markets because their current customer base already has the tools they need and won’t be expanding capex fast enough to drive what these companies need in terms of revenue growth.
The truth may be somewhere in the middle, but I lean more toward the bull case, at least over the long term. I think there is still a lot of opportunity to expand automation and machine vision on assembly lines and in logistics. We’re still at a point where most industrial warehouses and distribution/fulfillment centers don’t have much in the way of automation, and likewise there are still a lot of factories and sectors that make little to no use of machine vision for quality control. I also still see long-term opportunities in robotics, where the adoption of cobots (robots that can safely be used with and around humans) is still in its early days in most industries.
The Outlook
Cognex isn’t alone in seeing a significant reset to expectations over the last couple of years as automation capex spending has plunged, but the greater than 50% drop in Street expectations for Cognex’s 2024 EBITDA between now and this time two years ago is still painful to see. Moreover, the Cognex model clearly has significant operating leverage that may have taken investors by surprise.
The upshot of that operating leverage is that profits should accelerate rapidly once revenue growth returns. I’m a little below the Street average with FY’24 revenue, but that still translates into 10% year-over-year growth, and I am expecting reacceleration off a low base in the second half of the year. I expect a more significant ramp over the following three years, and I’m still looking for long-term revenue growth in the low double-digits (around 13% to 14%) from the 2023 level (or about 9% annualized from the last revenue peak).
That’s an ambitious target, I’ll grant, but I’m a believer in automation adoption, and I think there is still a long runaway for automation spending in logistics and manufacturing, not to mention leveraging reshoring of electronics (semiconductors, mostly) and future capex spending on EV capacity.
On the margin side, I do expect revenue reacceleration to drive strong incremental margins, with EBITDA margin recovering to high-20%’s/low-30%’s in 2025/2026. Over the long term, I still expect FCF margins to head toward the high-20%’s, driving around 9% FCF growth (from the prior peak) and a modest improvement in long-term weighted average FCF margins (about 100bp).
Discounting those cash flows back, and using margin, return, and growth-driven EV/EBITDA models, I get a fair value in the high-$40’s (including a blended 21x EBITDA on FY’26 EBITDA, discounted back).
The Bottom Line
I don’t pretend that these assumptions are conservative, and indeed there is still ample macro risk – EV adoption could take even longer, logistics automation may never go much past 20% or 30%, and new growth opportunities may just not be large enough to support significant sales leverage for Cognex.
On the other hand, I see automation as really the only way to deal with a shortage of skilled labor, and with falling birthrates across Western countries, that problem is only getting worse. As a key enabling technology, then, I still see a strong future for machine vision.
Specific to Cognex, no it’s not clearly a bargain today and there are still outsized risks. That’s the nature of buying pullbacks, though. You don’t usually get pullbacks without something really scary happening in that company’s business, and I think there’s enough upside to merit a closer look from investors who can afford to take on greater risks.
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