Cognex Stock Could Come Back To Life In 2022 (NASDAQ:CGNX)

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.

The First Quarter Should Be Fine For Growth

I’m not too worried about Cognex coming up meaningfully short on revenue in the first quarter (with the company likely reporting in the first week of May), and that’s against a strong recovery comp last year. Management socked away inventory to mitigate the risk of shortages crimping their ability to ship to demand, but I can see a risk that customers hold off on orders/installations due to shortages at other non-Cognex suppliers.

Auto demand should be healthy on EV/battery projects, and I expect solid demand in smaller (but growing) end-markets like food/beverage as companies are turning to automation to add capacity amid labor challenges.

I’m expecting little from the consumer electronics business. Nothing in recent trends suggests meaningful recent improvement, including higher inventories for chips related to smartphones, and the customers in this space don’t usually make their equipment/capex decisions until May. I would think management should have better visibility with this upcoming report, but a lot depends on what Apple (AAPL) is doing in terms of design changes for the next generation of phones, as that’s what often stimulates meaningful demand for new inspection/QC equipment.

Cognex doesn’t report market-by-market growth figures on a quarterly basis, but they will provide information on general trends. I’ll be very curious to hear what they say about the logistics business. Given huge investments made by Amazon (AMZN) last year, and the fact that Amazon is widely thought to be the company’s largest customer, making up about half of the logistics business, growth should moderate, but there is still a strong underlying cycle in warehouse automation that could drive some upside.

Supply chain costs are going to pinch, and while I think growth should be in the high teens, gross margin will probably be down around five or six points from the prior year and up modestly from the 71.7% figure in Q4’21. Management built inventory in FY’21 to help mitigate shortages, but margins are likely to be pressured all year.

Time For A Transition?

Autos, consumer electronics, and more recently logistics have been powerful drivers in Cognex growing from around $325M in revenue a decade ago to over $1 billion last year. I do expect, though, that the company is going to start seeing some transitions in its business as automation adoption increases across the industrial space.

The auto industry is going to be an important one for a while longer. OEMs are still retooling for EV launches, and the decision to insource more content should drive increased capex needs for the companies doing so. I also see significant growth opportunities on the battery side (assembly), and this demand should be volume-driven – meaning that as EV penetration and build volumes increase, so too will the demand for machine vision systems.

Consumer electronics is a harder call. As I said above, a lot of Cognex’s business has been driven by iPhone design changes, and I don’t see opportunities like AR/VR as particularly significant in the short run. Logistics, on the other hand, is a simpler call – I see strong multi-year growth potential here, as despite the well-publicized growth in the market, automation penetration is still low and operators are looking to adopt increasingly sophisticated automation capabilities.

Growing beyond its traditional base is a meaningful opportunity for Cognex and likely key to hitting my longer-term growth assumptions. Industries like food/beverage and biopharma are starting to embrace machine vision in a more meaningful way, and I believe other industries will follow suit, including medical devices and packaging. None of these industries are likely to become a top-three individually, but collectively, they will add up. I’m also looking for Cognex to extend its opportunities into other areas of vision and into adjacent markets. Most of what Cognex does now involves fixed cameras or readers that scan and inspect products as they go by. Over time, as more industries embrace robotics, I see more opportunities for more tightly integrated robot vision systems, particularly with companies prioritizing robots that can work safely with human workers and respond to a wider range of circumstances. I likewise see opportunities for Cognex to grow its 3D vision business, add more software capabilities, and possibly expand into metrology (Atlas Copco (OTCPK:ATLKY) has acquired its way into both machine vision and metrology in recent years).

The Outlook

I do expect supply chain pressures to weigh on margins in FY’22, but I also think Cognex could still end up driving year-over-year EBITDA and operating margin expansion. I don’t think my nearly 16% year-over-year revenue growth estimate is conservative, but I do see strength in areas like autos, logistics, and multiple smaller industrial end-markets supporting that growth.

Longer term, I’m still looking for low-double-digit revenue growth from Cognex, with the business exceeding $3B in revenue in FY’31. As I outlined above, I’m expecting Cognex to see its addressable markets grow over time as more industries adopt automation, particularly in areas like quality control, and I’m expecting stronger growth associated with opportunities like 3D vision, robotic vision, and software.

With a richer mix of higher-value sales (including software) and improved scale, I expect FCF margins to grow from the high-20%s in recent years toward the mid-30%s. By no means is that a conservative assumption, but it does help that this business is relatively capital-light (capex/rev below 3%) and that there are meaningful barriers to entry from an engineering perspective.

The Bottom Line

Even with the share price weakness, Cognex is still expensive on a conventional multiples-based approach. Using discounted cash flow, though, the shares do look priced now for a high-single-digit long-term total return. Of course, DCF is not a perfect methodology, and there’s a GIGO risk (“garbage in, garbage out”); if my assumptions for revenue growth and margins are too high, the shares are not going to live up to that return expectation.

Cognex isn’t what I’d call a low-risk proposition, but I’m a believer in automation and I believe Cognex is well-placed to ride a trend that is still closer to the beginning that the middle (let alone the end). With a more reasonable valuation than has been available for a while, I think this is a name to consider.