Cognex: A play on the trends of Artificial Intelligence, Edge Computing and Industrial Automation
Short-term macroeconomic headwinds for $CGNX is a long-term opportunity
TLDR: Computer Vision is an AI sector that holds promise for investors as it is powering industrial automation which is growing quickly thanks to secular trends of reshoring and lack of labor. Cognex, a leader in Machine Vision, has industry leading products and its customers include Apple and Amazon (known for operational excellence). Also, Cognex’s cameras, driven by advances in edge computing, are increasingly more intelligent. As an investment, Cognex is attractive as it is a pure play on Machine Vision, and having crossed the chasm is set up for a long runway of growth.
Artificial Intelligence has captured the imagination of most everyone. The media cannot get enough of ChatGPT and Generative AI. Computer vision is a well-established AI field that has a promising future. It was established in the 1950s (history here) and has evolved from its nascent phase to the present, affecting practical applications that vary from manufacturing to logistics.
What is Computer Vision:
According to IBM, “Computer vision enables computers to replicate human vision, and allows computers to derive meaningful information from digital images, videos — and take actions or make recommendations based on that information.”
Machine Vision: An application of Computer Vision
Machine vision is an application of computer vision mostly applied in industrial settings. A Machine Vision system combines computer vision software with hardware industrial equipment, enabling the latter to analyze and act on visual inputs.
Machine Vision applications include automotive, electronics, semiconductor equipment, logistics, life sciences, food and beverage, packaging, airport baggage handling and more. Here is a fascinating video on Cognex’s website (link). It demonstrates how machine vision activates automation in e-commerce fulfillment.
Machine Vision market growth for next five years is ~15%
According to Technavio, the global machine vision camera market has estimated growth of $12.8 Billon from 2022 to 2027 - at a CAGR of 15.23%. There are two tailwinds in the market: reshoring and lack of labor which encourage industrial automation. Also advances in edge computing through AI is creating machine vision cameras (cameras are an edge device) with higher accuracy rates. Next, we will cover Cognex, a company with a reputation for market leading products.
Cognex: A leader in Machine Vision
1. Leading product in the Machine Vision industry: customers include Apple and Amazon, and have high gross margins
An indicator of a good product is often how cutting edge its customers are. In its Annual Report, they talk about two major customers: Apple (electronics) and Amazon (logistics). Amazon and Apple are both known for operational excellence. Their due diligence indicates that others in logistics/electronics, are more likely to choose Cognex for their automation journey.
An example of this phenomena - (recent earnings call (2/16/23) ) reflects their expansion in a Fortune 50 retailer below: The (logistic) market is still in the early stages of adopting machine vision. Most companies are still highly reliant on labor … a recent win with a Fortune 50 retailer that was previously a relatively small customer...” Why they won: “Cognex was chosen .. because of our best-in-class algorithms that can reliably read barcodes at angles. Our tunnel solution enabled our customer to increase the number of products on a high-speed conveyor by reducing the gaps between them while still reading ..at near-perfect read rates.”
Cognex’s competitive advantages translate into high profit margins with gross margins of 71% and Operating margins of 23%.
2. Switching Costs are High
A big factor that makes a technology product durable is high switching costs; others are price performance advantage, protection from competition and ecosystem value. When an enterprise adopts a Cognex system, trains their employees, and integrates the system into their factories, they have little incentive to change due to the switching costs.
3. Diversified Biz in terms of Geography and industries
Cognex is diversified internationally - 34% of their revenues come from the US; 66% from the rest of the globe - the breakdown: 23% Europe, 23% China, 20% other.
Cognex’s revenues are diversified across industries that range from automotive - including electrical vehicles, electronics, logistics, life sciences and others. Here, they outline their plan for long term growth of 15%, as well as anticipated growth rates for individual sectors.
Recent headwinds creating long term investment opportunity
Cognex stock price recently suffered a one year return of -30% (reasons below), and volatility may continue due to macroeconomic factors. However, this may be an opportunity for long term horizon customers.
1. Reduced investment by their customers (Amazon) after pandemic growth
During the pandemic, there was a rapid expansion in warehouse investments and electronics manufacturing to keep up with demand. Presently the cycle turns - Amazon is cutting investments, impacting Cognex in the short term. While logistics has slowed down, Cognex’s other sectors including automotive (and EV), semiconductors and life sciences are showing promising growth. Cognex rides the historical impact from the cyclical nature of the industrial sector. This is reflected in Cognex’s 5 year and 10 year revenue growth of 6% and 14% respectively.
2. Supply Chain Challenges including a loss of inventory due to a fire
A recent fire in June 2022 at its Indonesian plant (link) caused a loss of significant inventory. It resulted in supply chain challenges to replenish inventory. Another consequence was a delay in some revenue and depressed margins (400 basis points for the year).
Risks, Valuation
Risks to Cognex’s moat can come from competitors - Zebra, Keyence, Datalogic, Rockwell Automation, Omron and Basler AG. It is arguable that the market is extensive enough for multiple players. From an investor POV - unlike competitors, Cognex is a pure play on machine vision. Small/mid caps like Cognex are often undiscovered, and are lucrative for investors as they are poised for a longer runway of growth vs large caps.
Source: Seeking Alpha
Its P/E (38) is expensive compared to S&P 500. This can be justified based on the 10-year past growth rate of 14% with a future target of 15% annual growth.
Conclusion
Cognex has high switching costs and a leading industrial product with a strong moat. It is well positioned, in the area of industrial automation - a sector with long-term secular tailwinds. Earnings report coming very soon on May 4, 2023. However, a long-term investor may consider Cognex irrespective of short-term outlook.
This blog is solely for informational purposes and is not intended to be a solicitation to buy or sell any particular security or recommend any particular investment strategy. We suggest you check with a broker or financial advisor before making any investing decisions.
The author, is an investment adviser representative with Tilden Path Capital, LLC, a registered investment adviser in California.
Past performance is no guarantee of future returns.
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In our analysis, we use third-party resources we believe to be reliable, but cannot guarantee the accuracy of such information. We believe the information we provide is accurate as of the date furnished, but we do not revisit past material to update it.