Liu Sishang
Depending on what indicators and metrics you follow, you might think there is nothing to worry about in the economy, especially the industrial and manufacturing economy. The S&P 500 is at or near its highs, and industrial stocks as a whole are While cruising, Industrial Select Sector SPDR Fund (Article 41) increased by 23% in the past year, Vanguard Industrials Index Fund (VIS) likewise rose 24%, despite continued weakness in indicators such as domestic and European manufacturing PMIs.
We believe that at least in some areas, the fundamentals are not that strong. Harcoof(Nasdaq:Hark) The second quarter 2010 results certainly bear that out. While some numbers were less bad than expected, orders are still worryingly weak, and when combined with other indicators, Lincoln Electric (Reco) Growth forecast revised downward ( FY24 organic revenue declined mid single digits; Fastenalof(fastManufacturing sales growth is sluggish and the outlook is not looking good.
Maybe this is the worst case scenario, but “maybe” is a shaky basis for an investment thesis. But the current bottom is the worst Hurco has been in a decade (excluding pandemic-impacted years), and this cyclical business is still subject to trends like “catch-up” capital spending in the U.S. and reshoring in key markets in North America and Europe, not to mention the drivers of a more typical cyclical recovery. I wouldn’t go so far as to say Hurco is a “must own” stock, and I still see risk for industrial stocks to fall from here, but I think investors looking for bottom-hunting opportunities could consider this stock as a 2025 recovery idea.
Another tough quarter as macro indicators weaken
Hurco has a number of aspects that make it difficult to benchmark, including its small size, somewhat uncommon customer base, and non-calendar reporting cycle (fiscal year ending in October). This means that Hurco can be a leading or lagging indicator, but its weak Q1 2024 performance appears to have been a harbinger of recent weakness in macro indicators. This is not good news, given that Q2 performance was again weak.
Revenue was down 16% year-over-year but up slightly quarter-over-quarter. The best news to come out of these results is that it suggests the business is stabilizing and perhaps in the process of bottoming out. Revenue was down 8% in North America (up slightly quarter-over-quarter) and 24% in Europe (down slightly quarter-over-quarter), while currency adjusted revenue increased 3% in Asia (down slightly quarter-over-quarter).
Gross margins fell more than expected, to 17.8%, down 560bps YoY and 370bps QOQ. I was concerned about the impact of inventory buildup seen in the last quarter, but in fact management blamed the decline in gross margins (and unfavorable product mix) on price cuts to clear inventory. While we expect revenue and gross margins to be at cycle lows, operating income fell to a loss for the second consecutive quarter ($3.4M vs. $1.8M last quarter).
The company ended the quarter with net cash of about $5.82 per share, but inventory was reduced by only about $1 million, equivalent to about 1.1 years’ worth of annualized cost of goods sold.
Orders were down 27% y/y and down 12% q/q (backlog ratio just below 1.0), with sequential declines that are of some concern in predicting a cyclical trough. US orders were down 23% y/y and down 18% q/q (backlog ratio of 1.01x), while European orders were down 28% y/y but up 23% q/q with a backlog ratio of 1.27x. Asia Pacific orders were weak (down 33% y/y and down 44% q/q with a backlog ratio of 0.6x), but we feel that order trends are not very predictive in this business segment.
I look around my neighborhood and I don’t feel well.
The risk of Haako losing out to a bigger rival cannot be denied. DMG Forest, Yamazaki Mazakand Okuma (And a direct comparison of earnings can be misleading), but looking at other metrics and indicators, Hurco is not isolated in terms of weakness in underlying market demand.
Unfortunately, U.S. cutting tool consumption figures are delayed, but in March they showed a decline (down 5.8% year-on-year) after two months of improvement. MSC Industrialof(Mainstream Media(MSC is a large distributor of cutting tools.)’s latest earnings report and guidance were not stellar. Similarly, U.S. machine tool orders fell about 4% in January, 27% in February, and 21% in March. Meanwhile, German machine tool orders fell 24% in the first quarter.
Figures released by the Japan Machine Tool Builders’ Association (which provide more rapid and detailed information) show that overall orders in April were down 9% compared to last year, with US orders down 23%, German orders down 23%, Italian orders down 11% and UK orders down 36% (Italy and the UK are also important markets for Hurco).
Turning to PMIs, the manufacturing PMI declined for two consecutive months (49.2 in April and 48.7 in May) after briefly rising above 50 in March, while Germany (Hurco’s main market) saw a slight improvement, from 41.9 in March to 42.5 in April and 45.4 in May.
Finally, anecdotal data points from other industries suggest continuing pressures. In addition to the weak data from MSC, Fastenal is reporting slowing growth among its manufacturing customers (+2% in heavy industry in March, +1.9% in April, and +1.5% in May). And Lincoln Electric recently revised its fiscal 2024 revenue growth forecast from low-to-mid single-digit growth to a mid-single-digit decline, citing “weakening industrial activity and capital spending.”
Looking at some of the major machine tool markets, auto companies are certainly cutting back some of their capital spending on EV projects, semiconductor investment remains cautious, machine investment is weakening, and mold activity is also slowing. This represents about 60% of the machine tool market, and I believe the uncertain political situation in the US could cause a pause in investment until the election results are known.
Outlook
Some readers may take issue with the idea that just because Hurco’s business has recovered in the past, it will do so again this time, but I don’t think anything has changed at a fundamental level.
It’s natural to complain about the lack of overall long-term growth and question whether Hurco can remain competitive with companies like DMG Mori and new technologies like additive manufacturing, but I don’t think the fundamental cyclicality of machine tools has changed much. I think the addition of long-delayed capital expenditure tailwinds among industrial customers and the reshoring of manufacturing in many of Hurco’s key markets will ultimately fuel a recovery. It remains to be seen whether that recovery will start to materialize in the next quarter or two, or whether performance could bottom out until 2025 (though orders should recover sooner).
I have made some revisions to the model, primarily by carrying over a portion of FY2024 revenue into FY2025 and FY2026. This lowers my FY2024 revenue forecast by approximately 6%, but leaves long-term revenue and growth unchanged and I still expect long-term revenue growth of close to 3%. FY2024 margins may be more compressed than expected but could recover as revenue improves, and I still believe Hurco can generate long-term FCF margins of 3% to 4%.
Comparing discounted cash flow and margin/return driven EV/EBITDA, Hurco shares look slightly undervalued in the high teens to low 20s.
Conclusion
Herco is not a good candidate for buy-and-hold investors. It hasn’t seen much growth over the past few years, and metrics like return on invested capital aren’t great. However, as counterintuitive as it may sound, lower quality cyclical companies often outperform during cyclical recoveries, and in that respect Herco does have some merit as an investment idea.
These stocks haven’t performed well since then. My last postInvestors need to be aware of the risks that the U.S. actually falls into a recession, and that Herco’s issues are company-specific, but this still looks like a promising near-term industrial recovery story for 2025.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
