In our summer Halftime Report (HERE), we highlighted new buys and sells for two Tech PMs we had tracked, one with good ~6 months duration performance, and one with exceptional long duration performance. In recent marketing meetings several buysiders asked us to update the anonymously selected PM buys/sells so they could see the trajectory of idea generation. Below are the updates and the stocks that stand out to us from the analysis.
Two stocks stand out from the attached lists.
Stock one: Sony
Both PMs are sellers of Sony (6758 JP, SNE, $58b cap). We disagree. We featured SNE bullishly in our recent vetting BB (HERE). The stock has admittedly had a big move since then but the fundamentals driving the beats seem somewhat sustainable. We like Sony as the company has:
- A leading technology position in the image sensor market, with greater use of image sensors in multiple applications on the path ahead
- Absence of incremental losses in other segments of the conglomerate
- Almost better than ever FCF generation
The challenges for investors on the long side in SNE are two-fold: 1) does next year’s capital cycle in image sensor infringe both on incremental profitability and add injury to the balance sheet (and oy vey if they plan to use equity), and 2) how will they ensure the movie business does not fall into losses and offset incremental gains on other businesses. Net, at 12-13x EV/FCF and with a path to ongoing improvement, we think the arrow is pointed higher.
Stock Two: COGNEX
One of the PMs initiated a position in Cognex (CGNX, $12.1b cap). The company is a machine vision pioneer founded by an MIT professor and his students in the 1980s…decades ahead of its time. At the start of the year the stock was trading just under 30x EV/FCF (LTM) growing just under 20% annually. Revenue growth accelerated this year to over 70%, the stock is up 120% YTD, and now it looks like you are paying over 50x EV/FCF (~2017E).
How does a PM initiate a new position in an equity up 120% YTD? It requires paying less attention to what is implied in near term expectations and taking a step back to see the bigger picture.
- Machine vision is still in early stages; for example this pioneer will have only ~$750m in total revenue in 2017
- Machine vision hit a tipping point of adoption in 2017 and revenue accelerated from ~20% to over ~70% (recent Q, y/y %)
- The company’s addressable markets continue to expand, making it tough to peg long term revenue upside potential. In other words, it may not be outlandish to think in terms of what will the company be worth at $3-5bn of revenue in 5-7 years' time
- CGNX has a strong IP position, high gross margins (~78%), and over 30% historical FCF margins (to revenue), so we know whenever they arrive at the destination, the company will have a strong FCF model
That doesn’t mean the stock is a layup. You are paying something like 25x 2019 FCF…assuming that when we get there in ~18 months the stock will be trading at ~35x.
For us the lesson of this effort is Process. Having a multi-faceted process forces us to check assumptions on stocks we like, such as SNE, and introduces us to important equities benefiting from powerful long term trends, such as Cognex. Happy hunting.
