Cognex

Despite falling some way from its peak in the face of weaker markets, Cognex maintains a premium valuation. This is largely thanks to the company’s exposure to automation trends in its key end markets: Automotive, Consumer Electronics and Logistics. While demand has been soft this year, Cognex expects to achieve 15% growth in the medium to long term. As can be seen from their investor presentations (below), the company enjoys selling the huge potential of this market to investors while presenting a dumbed-down explanation of what “machine vision” is

For the most part, the maket has been focused on revenue potential and gross margins. Here, however, we shine a spotlight on the balance sheet, specifically the increasing inventory balance. The waters have been muddied by volatility in inventories due to a fire at its Indonesian plant in Q2 22, an environment of inflation and supply-chain issues. However, taking a longer view over the past 2 years, the fact is that revenues have been in decline while inventories have risen in absolute terms. With inventories at £134m this now represents around 224 days of sales (or over 7 months) based on Q3 COGS of £54m. Our automated report shows the following pattern in DSI for Q3 23 over the past five years:

Excessive levels of inventory should be a concern given they operate in a high-tech market where products carry a risk of obsolescence. Furthermore, the company sell into a network of distributors, so we don’t know what level of inventory has also been built up in downstream channels.

Looking deeper into the Q3 filing (Note 10: Commitments and Contingencies), we find something that should raise the level of concern further: The company has made commitments to purchase future inventory from suppliers amounting to over $70m. If expected demand fails to materialize for Cognex, they might be obliged to buy the components and this inventory could also end up on their balance sheet.

One further disclosure that sticks out is the “Costs to fulfil a contract” paragraph, albeit the amounts are less material. These are costs that are typically incurred in setting up a contract ahead of its execution. However there tends to be a large degree of discretion involved in what gets capitalized. While the amounts involved are smaller, it’s noticeable here that the balance sheet value has been rising over the past 2 years (from $13.3 to $17.8m, even while revenues have been declining). This is an indication that management may have been aggressive in capitalizing these costs. Given the focus the market puts on gross margins, this could be making a significant difference to investor perceptions.