Business Breakdowns
· Matt Reustle
[00:00:00] S0: This is Matt Reustle and today we are breaking down machine vision leader Cognex. Our guest today is Brett Larson from NZS Capital and Brett returns to Business Breakdowns. We covered Trane Technologies last year and Brett gives us a different angle on the industrial economy with Cognex. Today we get into the history of machine vision and how Cognex is a factory player, but I particularly enjoyed the strategic angles of this discussion. Cognex is not your typical reoccurring revenue story. They are a self proclaimed cyclical that has tended to focus on a specific customer segment over time, looking for S curves that might trigger their next growth era. This is evolving and we get into a lot of that with Brett. In this discussion I'd mentioned the big name businesses tend to attract the widest audience, but these are my favorite episodes. So please enjoy this business breakdown on Cognex. All right Brett, it is great to have you back. It was about a year ago that we covered Trane, maybe a little bit more than a year ago, but it's an episode that I referenced quite a bit over the past few months and one that I consistently go back to. I'm hoping that we get the same thing today with Cognex. It was a name that I wasn't familiar with and it's a very interesting name that seems to not get a ton of attention or conversation going as I was doing my research. Easiest place to start is just with an introduction to who Cognex is and what they do.
· Brett Larson
[00:00:00] S1: Thanks for having me Matt. It was fun so I was excited to be able to join you again. Cognex stands for cognition experts and they are leaders in machine vision. What that means specifically is they sell ruggedized cameras with embedded processing and then software which is the real value add which captures images and analyzes them in order to automate decisions at high speeds in manufacturing and logistics environments. So the product might look like two cell phones stacked together with the Cognex yellow that sits right out there on the factory floor. And the applications generally fall into four categories. So there's Guide, Gauge, Inspect, and ID. ID is the DataMan family of products and that's using vision for reading barcodes and for optical character recognition, which is reading letters and numbers that are printed or etched on something. So the easiest example to picture for somebody would be an Amazon sorting facility that's moving tens or hundreds of thousands of packages per day at extremely high speeds. And Cognex's Vision products scan all those barcodes and then perform the automation, then performs the actions that are required. Insight is the other main product category and that covers Guide, Gauge and Inspect. Inspect would be quality inspection. So 2D and 3D vision systems that are used to inspect something. A common example would be a printed circuit board. The system would make sure that it has the correct number, size and placement of the different components and quality soldering. Or another classic example would be making sure bottles in a bottling machine have the lids on and labels. Guide would be vision systems, which are used to guide robotic arms. And then Gauge would be measuring the dimensions of something. And ultimately you can think of the value prop that they're trying to deliver as improving quality, throughput, reducing costs and waste. And then a more and more common one's just addressing labor constraints. And the payback period is usually quite quick for these types of products.
· Matt Reustle, Brett Larson
[00:00:00] S0: You mentioned there's the hardware, which I can imagine you have these cameras on a conveyor belt, the software aspect to them. They have to link into whatever you are working on. In some ways that software is machine to machine execution. Is there a lot that's also going back to humans or human interaction with the software? [00:00:00] S1: Ideally the only time the human's really interacting with the software primarily would be upfront when you're programming the application. And then after that the camera is really sitting out on their factory floor capturing the data, analyzing it, and then that data will be communicated to more like the programmable logic controller that Rockwell might sell, which is then performing whatever action needs to be done. Ideally, once it's out on the factory floor, the human's kind of out of the loop other than overseeing it. [00:00:00] S0: I think you brought up a great visual in terms of an Amazon sorting facility and how much of that is now automated. You don't have the humans involved moving the big packages here, the smaller packages there. So it's gotten more advanced. But how big of a market is this machine vision world today? And I'd also just be curious how much that has grown recently if there's been a step change in terms of the growth of the market.
· Matt Reustle, Brett Larson
[00:00:00] S0: I think you brought up a great visual in terms of an Amazon sorting facility and how much of that is now automated. You don't have the humans involved moving the big packages here, the smaller packages there. So it's gotten more advanced. But how big of a market is this machine vision world today? And I'd also just be curious how much that has grown recently if there's been a step change in terms of the growth of the market. [00:00:00] S1: There's a lot of different TAM estimates out there for machine vision, but Cognex doesn't play in all the different niches within it that get captured usually. Cognex last estimated their serviceable addressable market at 6.5 billion, which was up from 2.9 billion in 2017. And they'll probably update their SAM again at their investor day and it'll probably be something like 8 to 9 billion based on new product categories they've entered. Industry's probably grown at a 10% type of CAGR the past decade and obviously there's cycles in there and then there's dispersion between some that are growing above that range, like Cognex and some that have been below. [00:00:00] S0: I like the SAM terminology. I might have to mix that in with TAM in the future. Where does Cognex rank in terms of market share within the market? What are some of the characteristics about their positioning and then just the market overall?
· Brett Larson
[00:00:00] S1: Cognex is number two behind Keyence, which is a company based in Japan. The two companies do obviously compete, but they've also historically focused in slightly different areas, which is interesting. So Cognex, they historically have focused on the top of the pyramid. When you think about the sophistication of the customer, typically they're hiring very trained engineers who are working with customers to spec systems for specific tasks. So it's a more technical sale with very sophisticated customers that are automating very complex tasks. Basically they're not winning on price, they're a more expensive vendor of machine vision. But they have a reputation for having really good application engineers, the best tech that they can differentiate at the spec level. So for example, that logistics facility where let's say you're scanning 100,000 packages a day, Cognex usually they can deliver read rates that are 100 basis points or even 2 or 300 basis points better than a peer. So over even just a day, that's thousands of packages that don't have to have a human there to look at something. That's usually how they go about competing. And there's a really strong brand reputation as well. So like if a new COO of a company walks into a factory for the first time and sees the yellow Cognex cameras, that says something to them. The installed base is very sticky as well for all of the vendors and I'll foreshadow a bit, but they're focused on the top of the pyramid currently. They're also broadening out a little bit lower as well, which is interesting. And then Keyence as I mentioned is number one. They're based in Japan. It's been a really successful company and it's also very much an enigma just in terms of it's a public company but there's just not a lot of intel out there on it. My best guess from what I've gathered is maybe 20% or so of their sales are comparable to Cognex. They also do things like scientific microscopes and PLCs and direct part marking and stuff like that. But what's also quite interesting is they spend 2% of sales or low single digits on R&D and have mid-80s gross margins. And that compares to Cognex which spends more like mid teens on R&D and has more like 70% gross margins. And the other machine vendor peers spend a little bit less and have even a little bit lower gross margins than Cognex.
· Brett Larson
And it really comes down to the way Keyence goes to market and how they focus. They generally focus just on the middle to lower tiers of customers and then they're really trying to develop more standardized products, are going after the very high frequency applications and it's a very process oriented sale. So they'll hire more college graduates compared to Cognex and then they'll train them with the products, put them out in the field. And it's more of a scripted sales process where they're keeping track of more of those activity like KPIs in the CRM. So it's how many calls are you making, how many shop visits, how many demos. It's really good coverage and really relentless. If you go down the rabbit hole, it's become a meme in the community. There's some pretty funny memes out there. If you're going to download a product spec sheet up the website, you should use your buddy's email and phone number, not your own. You'll never hear the end of it. That's the two main players. Maybe I'll briefly mention a couple other competitors while we're here. The other bucket I would say is China and these are primarily for manufacturers in China. Hik Robotics, which is division of Hikvision, is probably the third largest player in the industry overall and they've grown quite quickly driven by that domestic market with the domestic manufacturers. And they're probably about half the size of Cognex in terms of sales. There's a number of other smaller Chinese players as well. And then outside of there, there's more legacy players. There's within Teledyne, there's DALSA and Point Grey, there's SICK and Basler in Germany, Datalogic, Matrox was a company acquired by Zebra. And there's even companies like MVTec that just sell the software and then you can go get your own hardware. So that's kind of a lay of the land in terms of the industry structure.