Machine tool manufacturer Hurco (NASDAQ: HURC) continued to ride the wave of improving conditions in the global industrial economy during the fourth quarter. While the company still looks undervalued on the basis of its long-term prospects, investors in this under-followed capital equipment company may well worry about the order situation. If 2012 does see Europe tip over into recession, the timeline for Hurco to realize its potential will get that much longer.
Solid Results Across The Board
Hurco reported that its fourth-quarter revenue jumped 40% - topping the lone analyst estimate by about 8%. North America continues to be the growth leader, with sales up 60% this quarter on a 38% increase in unit shipments. Europe remains the largest part of its business, with sales up 39% and units up 18%. Asia-Pacific was disappointing this quarter, as revenue fell 4% on a 6% decline in volume.
Hurco managed to drive good leverage from its higher revenue base. Gross margin improved by a full point on a sequential basis and jumped almost eight points from the year-ago level. While Hurco is seeing the same input-cost inflation as everyone else, price hikes and a mix shift to higher-margin machinery is helping.
Hurco did see a worse than three point sequential erosion in operating margin (to 9.5%), but this was not wholly unexpected. The company has been hiring more reps and increasing its marketing spend to take advantage of the improving industrial climate. While Hurco did beat on all of its operating metrics, a sizable "other expense" increase from foreign currency mitigated the bottom line leverage and earnings were in line.
Orders - Some Good, Some Bad
Hurco reported that machinery orders increased 12% in the quarter versus last year and ticked up slightly on a sequential basis. Orders in North America are staying strong, with 19% unit growth and 31% dollar value growth, but dollar orders in Europe were flat and units ordered were down 13%.
This should be the biggest worry for Hurco investors. North America is not the problem - the ISM number is looking stronger and suppliers like Grainger (NYSE: GWW) and MSC Industrial Direct (NYSE: MSM) are posting strong growth and solid guidance (especially relevant with MSC Industrial given that company's large exposure to the metalworking sector).
The problem is clearly Europe. Hurco not only sells a lot of machinery to shops in Germany and Eastern Europe, but it sells a lot of its highest-end machinery there. As economic worries and slower growth has hammered European industrials like ABB (NYSE: (NYSE:ABB), Siemens (NYSE: (SI), Sandvik, and Atlas Copco, it seems to now be leaking through to Hurco. If there's good news, it's that the large European industrials have remained publicly confident about a stronger second half to 2012 and countries like Germany continue to prioritize the sort of high-value machined exports that fits in with Hurco's target market.
Asia Too Small To Matter
For the time being, stronger orders in Asia are effectively trivial for Hurco. The business is just too small (about 10% of total orders in the fourth quarter) right now and frankly it doesn't play to Hurco's strengths - Asia is a market better-suited to Hardinge's (NASDAQ: HDNG) machinery, as it works well in large production run situations.
The Bottom Line
With neither the North American nor the European industrial economy running at close to its prior peak levels, there's still significant growth potential for Hurco. The question, though, is whether austerity and the resulting economic slowdown in Europe freezes that momentum. While Hurco's North American business is improving, it's not strong enough to drive the bus yet.
Although I am not changing my long-term view of Hurco's value, I do believe the risk has increased in the short term. Investors who own Hurco can afford to sit tight, but new money may want to pause a quarter or two and see how the European situation shakes out.