As a tiny industrial company focused around capital equipment and generating more than half of its revenue from Europe, it shouldn't surprise anyone that Hurco (HURC) is seeing some challenging operating conditions. That said, the company is managing this tough market reasonably well and while the next couple of quarters are likely to be touch-and-go, the long-term potential of this company ought to make it a solid candidate for small-cap investors.
Third Quarter Results Show Some Resiliency
All in all, Hurco did pretty well in a tough market during its fiscal third quarter. Revenue did fall 1% as reported, while adjusting for currency shows about 6% growth. North America was a source of strength for the company, as 6% shipment growth led to 18% revenue growth. European sales were down 7% on a 10% drop in units, while revenue from Asia-Pacific dropped 12% on a 13% shipment decline. While this result was slightly better than expected, that has to be tempered by the fact that there is only one sell-side analyst currently following this name.
Profitability was likewise not great in absolute terms, but not so bad given the circumstances. Gross margin improved about a point from the year-ago level and almost three points on a sequential basis. Operating income did fall 11% from last year, but the operating margin is again solidly above 10%.
Orders - Good, Bad, And Still Ugly
It's not easy to give a simple "good/bad" answer to how Hurco's orders looked for the third quarter. While 16% growth from last year sounds nice, the year-ago order levels were unusually low due to an announced price hike that pulled orders into the FY11 second quarter. Likewise, orders did fall 9% from the prior quarter.
On a more positive note, North American orders jumped 41%, while Europe improved 23% (while falling 8% sequentially). Compared to fellow small-cap tool maker Hardinge (HDNG), Hurco did quite well on the orders and doesn't seem to be seeing the same slowdown in North American industrial activity. Likewise, Hurco's European performance looks relatively solid when compared to the 26% drop in overseas machine tool orders in Germany for the second quarter, as well as the performance of larger players like Gildemeister.
With so very few clear comparables, Hurco investors have to cast around a bit for incremental data points and comparables. Looking at industrial companies that serve some of the same customers, a list that includes names like Lincoln Electric (LECO), Atlas Copco (ATLKY.PK), Colfax (CFX), MSC Industrial (MSM), and Grainger (GWW), it's pretty clear that Europe is in dicey shape, but that there's still cautious optimism for countries like Germany (a key Hurco market).
Likewise, North America continues to see good industrial growth. Hurco seems a little stronger here than the norm. Whether this is part of the over-hyped return of manufacturing to the U.S. or simply a case of gaining share with new products, I do not know. What I do know, though, is that a stronger base of sales in the U.S. won't do Hurco any harm at all.
The Bottom Line
I don't really expect Hurco to be in a position to show its true colors for at least a couple of quarters; there's just too much uncertainty in Europe for that now. If efforts to stabilize the continent pay off, though, I would expect to see orders improve next year and that should help fuel more interest in this stock.
Hurco has shown in the past that it can deliver mid-teens operating margins during the good times, and if anything I think the company is in better shape today with respect to its cost structure. Accordingly, I do believe that Hurco can pair mid-to-high single digit revenue growth with improving cash flow generation in the years to come. Though I think the company's true fair value potential may be in the $40's (or higher), I'll settle for a target in the $30s today as investors await better visibility/certainty regarding the health of Europe's industrial sector.