Hurco: A Buy at the Current Price

Hurco (HURC) is a leading manufacturer of computerized machine tools used in metal cutting in a variety of industries that include aerospace, defense, medical equipment, energy, electronics and automotive. They incorporate a proprietary computer control system for use on a PC system that improves the quality of cutting and ease of use. In addition to producing the machinery and control systems, Hurco also provides software upgrades, parts, service and support to customers. Hurco manufactures its cutting machines in Taiwan, and sells its  products in Europe, Asia and North America via direct sales and through independent distributors.

Hurco's competitive advantage appears to be the computer controlled cutting system it has developed. In machine cutting, the setup and accuracy of the process greatly affects efficiency and cost. If Hurco is able to decrease setup time and reduce errors via its proprietary software, it would give the company an advantage over its competitors, such as Hardinge (HDNG), that don't have the sophistication of the Hurco product. This is reflected in its return on capital of 24.15%, net margins of 11.1% and 5-year sales growth of 22.7%, all of which are higher than any of its peers. In addition, it has $4.50 per share in cash and no long-term debt.

Hurco is not without its challenges. According to the most recent 10-Q, approximately 89% of global demand for machine tools comes from outside the United States, and as a result, Hurco's sales are heavily concentrated in foreign markets, with 73.6% of sales coming from Europe, compared to 20.8% from the United States and 5.6% from Asia. Because of this, the company earnings are sensitive to foreign currency fluctuations, which have a material impact on earnings based on the relative strength of the dollar versus the British Pound and the Euro. In addition, because of the time it takes to manufacture and ship products from Taiwan, Hurco must schedule production based on sales forecasts for 4-5 months in the future. Therefore, it would be slow to respond to a rapid decrease in orders, resulting in excess inventory and a decline in return on equity.

This may be what happened during the last recession in 2001-2002, when cash flow per share dipped from $1.25 in 2000 to -$0.28 in 2001 and -$1.48 in 2002, before rebounding in 2003 and increasing to $3.24 in 2007. In addition to an economic slowdown, rising prices for steel are also a concern, as they may pressure margins for Hurco and its customers. Such conditions have yet to slow growth, as Hurco managed to grow sales by 37% in the first six months of 2008 versus the same period in 2007. Sales in the United States were flat, but sales in Europe and Asia increased 50%, with currency exchanges resulting in a favorable impact of 17% in Europe and 14% in Asia. Sales of machine tools accounted for 89% of revenue with service fees and parts making up the remaining 11%.

The last five years of the falling dollar have benefited Hurco by making its machining tools less expensive abroad, a trend that is at risk of reversing as the European Central Bank and its British equivalent are being pressured to lower interest rates by slowing economies. The prospect of an economic slowdown has hit shares of Hurco, driving them from a high of $60.44 per share in October 2007 to a recent price of $31.00. This has resulted in a trailing P/E of 8, near the low end of its historical range, and an EV/Ebitda multiple of 4.3 for the last 12 months. This is cheap for a company that tripled earnings from $1.04 in 2003 to $3.24 in 2007. The only analyst covering the stock expects 2008 earnings of $3.58 per share with 2009 earnings growing 12% to $4.00 per share. This would result in a forward P/E of 7.87 and an attractive earnings yield of 12%.

Hurco holds an attractive niche in the machine tool market. In a world that will demand lower costs and greater efficiency as emerging markets grow, Hurco stands to benefit as a provider of quality, cost-saving manufacturing tools. Given the cyclical nature of this business, buying opportunities will present themselves on a frequent basis, as investors respond with fear to economic news and earnings calls. While I believe the current price to be a good entry point, a return to the $25-$28 range is not an unreasonable expectation. It would be wise to enter a position in thirds, the better to take advantage of declines in the share price in these uncertain times. Doing so should provide a good return for the long-term investor.

No disclosures.

Comments

[3006:]

Good article that appears to right on the mark. Hurco is a good solid company selling a good product. It will do well.

2008 Sep 09 10:20 AM

[Chandler Lutz:]

Great article! I agree that hurc is a global cyclical. Even though it is a great little company, performance will undoubtedly suffer if the dollar strengthens and foreign economies slide...As for the rising input costs, is it possible that customers would look to hurc's services to increase efficiencies and decrease waste??...this thesis seems logical to me but I am unsure what magnitude this situation will really have..

2008 Sep 09 11:21 PM

[Tim Meador:]

Chandler, your idea on input costs would seem to favor Hurco over its competitors, but like you I don't know to what extent this would help the company. I imagine it would give them an edge and allow them to take some market share in the down part of the cycle, which is never bad. Regardless, if one is to own an owner of manfacturing tools, I can't think of a better one at the current price.

2008 Sep 10 12:29 PM

[StrictNon-C...:]

Chandler,

Hurco doesn't have anything outside of the tools it sells, unless they've suddenly branched out into teaching people classes, which is largely redundant with their CNC machines: I know how redundant that'd be, because I was laid off from Hurco in 2001 when they went down into the bad part of the cycle, where I was working on the code for the CNC and press brake control software.

I understand from talking to my former boss that while Hurco clearly appears to be far more profitable financially, it has changed atmosphere in a way that's not as employee-friendly.

2008 Sep 25 08:42 PM

[drbob66:]

This stock is currently trading at around $14. Do you still think it was a "good buy" at $31?

Feb 04 07:55 PM

[Tim Meador:]

Given the information I had available at the time, I think there was a good case to be made for buying Hurco at $31. I didn't expect, and I imagine many people didn't expect, for things to go south so quickly and completely as they did. At $14, Hurco was down 55% from the time I recommended it. That is worse than the market average, but given the cyclical industry it's in, it is not unreasonable. My fault for not recognizing the bottom was a long way off. I must say that I really like it at $14 a share for a long term investor, as there is plenty of upside when manufacturing restarts.

Apr 10 11:09 AM

[Ravi Nagarajan:]

Not to mention the fact that it is a classic Ben Graham net-net at current levels... for a company that is profitable despite a more than 50% decline in Q4 revenues and has average five year ROE at levels that most anyone would envy ....

But shhh, let's just say for argument's sake that the sky is falling so the price will get cheaper... :)

Apr 13 07:40 PM

[Ravi Nagarajan:]

I've written up my evaluation of Hurco at current levels (disclosure: I purchased shares last week):

www.rationalwalk.com/?...

Apr 17 11:06 AM