There's an old NFL Films clip of Vince Lombardi fuming along the sidelines and yelling out "What the <bleep>'s goin' on out here?" That encapsulates my feelings about the machine tool market and Hurco's (NASDAQ:HURC) place within it. Hurco's limited focus on short-run, high-spec systems reduces the comparability to larger firms like Gildemeister, Mori Seiki (OTCPK:MRSKY), Okuma (OTC:OKUMF), and Makino Milling (OTCPK:MKMLF), but it's still frustrating to see the company fail to make progress with its revenue, margins, and order flow.
A Step Back With The Third Quarter
To the best of my knowledge, there is only one analyst covering Hurco at this time and I thought his projections for Hurco were a little odd, so I don't really put all that much emphasis on how the company performed relative to those targets. Still, I call this a disappointing quarter and the reported results were below my expectations.
Revenue fell 10% yoy this quarter, as well as 9% from the prior quarter. North American sales were down 5%, and that's as good as it got - sales in Europe (almost 60% of the total) were down 11%, while sales to customers in the Asia-Pacific region (10% of the total) were down 17%.
With lower sales, the company also saw meaningful operating de-leverage. Gross margin fell more than six points from the year-ago level and almost five points sequentially. Operating income plunged 71% as operating margin dropped almost eight points (to below 4%) from last year and five-and-a-half points sequentially.
Echoing my prior comments about the comparability of Hurco's results, it's hard to say what to make of these numbers relative to the biggest names in the industry. Gildemeister saw revenue rise 9% in its second quarter, with weak results in Germany (down 14%) offset by better performance in the U.S. and Asia. Given Hurco's heavy reliance on the German machine tool market, that's not a terrible performance all in all, but it certainly highlights the importance of building up the company's position in other markets. I would also note that North America has been much stronger of late for Mori Seiki, Okuma, and Makino.
Is A Late 2013 Rebound Still In The Cards?
Disappointing as the financials were, the order numbers were just as uninspiring. While technically flat, orders were down 9% on an organic basis excluding the LCM acquisition. Although orders were up by double-digits in North America, orders in Europe were down 12% organically and down 40% in Asia.
Gildemeister's orders were also soft - down 10% overall, with Germany down 16% and the remainder down 7%. North American orders have stayed pretty firm for the industry, but orders in Asia have apparently been quite idiosyncratic with some companies reporting sizable gains and others large declines. All told, the VDW (German Association of Machine Tool Builders) and Oxford Economics are still looking for net growth in the worldwide machine tool market, but the outlook is definitely "uncertain."
LCM Should Pay Off Down The Line
About two months ago, Hurco announced an M&A deal - the company acquired Italian machine tool component company LCM Srl. LCM makes high-end electro-mechanical components, and Hurco uses LCM for its direct drive spindles, swivel heads, and rotary torque tables in its 5-axis tools. Buying LCM should improve the company's cost structure over the long term, and should also improve the company's competitiveness in higher-end machine tools down the line.
Evolution Or Extinction?
Hurco is a tiny company in the context of the machine tool market, and tiny companies have to be nimble if they want to avoid being squashed. High-spec tools are a good place for Hurco to be (although they're not as high-spec as Mori Seiki), but the company cannot rest on its laurels.
I believe that companies like Kennametal (NYSE:KMT) and Atlas Copco (OTCPK:ATLKY) make a good case for ongoing manufacturing (more specifically, metal-cutting and metalworking) activity in developed markets like the U.S. and Germany. Still, many of the leading tool companies are looking to BRIC countries and emerging markets to fuel their future growth. While Hurco's machinery isn't really well-suited for long-run mass-production settings, that may be an area where the company ultimately has to compete to keep up with the market.
Said differently, it sounds like industries like automobiles and aviation are where a lot of the demand is right now, but I see Hurco as more of a specialty/small-shop tool vendor. If and when economic conditions improve in Europe (and the U.S.), the company should see results improve, but it will create choppiness and difficult comps as the company doesn't address those large process industries.
The Bottom Line
Hurco shares are down about 8% as of this writing, and that seems like an appropriate correction all things considered. That's not to say that Hurco is at fair value, though. While I'm revising my expectations for this year and next (lower), I still look for long-term revenue growth of about 5% and free cash flow margins in the mid-to-high single digits. That supports a fair value of around $33, or about $2.50 lower than my prior target (and in line with today's correction).
Net-net, I'm still bullish on Hurco, still remain a shareholder, and still believe it's a stock worth buying. As this quarter so amply demonstrates, though, Hurco doesn't address a customer base that is always representative of the wider machine tool industry and this is still a choppy, volatile name to own in an uncertain economic climate for European manufacturing.
Disclosure: I am long HURC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.