In my last article, The Looming Labor Crisis No One Is Talking About, I detailed two issues with tight labor markets that no one is talking about. There is such a shortage of workers in America that there aren't enough to fill all the available jobs. This is leading to increased competition for workers, rising labor costs, and may lead to slower growth in coming quarters.
A discussion in the comments shed new light on the problem and led me to a new opportunity for investment. Businesses like McDonald's (MCD) and other fast food operations are quickly turning to automation. Automation allows restaurants to operate more efficiently and today's tech-savvy customers are embracing the shift.
The Problem With Automation
The problem for McDonald's and other operators seeking to utilize automation is that experts agree it will not significantly reduce the size of the labor force. Early estimates dating back as far as 2014 projected a near 50% loss in jobs due to automation; experts now say the loss will be closer to 7% and that by 2025.
The flipside to this problem is that employers now have a need for tech-savvy employees to operate the systems, and smiling faces to interface with customers. While fast-food operations may see some gains in productivity and quality control automation is not expected to lower the cost of labor, but that doesn't mean there isn't an investment to be made.
Invest In The Automators, Not Automated Businesses
Despite the hurdles restaurateurs face, automation is sweeping the globe and is found in all industries and business types. The IoT, the Internet of Things, is the fastest growing technology on the planet and driven by and a driver of automation. The number one investment in this arena is Nvidia (NVDA). Nvidia is the leading manufacturer of semiconductor technology suitable to power the data-centers, robots, and sensors that the IoT is made of.
Here are some statistics to help you understand how big the IoT, automation and the cloud is...
- The Manufacturing, Transportation & Logistics, and Utilities sectors are all expected to spend at least $40 billion on IoT infrastructure and build-out over the next two years. That's a total greater than $120 billion over the next 24 months.
- The IoT industry is expected to value near $581 billion by 2012 with a compound annual growth rate near 10%.
- The Industrial sector is leading the adoption of IoT with a rate of 45% and another 22% expected within 12 months.
- Smart Cities, Connected Industry and Connected Buildings are the top three IoT segments and account for +50% of IoT spending.
- There are about 20 billion connected devices right now, there will be more than 50 billion by 2040.
When it comes to the cloud and data-centers, the top three names will not surprise you. They are Amazon (AMZN), Google (GOOG) (NASDAQ:GOOGL), and Microsoft (MSFT) which account for roughly 75% of the market share. All three report YOY revenue growth in their cloud businesses in the high-double digits and the sector is expected to continue growing at this pace for many years.
This Is How To Invest In Automation
When I began my search for stocks in the automation and IoT infrastructure arena, I quickly became aware of the Global Robotics and Automation Index ETF (ROBO). It is a well-diversified ETF spanning all sectors of the economy but, like all index ETFs, contains the bad right next to the good.
What I mean by bad is stocks like struggling consumer product maker iRobot (IRBT) are right next to high-quality growth names like Intuitive Surgical (ISRG) who provide true value to the IoT and automation industry. The ROBO ETF is not a bad choice for someone wanting exposure to automation but there are better choices that may fit better into individual portfolios.
#1 - Intuitive Surgical
Intuitive Surgical is a very specific play in the IoT universe as the maker of surgical robots. The good news for them is that spending on healthcare is also expected to increase at a high double-digit pace as well, providing a double catalyst for this stock. In the last earnings report, the company reported the 16th quarter of double-digit revenue and EPS growth (14 of 15 quarters were above expectation) which resulted in a round of analyst upgrades.
The consensus target is now near $630 which is a 16% upside to today's prices. The only risk I see is that it trades at a very high multiple, about 44X forward earnings, but that valuation is in line with the growth outlook for IoT and healthcare.
#2 - AeroVironment, Inc. (AVAV)
AeroVironment, Inc. is a manufacturer of unmanned aircraft and missiles, otherwise known as drones. While the company does a lot of business with the government that is not its only revenue source. The company has been experiencing the benefits of a new CEO and that is seen in the share price. The company has grown revenue by high-double digits for the past four quarters and beaten expectations for five.
A recent contract awarded by the US Air Force is expected to help drive revenue over the next few quarters. Once again the risk here is valuation. Even with the recent pullback in prices, the stock is trading at 65X forward earnings and expensive relative to the broad market. Regardless, the stock is trading above a key support level and a buy for long-term investment.
#3 - Zebra Technologies Corporation (ZBRA)
Zebra Technologies Corporation has been working hard over the last few years to shift from an industrial services company to an industrial IoT company. The company is the leading supplier of IoT infrastructure technology to industry and focused on automated data capture or ADC. ADC used to mean wands, registers, and readers to log and track inventory, shipments, and other industrial needs. Now IoT uses environmental scans to recognize items and automatically track their movement throughout a system.
Revenue growth has slowed in recent quarters but from a high 200% throughout 2015 to a mere 10% in the last quarter. Based on the adoption rate and expected adoption rate of IoT by industry I expect to see revenue continue to grow if not accelerate. On a valuation basis this one is much more attractive trading at only 14X forward earnings, a valuation I think is way too low. The company is in unique positions and commands a market share greater than 90% relative to its two closest comparisons Intellicheck (IDN) and ImageWare Systems (OTCQB:IWSY).
#4 - Cognex (CGNX)
Cognex is engaged in the development, manufacture, and sale of machine vision technology. Machine vision gives IoT devices the ability to recognize environmental factors and then act on them. It is what facilitates the automation of warehouses, factories, restaurants and any other IoT operation in which environmental factors may play a role. Unlike most other stocks on my list, this one pays a small dividend, about .40%, but that is not why I like it. I like it because its technology is fundamental to the roll-out and adoption of the IoT/automation and the leader in the field.
The company has been growing revenues by high-double digits for more than four years (minus two quarters in 2015) and likely to keep doing so over the next few years. On a valuation basis, Cognex may be the most fairly valued of all trading at a forward P/E of 30X. On top of that, Cognex could be a takeover target for bigger players in the sector and that could easily produce additional lift for the stock price. As the maker of such specific equipment, machine vision technology, the company could be easily incorporated into or merged with a company like Zebra Technologies that is in business deploying solutions based on the technology.
What's The Risk?
The biggest risk today is that valuations may already reflect a lot of the growth expected in this sector. The forward P/E of Intuitive Surgical and AeroVironment certainly reflect a high expectation of growth. Regardless, these companies are supported by economic conditions as well as the build-out of the IoT so a contraction of business is not in the outlook.
In addition, because these stocks are based on emergent and often experimental technology, there is a risk that better solutions will be found, or business models will be disrupted. This could result in a rapid devaluation of the share price for an individual stock but will only help to catalyze the rest of the sector.
Finally, growth stocks seem to be falling out of favor. The October correction, sparked by fear of rising rates, may have also sparked a secular cyclical rollover from the growth names to safer plays. This condition may sap momentum in the sector in the near term but I would view any additional weakness in prices as an opportune time to buy.
The Bottom Line In Automation
Regardless of your choice of investment vehicle, it is without a doubt that the IoT and automation sectors are growing, growing fast, and in position to deliver returns for shareholders. Tight labor markets? They're going to stay tight for a long time and that is going to help drive revenues in this sector. With IoT spending in the Industrial, Transportation, and Utilities sectors expected to top $120 billion over the next two years the time to invest in these stocks is now.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ZBRA, CGNX over the next 72 hours. 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.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.