The underlying secular growth drivers behind investing themes like automation and industrial software are too powerful to be derailed by a cyclical slowdown caused by rising rates. In other words, the cyclical weakness in the industrial sector in 2023 is creating an interesting buying opportunity in stocks like PTC (PTC 0.62%), Cognex (CGNX 2.06%), and Emerson Electric (EMR 0.27%). Here's why all three are attractive stocks to buy.
Cognex
There is cyclical weakness in the many parts of the industrial sector right now. Rising interest rates put particular pressure on consumer discretionary spending. That hits customers in Cognex's three main end markets: consumer electronics, automotives, and logistics (primarily e-commerce warehousing).
Cognex is a leader in the machine vision market. It's a technology that helps customers ensure production quality control, increase production efficiency, and save costs by replacing labor while generating data that can be used to improve processes. Think of the precise layering of screens on mobile phones (Apple is a major customer), precise manufacturing of electric vehicle batteries, or monitoring and guiding packages in e-commerce fulfillment centers.
Unfortunately, all these markets have come under pressure this year, and Cognex's sales are set to drop by 17.5% according to analyst estimates as customers have delayed capital spending decisions in reaction to weak sales.
That said, the need to restructure global supply chains, reshore manufacturing from low-labor cost countries, and take full advantage of major enhancements in advances in digital technology and the Industrial Internet of Things isn't going anywhere anytime soon. As such, when the interest rate cycle eventually turns, it's likely Cognex will start winning major orders again. There's a limit to how long consumer electronics and automakers can delay developing new models, and when they do it's likely that spending on machine vision will be a part of their investment in assembly lines.
PTC
The secular growth drivers discussed above also play into industrial software company PTC's growth prospects. The company offers a range of software solutions that help manufacturers digitally transform their business within a so-called "closed-loop digital thread."
The digital thread runs from creating and designing a physical product through its production, distribution, servicing, and, ultimately disposal. For example, PTC's computer-aided design (CAD) software is used to digitally create the physical product, while its product lifecycle management (PLM) digitally manages the production of the product using PTC's Internet of Things software to digitally connect it. Meanwhile, service lifecycle management (SLM) digitally manages after-sales support.
The major advantage of digitalizing these processes is that information and data can be constantly gathered and analyzed to produce actionable insights that improve the whole process iteratively. That's the closed loop.
That was a lot of jargon, so allow me to give a simple example. Say a product is digitally designed using PTC's CAD and then produced in a factory monitored by PLM, with its servicing controlled by SLM. If PLM produces a digitally modeled insight that implies the product would be more cost-efficiently produced by adjusting its design, and SLM confirms there's no significant impact on servicing costs, then it can be digitally redesigned in CAD. It's part of a closed-loop process that involves constantly analyzing data to improve outcomes.
Image source: Getty Images.
Unlike Cognex, PTC hasn't seen a major slowdown in sales or contract growth, yet, from the pressure on its customers. Still, it's hard not to think its growth would be even better in a lower interest rate environment.
Undoubtedly, productivity and quality control enhancements can be gained by using digital technology. PTC's growth rate is likely to improve as its adoption spreads through the manufacturing sector.
Emerson Electric
The company's management is in a hurry to meet the future, and that future is automation. Having sold the majority of its climate control business last year, and recently bought software-connected automated test and measurement systems company National Instruments (NI) for an equity value of $8.2 billion, Emerson's management has firmly set its stall out in the automation market.
NI's test and measurement solutions operate in one of the four adjacent markets that Emerson's management sees as being complementary to its existing strength in process and hybrid automation. The other three are industrial software, factory automation, and smart grid solutions. In fact, Emerson already owns 55% of Aspen Technology (a company created out of a combination of Emerson's existing industrial software business and the former Aspen Technology business).
In the words of CEO Lal Karsanbhai on a recent earnings call, Emerson is now focused on an automation market driven by "macro secular drivers," including "energy security and affordability, near-shoring, sustainability and decarbonization and digital transformation."
To be clear, Emerson is seeing pressure in its factory automation and test and measurement businesses in line with the cyclical slowdown, but management still expects 4% to 6% underlying sales growth in its fiscal 2024. That would be an excellent result in a challenging operating environment, and it could be even higher if interest rates come down next year.
