Introduction
Hurco Companies, Inc. (Public, NASDAQ:HURC)
Hurco designs, manufactures, and sells computerized machine tools and related software. Hurco, founded in 1968, has been around the block a few times and was a pioneer in the application of microprocessor technology and conversational programming software on machine tools. While Hurc’s Computer Numeric Control (CNC) systems are proprietary, they use industry standard personal computer components. Hurco sells their products to independent job shops and short-run manufacturing operations within large corporations in the aerospace, defense, medical equipment, energy, transportation, and computer equipment industry. Hurco machine tools range in price from $40,000 and $300,000.
Sales
After suffering two years of declining sales in 2001 and 2002, Hurco’s sales have been chugging along nicely and the prospects for future growth remains positive.
Yearly Sales Growth
| Fiscal Year | Sales (in millions) | Growth over Prior Year |
| 2003 | $75.5 | 7.16% |
| 2004 | $99.6 | 31.83% |
| 2005 | $125.5 | 26.05% |
| 2006 | $148.5 | 18.33% |
| TTM (thru Jan 31) | $163.5 |
Despite growing sales over the past four years, the rate of growth has been decelerating. I suspect this trend to shift in 2007 as a result of the accelerating demand in Europe, the introduction of a new product in the first half of 2007, the announced expansion projects in China and India, and the weakening of the U.S. dollar.
Accelerating European Demand
Huro’s sales are diversified across North America, Europe and Asia. Historically, Europe has accounted for the majority of sales. In fiscal year 2006, Europe accounted for 59% of sales versus 34% and 7% for North America and Asia, respectively. With the higher percentage of sales coming from Europe, a shift in European demand has a disproportionate affect on total sales.
Reflective of the disparity of economic growth between North America and Europe, sales growth in North America has outpaced Europe since Hurc’s turnaround in 2003. Recent economic data indicates economic growth is accelerating in Europe and moderating in the U.S. A continuation of this trend will result in a net benefit to Hurco. Early signs of this benefit were evident in Hurco’s first quarter of fiscal 2007. In the quarter, Hurco’s sales increased 47% over the year-ago quarter and management specifically attributed a portion of the increase to improved demand from Europe.
New Product Release
At the recent IMTS 2006, one of the largest industrial trade shows in the world, Hurco introduced five new products. The most exciting product introduced at the trade show was the WinMax Control System, which runs on a Windows based platform. Hurco expects the feature rich control system to maximize efficiency and productivity at job shops around the world by reducing setup time and improving surface finish. At the trade show, Hurco provided hands-on live demonstrations to customers that entered the booth and was very much encouraged by customer feedback.
"I was pleased to see how many customers embraced WinMax and quickly understood its value. For Hurco, WinMax will play a pivotal role in continuing to develop new technologies while taking advantage of trends in commercial technologies that enable our customers to realize measurable productivity gains," said Jim Fabris, President and COO of Hurco Companies, Inc.
The new Winmax Control System will span the entire Hurco product line of machining and turning centers. Winmax will be available in early 2007 and it will be sold as the standard control system on all machining and turning centers. Furthermore, it will be available as an upgrade to products sold within the last five years. Conceivably, Hurco software could be sold for use on non-Hurco machines.
The release of the Winmax Control System is big for Hurco. Lakshminarayana Ganti, an analyst with Thomas Weisel International, likened the significance of the release to Microsoft’s release of Vista (IBD article linked below).
Expanding Presence in China and India
In 2005, Hurco opened a permanent Technical Center in Shenzhen, China, a center for technology and manufacturing. The new location expanded on Hurco’s existing sales office in Shanghai. Hurco opened the Technical Center to serve as an application and service center for Hurco’s customers in China, the largest machine tool consumer in the world.
Recently, Hurco announced it is developing a manufacturing center in Ningbo, China. The Ningbo facility will expand Hurco’s manufacturing capacity beyond its existing manufacturing facility in Taiwan. The new facility will focus on machine castings and components but will have the capacity to be expanded to include sub-assembly operations. Eventually, machines designed specifically for China will be manufactured at the Ningbo facility.
China is the world’s largest machine tool market and grew 20% in 2006 to $12.9 billion. According to Gardner Publishing, worldwide output increased 10% in 2006 and one in every five machines produced went to China (See link to IBD article). Hurco’s expansion into China puts it in a solid position to benefit from the expected continuation of growth in Chinese demand for machine tools. While there are a number of domestic suppliers in China, domestic production is more focused on lower-end tools and not the more complex CNC machines made by Hurco.
Sales in Asia dipped a bit in the first quarter of fiscal 2007. Management attributed the sequential decline in sales to the timing of orders. As such, the second quarter is likely to receive a boost over the first quarter and the year-ago quarter.
In November of 2006, Hurco registered a distribution company in India and it is in the process of establishing a sales office. In its first quarter earnings release, Hurco also said that it participated in the Indian Machine Tool Exhibition 2007. To the best of my knowledge this was the first time Hurco participated in this show. According to management, Hurco’s powerful yet easy to use machine tools are an ideal fit in India where shop owners are faced with high employee turnover and an unskilled to semi-skilled work force.
Weakening U.S. Dollar
As the majority of Hurco sales are outside of the U.S. and paid in foreign currencies, fluctuations in exchange rates will have an impact on sales, which are reported in U.S. Dollars. A weaker U.S. Dollar relative to customers’ base currency, will inflate reported sales, and vice versa.
As of late, the dollar has been losing strength relative to other currencies in both Europe and Asia. Many economists and investors, including Warren Buffet, believe this trend will continue. Recent weakness in the Dollar accounted for 9% of the 47% increase in sales in the first quarter of fiscal 2007 compared to the year-ago quarter. At the Dollars current levels, the exchange rate will continue to have a favorable impact on year-over-year sales comparisons.
For all the reasons mentioned above, I believe Hurco’s sales growth will accelerate in 2007.
Margins
Gross margins and operating margins have been on the rise since Hurco’s turnaround in 2003.
Recent Margin History
| 2003 | 2004 | 2005 | 2006 | |
| Gross Margins | 27.57% | 30.43% | 33.91% | 35.90% |
| Operating Margins | 2.91% | 8.47% | 13.15% | 15.24% |
| Pre-tax Margins | 1.88% | 7.60% | 12.81% | 15.56% |
In the most recent quarter, Hurco showed continued improvement with gross margins of 36.96%, operating margins of 17.22%, and pre-tax margins of 17.90%. From quarter-to-quarter margins tend to fluctuate mostly due to product mix but the overall trend is clearly positive.
The above table excludes net profit margin because 2006 was the first year the company was fully taxable. In prior years, Hurco was working through their operating loss carryforwards. As such, the pre-tax margin comparison is the best method of comparing year-over-year results. At a full tax rate, Hurco reported a net profit margin of 10.42% in 2006 and 11.51% in the first quarter of fiscal 2007.
As a software product, Hurco’s new WinMax Control System should boost margins further in 2007. Presumably, Hurco should be able to boost the cost of its existing products given the advanced software that will ship as a standard component on future shipments. Furthermore, upgrades to existing customers should come at a relatively low cost.
My expectation for higher sales spread out over Hurco’s fixed costs along with increased software sales, should lead to continued margin improvement in 2007. While the costs of raw materials have increased, I believe Hurco will continue to have the pricing power to pass these costs onto its customers.
Earnings/EPS
In 2006, Hurco reported earnings of $15.5 million or $2.42 per share compared to $16.4 million or $2.60 per share. When comparing year-over-year earnings, investors should keep in mind that Hurco did not become fully taxable until 2006. In fiscal year 2005, Hurco recorded a net tax benefit of $361,000 compared to a 2006 tax expense of over $7.6 million. Assuming a comparable tax rate in 2005, Hurco would have reported earnings of $10.8 million or $1.70 per share in 2005.
In the trailing twelve months, Hurco’s reported diluted earnings per share of $2.78. For the full-year 2007, analysts expect Hurco to report $3.22 per share for a 33% increase over the $2.42 per share reported in 2006. Furthermore, analysts expect Hurco to report $0.79 per share in the second quarter of fiscal 2007 compared to $.84 in the first quarter.
I am not sure why analysts are expecting a sequential decline in earnings. Perhaps analysts believe earnings will moderate a bit after the benefit of the IMTS trade show in the prior quarter. Another possibility is that analysts might be expecting customers to delay purchases until after the release of WinMax. Regardless, analysts clearly believe the company is poised for growth in the full-year. The current quarter ends on April 30. If Hurco releases WinMax early enough in the quarter, we may see analyst up their estimates for the quarter.
At a share price of $40, Hurco’s trades at a multiple 14.39x trailing earnings, 12.22x analysts’ 2007 earnings, and 10.50x analysts’ 2008 earnings.
Balance Sheet
Hurco has over $32 million in cash and roughly $3.8 million in long-term debt. Net cash per share totals $4.46. The company has $62 million in working capital and a long-term debt-to-equity ratio of 5%. Hurco’s solid balance sheet puts it in a strong position to weather a downturn.
Cash Flow Statement
As evidenced by the growing cash position, Hurco has not had a problem generating cash. More importantly, cash flows from operating activity have closely approximated earnings and cash flows from financing activity have been limited. In fact, Hurco has been paying down debt and has been restrained in issuing new shares. Over the last year, diluted shares outstanding have increased a modest 1.42%.
Management
Michael Doar was elected Chairman of the Board and CEO of Hurco in November, 2001. Previously, he was vice-president of sales and marketing of Ingersoll Contract Manufacturing, a subsidiary of Ingersoll International. Doar held various management positions with Ingersoll International beginning in 1989.
James D. Fabris was elected President and Chief Operating Officer on November 14, 2001. Mr. Fabris served as Executive Vice President of Operations from November 1997 until his current appointment and previously served as a Vice President of Hurco since February 1995.
John G. Oblazney was elected Vice President, Secretary, Treasurer and Chief Financial Officer in September 2006. Mr. Oblazney served as the Chief Financial Officer of Carrier Corporation's Light Commercial Business, a division of United Technologies Corporation, since December 2005. Prior to that, Mr. Oblazney served in various other financial positions with Carrier Corporation from 2000 to 2005. Prior to joining Carrier Corporation, Mr. Oblazney was employed for six years with Cooper Industries and employed three years by an international public accounting firm.
In his early years at Hurco, Doar managed the company through some tough times. He not only pulled Hurco through the storm, he positioned the company for better days ahead. Doar has been in the machine tool industry for a long time. He has done a commendable job at Hurco and has earned the trust and confidence of investors.
Competitors
Hurco competes with many companies in the U.S. and abroad. Most of Hurco’s competitors are larger and have greater financial resources. Hurco relies largely on its patented software (i.e. WinMax control software), proprietary features, and strong reputation to distinguish itself from its competitors.
Hurco lists several U.S. and international competitors in its 10k. While various research reports and investment websites identify a number of other competitors, these companies do not provide a reliable comparison for a number of reasons. Hardinge, Inc. (HRDG) is probably the best company for comparison purposes.
HURC Versus HDNG
Trailing 12 Month Comparison
| HDNG | HURC | |
| Sales | $326.6 million | $163.5 million |
| Gross Margins | 30.66% | 36.53% |
| Operating Margins | 7.07% | 15.95% |
| Net Margins | 4.27% | 10.91% |
| EPS Diluted | $1.58 | 2.78 |
| Share Price | $23.00 | $40.00 |
| PE | 14.56 | 14.39 |
| (Cash – LT Debt)/Share | ($6.93) | $4.46 |
| LT Debt-to-Equity | 43% | 5% |
| ROA | 4.57% | 14.92% |
| ROE | 9.24% | 24.50% |
Despite Hurco’s superior margins, capital structure, and returns, Hurco trades at a slight PE discount to HDNG.
Ownership
Institutions hold 61% of Hurco’s total shares outstanding, or nearly $3.9 million shares of the $6.39 million shares outstanding. Last quarter, institutions were net sellers to the tune of 144,000 shares, which is seemingly insignificant in the broad scheme of things. Royce & Associates, an institution identified by Motley Fools as one to watch, is the largest institutional shareholder with 772,350 shares.
Yahoo and several other websites report insider ownership at around 20%. On March 1, 2007, Richard Niner, a Director, filed a Form 4 indicating he sold 500,000 shares. I suspect Yahoo and the other websites have not been updated to include this recent transaction. If this is the case, insiders now own roughly 13% of Hurco’s outstanding shares, which is still high for a non-founder run company. While the Niner sale is worth noting, I am not overly concerned at this point. From what I can tell, Niner is not a machine tool guy and he is still the largest natural shareholder with nearly 232,000 shares. I suspect Niner sold his shares to cash-in on a very nice gain and to further diversify his assets. I don’t believe his decision was based on his expectations for the company or the machine tool industry. Again, my opinion on this matter is purely speculative.
Other than the Niner transaction, there have been no other insider transactions of particular significance. Investors should watch for additional insider and/or institutional transaction over the next couple of months.
Conclusion
Since its turnaround in 2003, Hurco has enjoyed several years of impressive growth and share price appreciation. Furthermore, Hurco has expanded its product line, strengthened its balance sheet, and diversified its sales across a number of regions.
The biggest risk to Hurco’s future is a global economic slowdown. While the diversification of Hurco’s sales across various regions will reduce the negative impact of regional weakness, there is no hiding from a global slowdown. Despite the recent downturn in global equity markets, I believe the global economy is poised for continued growth. I agree with Mr. Bernanke that the U.S. will continue to see slower growth in the first half of 2007 but growth will accelerate in the second half of the year. I believe Asia, in particular China, will continue to grow at a rapid pace and Europe will continue to strengthen. In this scenario, Hurco will prosper.
With the current correction in equity markets, Hurco is a good stock to put on your watchlist. I would wait for things to shake-out in the market before taking a position. I am not sure the opportunity will present itself, but a buy in the $35 or $36 range would be nice.
For those looking for a technical take on HURC, downtowntrader promised he would give his view on HURC later tonight.
Disclosure
I am long Hurco since 2004 when it was introduced to me through the Motley Fools Hidden Gems Newsletter.
Source Documents
Hurco History from Hurco Website
Yahoo Key Statistics (HURC)
Yahoo Key Statistics (HDNG)
HURC Q1 Fiscal 2007 Earnings Release
HDNG Year-End and Q4 2006 Earnings Release
Latest 10K filing
Richard Niner Form 4
Yahoo Analyst Estimates
NASDAQ Holding Summary
Recent IBD Article
Wallstreet Journal Article from 2003 (Hurco low point)
Monthly Survey of Machine Tool Consumption (Note that U.S. consumption was positively impacted in September and October by the largest U.S. trade show)
3 comments:
nice work Tuff, alot of detailed information and well written now if you get get some decent TA out of that other guy ;)
Nice analysis. HURC caught my eye in IBD.
woodshedder,
Thank you. I started writing by entry prior to the IBD article but they beat me to the punch. In the end, it worked out good because I was able to incorporate some additional information.
Regards,
Tuff
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