Editor's Choice

Are Irrigation Stocks Raining Profits?

BA is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Some like it hot. I'm not referring to the classic Marilyn Monroe comedy, but to the weather and companies, such as Valmont Industries (NYSE: VMI) and Lindsay Corp (NYSE: LNN)that produce and sell irrigation systems for the agricultural industry.

They're not the only ones, as there are a few investment plays on the longer-term US warming trend:

  • Irrigation Systems Manufacturers
  • Water Utilities
  • Fertilizer Companies 

Of the three, water stocks are the best core long-term holdings, in my opinion. They provide solid dividends, have very low betas (volatility in terms of stock price fluctuations), and their total returns have generally beaten the market over longer periods. American Water Works (NYSE: AWK), Aqua America (NYSE: WTR), and American States Water (NYSE: AWR) look attractive. Here's an analysis of water stocks.

But less-risk adverse investors might want to consider fertilizer stocks and/or irrigation systems stocks. We'll cover irrigation systems stocks here. 

Heat & High Crop Prices Driving Demand

The record-breaking hot and dry weather in the US Midwest, and other areas, has been a boon to irrigation systems companies. Farmers are making every effort to salvage as much of their crops as possible, given crop prices are high. Crop prices should remain high -- the USDA said last week that crops were in their worst condition since the drought of 1988.

Irrigation systems sales were strong in early 2012 as farmers prepared for an anticipated warmer and drier than average planting season. Subsequent earnings released have shown continued robust demand. 

The Competitive 'Landscape'

Globally, there are only a handful of companies manufacturing center pivot irrigation systems, and the four largest -- Valmont, Lindsay, T-L Irrigation, and Reinke -- are all based in Nebraska. 

Only Valmont and Lindsay are public companies. Valmont is #1 in the industry; it's not possible to rank the others since private companies aren't required to divulge sales data.  

Got Water -- and Moat, Too!

Valmont owned the original center pivot patent, though naturally competitors flooded in when it expired. The industry was initially crowded, but competitors quickly dropped out. That's a good sign for potential investors -- it indicates a decent moat.

Center Pivots -- The Gold Standard in Agricultural Irrigation

Center pivots do just that -- pivot around a center point, thus their coverage areas are circular. They are highly-engineered, and can be quite high-tech. Some are equipped with GPS capabilities for instance.

Center pivot & lateral move (a form of center pivots) systems provide considerable advantages over older methods -- such as furrow and gravity fed irrigation -- as they conserve water, energy, and labor while increasing or stabilizing crop production.

Valmont Industries

Valmont is the world leader in mechanized irrigation equipment for agriculture. Its systems are sold under the Valley brand.  

It's also a global manufacturer of engineered products for infrastructure, and provides coating services. It produces and sells fabricated metal products and pole and tower structures. These products are used in wireless, electrical transmission, lighting, and other industrial applications.

Latest revenue breakdown by segment:

<img src="/media/images/user_13269/val-revs_1_large.jpg" />

2012 Financial Results

The company's calendar Q2 results are due out on July 25.

It had a good first quarter. Net Income doubled on a 26% sales increase -- a nice widening of margins. Here's the full earnings release

(Foolish investors know looking at just earnings is not enough -- they need to dig deeper and check cash flows.) 

Here's how each segment performed in the quarter:

<table> <tbody> <tr> <td>Segment</td> <td>Sales vs. Q1 2011 (%)</td> <td>Operating Margin (%)</td> <td> <p>Operating Income vs.</p> <p>Q1 2011 (%)</p> </td> </tr> <tr> <td>Irrigation                                             </td> <td>30 </td> <td>19.6</td> <td>61</td> </tr> <tr> <td>Utility Support Structures                 </td> <td>52</td> <td>13.1</td> <td>86</td> </tr> <tr> <td>Engineered Infrastructure Products<strong> </strong></td> <td>17</td> <td>4.1</td> <td>300+</td> </tr> <tr> <td>Coatings</td> <td>13</td> <td>19.9</td> <td>60</td> </tr> <tr> <td>Other</td> <td>--</td> <td>--</td> <td>--</td> </tr> </tbody> </table>


Drivers for results:

  • Irrigation -- Favorable agricultural economy factors in all regions, such as record plantings and high commodity prices. Dry weather in Midwest. 
  • Utility Support Structures -- Large projects to upgrade N. American electrical transmission grid.
  • Infrastructure Products -- Increased demand in N. America.
  • Coatings -- Increased demand in N. American & Australian markets. 


Lindsay Corp. -- The Pure Play

Lindsay manufactures and sells its irrigation systems under the brand names Zimmatic, Greenfield, and GrowSmart in the US and internationally.  It also has an Infrastructure segment that sells its products to departments of transportation, municipal transportation agencies, road contractors, distributors, and dealers. 

Here's its latest revenue breakdown by segment (this breakdown appears quite steady as it also applies to the company's revenue in the first 9 months of fiscal 2012):

<img src="/media/images/user_13269/lindsay-revs_large.jpg" />

Lots of Water in One Bucket -- Volatilty Alert!

With 87% of revenues derived from its irrigation biz vs. Valmont's 27%, it's the decided pure play on irrigation systems. This could be a plus or minus, depending upon irrigation systems demand over time.

2012 Financial Results

On June 27, Lindsay released its fiscal third-quarter 2012 (period ending May 31) results.

Revenue was $172.1 million, up 12% from a year ago, and net income rose to $18.8 million, up 23% from $15.3 million. Both figures topped analysts' expectations.

(Again, Foolish investors know looking at just earnings is not enough -- they need to dig deeper and check cash flows.)

Here's how the segments performed:

<table> <tbody> <tr> <td>Segment</td> <td>Sales vs. Fiscal Q3 2011 (%)</td> <td>Operating Margin (%)</td> </tr> <tr> <td>Irrigation                                            </td> <td> 18</td> <td> 20.9</td> </tr> <tr> <td>Infrastructure               </td> <td> -16</td> <td> 6.4</td> </tr> <tr> <td>Overall</td> <td>12%</td> <td>16.7</td> </tr> </tbody> </table>


Driver for results:

  • Strong demand for irrigation systems in the US


  • Overall margins increased to 16.7% from 15.1%
  • Irrigation margins increased to 20.9 % up from 20.2%
  • Irrigation sales breakdown as 71% US, 29% international
  • US irrigation sales up 38%, international down 12%

What's with Infrastructure?

This segment is small, so relatively small dollar value changes will have a significant effect on percentages. Additionally, infrastructure is a highly seasonal business, so weather differences from one year to the next can affect when revenue gets booked.  

The core issue is infrastructure spending -- it's been down in the US. The company reportedly has a potential sizable contract in the works, 'if' the project moves forward in 2013 as planned, involving movable barriers on the Golden Gate Bridge.

What's with International Irrigation Sales? 

International sales tend to be project-based, so revenue is not going to be linear. 

For instance, the company reportedly has a China project under negotiation, which -- if it pans out -- should cause a revenue "lump" on its next quarterly report. 

Valmont & Lindsay Water-Balloon It Out

No industry average is included, as Valmont is grouped in "Metal Fabrication," and Lindsay in "Farm Equipment." 

Key Stats

<table> <tbody> <tr><th> </th><th>VMI</th><th>LNN</th></tr> <tr> <td>Market Cap $ millions</td> <td>3,580</td> <td>905</td> </tr> <tr> <td>Price/Earnings TTM</td> <td>14.1</td> <td>22.5</td> </tr> <tr> <td>PEG</td> <td><strong>0.99</strong></td> <td>1.17</td> </tr> <tr> <td>Rev Growth (3 Yr Avg)</td> <td><strong>11.8</strong></td> <td>0.9</td> </tr> <tr> <td><span><span>EPS</span> Growth </span>(this yr)</td> <td><strong>140.7</strong></td> <td>46.8</td> </tr> <tr> <td>EPS Growth (3 Yr Avg)</td> <td><strong>19.5</strong></td> <td>17.3</td> </tr> <tr> <td>Operating Margin % TTM</td> <td>10.7</td> <td>12.8</td> </tr> <tr> <td>Net Margin % TTM</td> <td><strong>9.0</strong></td> <td>7.3</td> </tr> <tr> <td>ROE TTM</td> <td>23.4</td> <td> 14.2</td> </tr> <tr> <td>LT Debt/Equity</td> <td>0.4</td> <td><strong>0.0</strong></td> </tr> <tr> <td>Dividend %</td> <td>0.7</td> <td>0.5</td> </tr> <tr> <td>Beta</td> <td>1.5</td> <td>1.5</td> </tr> <tr> <td>Insider Ownership %</td> <td><strong>12.5</strong></td> <td>0.7</td> </tr> <tr> <td>Short Float %</td> <td><strong>1.6</strong></td> <td>11.3</td> </tr> </tbody> </table>


VMI's numbers mostly look better. Exception -- Debt/Equity ratio. A 0.4 D/E is not excessive, though a thorough check of cash flows should be performed. 

I like VMI's insider-ownership figure, and it's 1.5% profit margin advantage. The seeming ROE advantage is misleading -- it's due to the debt leverage, so that metric's a wash.  

2-Year Stock Price Performance

Valmont in blue; Lindsay, green; S&P 500, red.

<img src="/media/images/user_13269/irrig-2-yr_large.jpg" />


Bottom Line 

These companies look like potentially promising investments, as the sustainable factor in demand is the continued population growth.

However, these companies would only be suitable investments for less risk-adverse investors who regularly keep up with their stocks and their outlooks. Buy-and-holders who want to 'Keep it Simple' would be better served by investigating water utility stocks.  

As always, Foolish investors should consider this analysis a solid start to their own due diligence, not a complete analysis!


BAMcKenna has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Aqua America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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