2 Machinery Companies to Buy, 1 to Avoid

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

A country's economic activity is the prime driver of its machinery industry's demand. According to an IMF estimate, the world economy will grow 3.3% in the current year and 4% in the coming year. This will drive growth in the machinery industry as it focuses on activities like agriculture, construction, and mining.

In light of positive global economic trends, here is an analysis of three companies. While Deere (NYSE: DE) and CNH Global (NYSE: CNH) primarily derive revenue from their agricultural machinery segments, Caterpillar's (NYSE: CAT) key revenue driver is its construction and mining equipment segment. These companies have framed strategies to benefit from improving macroeconomic factors, but will their strategies lead to sales growth?

Innovation drives expansion

Deere started a new 300,000 square-foot manufacturing plant at its Des Moines Works in Ankeny, Iowa. This plant will use the latest technology in farm equipment. The company has invested $85 million in this expansion. This plant will assemble sprayers, which are used to control weeds and apply nutrients. The plant already manufactures agriculture-related equipment for crop-care. With the contribution of this plant, the company expects quarter-over-quarter revenue growth of 3% in the third quarter ending in July.

In May, NavCom Technology, a wholly owned subsidiary of Deere, launched a new feature, "StarFire Rapid Recovery" for its products. With this feature, NavCom's Global Navigation Satellite System, or GNSS, will see an improved connection. GNSS is a system that supports the functioning of blades and buckets in agricultural equipment. With the help of this feature, GNSS will take 2-3 minutes to reconnect satellite signals, compared to 45 minutes previously, and will provide a supportive visual aid to machinery operators with the help of a satellite connection.

Helping farmers save time means helping farmers increase their production yield. The GNSS system has an impressive growth potential, as it is already used in 700,000 machines and is growing at CAGR of 12%. This will help the company to increase its revenue from its agricultural & turf equipment segment. It is expected that revenue from this segment will increase 8.9%, year-over-year, amounting to $29.54 billion in the current year.

The growing market for GNSS application

<img alt="" src="http://g.fool.com/editorial/images/54821/image-1_large.png" />

Source: gnssconsulting

Merger opens new opportunities for growth

CNH Global recently announced SEC approval for its merger with Fiat Industrial. This deal will close in the third quarter of 2013. The merged company, CNH Industrial, will become the third-largest capital goods provider. CNH Global is already a leading company in agricultural and construction equipment with around 11,500 dealers in 170 countries, while Fiat is among the top companies in the capital goods sector and even does equipment marketing for CNH Global.

This is a strategic merger, as CNH Global plans to expand its agricultural and construction segment. CNH Global generated revenue of $19.13 billion in fiscal 2012 and estimates growth of approximately $19.26 billion in fiscal year 2013. Moreover, Fiat reported revenue of around $33.64 billion in the previous year and expects revenue growth of 4% in the current year. These expected revenues will now contribute to the growth prospect of the new company.

Last year, U.S. farmers received pay outs from crop insurance and invested the funds in purchasing agricultural equipment. Thus, in the first quarter of 2013, the company reported a 26% year-over-year rise in earnings from its agricultural equipment segment, amounting to $469 million. It has further increased its inventory in its agricultural equipment segment, looking at the increasing demand in the second quarter.

This expectation is due to the approaching corn planting season in the U.S., which is the nation's prime agricultural product. The company's agricultural equipment segment will increase to approximately $3.41 billion in the second quarter of 2013, up from $3.06 billion in the first quarter of 2013. Overall, with rising demand, it is expected that annual revenue from this segment will be $13.3 billion in the current year, up from $12.3 billion in the previous.

Mining sector a headwind for this company

With slow mining growth in China, along with a recession in Europe last year, dealers at Caterpillar were pessimistic about future demand for construction and mining equipment and reduced their inventory by $700 million for the current year. This reduction in inventory levels negatively impacted Caterpillar's sales of its construction and mining equipment. As this segment contributes one-third of the company’s sales, total revenue was down 17% year-over-year, amounting to $13.2 billion in the first quarter of 2013. It is estimated that Caterpillar’s total sales will be around $61 billion in 2013, down from approximately $66 billion in 2012.

The board of directors have authorized a $7.5 billion repurchase, which was scheduled to expire on December 2011 but is now extended through December 2015. The company has already used $3.8 billion of this total authorized repurchase. The company has a strong balance sheet, as in the first quarter it generated free cash flow of $368 million, which will help it with the repurchase. This should offset the impact of falling revenue in the construction and mining equipment segment and will boost investors’ confidence. In the second quarter of 2013, this strong cash flow will be utilized to repurchase $1 billion worth of shares.

Bottom line

Deere plans to expand its plant located in Ankeny, where it will produce agriculture-related equipment and assemble agricultural spray. Further, the company launched a new feature, StarFire Rapid Recovery, which will improve satellite re-connection speed. These strategies should help the company capture a higher market share.

CNH Global will merge with Fiat Industrial, which will help the company become the third-largest capital goods provider. Moreover, its agricultural segment is showing impressive growth due to macroeconomic factors.

Caterpillar’s construction and mining equipment segment is falling, as its dealers reduced their inventory. In order to offset and boost investors' confidence, the company plans to resume its repurchase program.

Keeping these in mind, Deere and CNH look like buys while Caterpillar is a hold.

With the American markets reaching new highs, investors and pundits alike are skeptical about future growth. They shouldn't be. Many global regions are still stuck in neutral, and their resurgence could result in windfall profits for select companies. A recent Motley Fool report, "3 Strong Buys for a Global Economic Recovery," outlines three companies that could take off when the global economy gains steam. Click here to read the full report!

Madhu Dube has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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