Don't Expect This Stock to Inch up so Soon

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‘Your Agriculture Company’ isn’t really doing you too many favors. The company that boasts the tagline, AGCO (NYSE: AGCO) had a decent third quarter, but a drastic cut in its full-year earnings outlook was the last thing investors wanted to hear.

If you thought it is the aftermath of the drought, that’s not the case. There’s something else worrying AGCO, which I feel will keep its share prices subdued in the months to come.

It’s Good, but…

AGCO’s organic sales climbed 10% from the year-ago quarter, which is excellent news for a company that made one of its biggest acquisitions late last year. Organic sales do not include contribution from acquisitions, and the high growth even during a period that is seasonally the weakest for agricultural companies bears testimony to AGCO’s core business strength.

Things get even more exciting when acquisitions start adding value as well. Nearly half of the 66% rise in AGCO’s sales from North America from January through September can be credited to GSI, the grain-storage and poultry-raising equipment company AGCO took over last year.

Yet, it could be too early to stamp GSI a success. The acquisition does not help AGCO anyway in its core tractor business. GSI does add a business line that’s ancillary to AGCO’s portfolio because storage facilities are as important for farmers as tractors are, but timing seems to a problem.

Tough Luck

After GSI, fortunes of AGCO became closely tied to protein producers and poultry and livestock companies, who unfortunately are on rough track right now. Soaring crop prices (particularly of corn which is a key feedstock for poultry) have punched their margins hard this year, compelling them to slash costs and lower capital spending. That things won’t improve so soon were confirmed by Tyson Foods (NYSE: TSN) and Archer Daniels Midland (NYSE: ADM) during their recent earnings releases.

Tyson’s sales rose 4% during the first nine months of the year, but that was entirely on high selling prices. Volumes fell 5% from the comparable period last year, suggesting sluggish demand. The nation’s largest meat company expects protein production to fall further next year on account of high input costs, which is anything but good news for AGCO.

Likewise, a small U.S. harvest following the drought means there’s not much for grain processing companies to store. We could see it right through in Archer’s last-quarter earnings. Operating profits for its agricultural services division, which is all about handling and merchandising of grains, slumped a staggering 76% from the year-ago period as crop yield in the U.S. shrank. Smaller crop also makes it expensive for Archer to process corn. Taking stock of challenges ahead, Archer is aggressively cutting costs to survive trying times.

Naturally, GSI’s equipment will find it hard to sell, something AGCO knows well. Which is why even though GSI added $0.50 to earnings per share for the first nine months, AGCO expects its full-year contribution to be anything between $0.30 and $0.45 per share. Yes, you did your math right – instead of adding anything, GSI will take a bite out of AGCO’s fourth-quarter earnings.

Primary Business to Fill in

AGCO investors needn’t sulk though, because AGCO’s core business of tractors and combines should head to greener pastures as preparations for the next U.S. spring planting season begin. Both AGCO’s and CNH Global’s (NYSE: CNH) latest numbers tell me that agricultural companies aren’t losing much even after the crippling drought. Both companies sold a decent number of tractors and combines in this past quarter, which, as I mentioned earlier, is a seasonally weak period. Robust demand for high horsepower tractors from North America pushed CNH’s third-quarter agricultural-equipment sales up by 18% from the year-ago period. The other market that should steer sales forward in the next quarter is Latin America. These two markets together accounted for nearly two-thirds of CNH’s sales in this past quarter.

Tractor king Deere (NYSE: DE), which is about to release its numbers in about two weeks’ time, held an optimistic view about its fourth quarter even as the drought ripped through the U.S. three months back. Deere forecast its fourth-quarter sales to be 13% better from last year, which looks achievable especially after AGCO’s and CNH’s numbers. It's even more so, because Deere derives 40% sales from the U.S. and Canada, and nearly 20% came from Brazil alone last year. But there’s one thing that could put a wrench to Deere’s numbers – I’ll soon tell you more when I preview its earnings.

Beyond Boundaries

Developing markets will also hold the key to growth for AGCO in the years to come. While demand in the U.S. is likely to be driven by the need to replace an aging fleet (according to Deere, 85% of the combine fleet in the U.S. is more than 5 years old), large parts of emerging markets still don’t use advanced tractors and combines.  AGCO can easily tap international markets for growth while Deere concentrates on the U.S. market. AGCO already dominates the Brazilian tractor market and is expanding capacity further, and derives more revenue from Latin America and Asia-Pacific combined than it does from North America. With Latin America set for a record planting season, AGCO is poised to benefit in the short as well as long run.

Foolish Takeaway

Lower expected sales from GSI prompted AGCO to lower its full year earnings per share guidance to $5.20 from a range of $5.50 to $5.75 given earlier.  That’s not too heartening, and AGCO’s stock prices could reflect the sombre mood over the next couple of months.

Yet, in the long run, AGCO’s investments highlight its focus on getting bigger and better. It has even opened a new Fendt (one of the key AGCO brands) facility in Germany that can produce more at lower costs.

AGCO might be behind Deere and CNH in terms of total sales, but it has its feet firm on the growth accelerator. Once markets improve, GSI should start contributing positively as well. To make sure you do not miss that opportunity, click here to add AGCO to your stock watchlist.

Neha Chamaria has no positions in the stocks mentioned above. The Motley Fool owns shares of Archer Daniels Midland Company. 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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