3 Undervalued Agricultural Stocks to Buy
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The agriculture business is notorious for low margins, intense competition, and volatile demand. However, there are instances where the headwinds have been overly factored into stock prices. Such is the case for Mosaic (NYSE: MOS), Deere (NYSE: DE), and Manitowoc (NYSE: MTW). I recommend diversifying in all three producers to capitalize off of a market correction.
Deere & Manitowoc
Deere can be thought of as Caterpillar with an agricultural motif. The company is noted for its "John Deere" brand that includes land & turf equipment, earthmoving material, crawler dozers, excavators, skid-steer loaders, log harvesters, and a variety of attachments. It is the go-to brand for agricultural machinery but it is largely a buy-and-sell stock for investors. Investors will bid the price up if strong earnings suggest an upswing in business, but will bid the price down if there are poor earnings. While that is true generally for most industries, it is particularly the case for agriculture-centric businesses that are highly cyclical and can't rely on "long-term fundamentals." Accordingly, the stock is 53% more volatile than the broader market.
Fortunately, operations are pointing towards strong business activity. The business has been roughly flat over the past 12 months, but it is still roughly near the 52-week high. Record farm incomes have been in marked contrast to Deere's underperformance. At 10.8x past earnings, the stock is trading well below its historical 5-year average PE multiple of 15.7x. Free cash flow trends may have been shaky, but it still looking well above the low $600 million amount generated between 4Q08 and 2Q09 over a trailing twelve month period.
Manitowoc similarly looks poised for excellent returns. The business offers a low dividend yield not because it fails to generate significant free cash flow, but because it is confident in its ability to reinvest earnings. Average annual free cash flow generation over the last 5 years has been $140.5 million, which is at more than a 7% yield to the market capitalization - not great, but not terrible either. Future value creation will come from the market correcting its poor factoring of growth. Analysts forecast Manitowoc to increase earnings by 15% annually over the next 5. 5 years. Double-digit declines have, however, put investors on the fence and generated increased speculation, as evidenced by the beta of 3.1. At the same time, investors are starting to pick up on how badly risk has been exaggerated - a market correction that has sent shares soaring 153.5% from the 52-week low.
Mosaic is a bit different from Deere and Manitowoc in that it does not operate in the construction industry. Rather, it is an agricultural basic materials play producing everything from potash and phosphate to animal feed and industrial products. The spread between the 52-week high and 52-week low is relatively even, which indicates that the market has been very neutral on the prospects over the last year.
Fortunately for entering value investors, this "neutrality" has hovered unreasonably towards the bearish side. Shares trade at only a respective 13.5x and 10.7x past and forward earnings while liquidity at a current ratio of 3.4x promises strong growth prospects. With the low bar that has been set for annual EPS growth over the next 5 years (9.2% versus 36.3% over the past 5 years), the potential for outperformance is very compelling.
Assuming the company meets analyst expectations, 2016 EPS will come out to $7.27. At a multiple of 16x, the future stock value of Mosaic is $116.32. Discounting backwards by 10% yields a present value of $72.22, which is at a significant premium to the current market capitalization. During the 2Q earnings call, management revealed impressive performance with top-line growth of 6% and a realized gain in margins for the foodservice business. With the fundamentals looking solid at a time when shares are at a discount, I recommend buying a few shares.
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