Construction Equipment Roundup: Buy This Stock

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

If the drought has you thinking about investing in agricultural stocks, I recommend looking at several variables: growth, multiples, and catalysts. More importantly, it's important to consider the long-term and whether multiples can sustain their current levels or even expand. Below, I review 3 stocks with this in mind.

Why You Should Buy Deere (NYSE: DE)

The maker of agricultural construction equipment trades at a respective 11.2x and 9.6x past and forward earnings with a dividend yield of 2.2%. This compares favorably to a 17.1x sector average PE multiple and a 15.3x 5-year average PE multiple. Early this year, UBS rated the stock a "buy" with a $115 price target, which is at around a 35% premium to the current market assessment despite appreciating 24.4% format the 52-week low. Warren Buffett apparently sees the upside and has, accordingly, bought a stake in the business.

Free cash flow has been very volatile, on the other hand, falling from $3 billion for the TTM ending January 2010 to just $648 million by Halloween time. There are several reasons to be optimistic, bearing in mind that companies are valued based on the long-term trajectories. Fragile economic conditions in the recent quarter were largely responsible for recent weakness, and macro conditions are improving.  Even despite challenging conditions, management still beat revenue guidance by $180 million with $9.8 billion in the fiscal fourth quarter. Strong crop prices are expected to drive even greater cash receipts next year.

I am particularly optimistic about the company's potential in international markets. Government programs in Brazil allow for strong financing and low interest rates, although soft economic conditions in Asia continue to be a headwind. During the past 5 years, EPS grew by 13.8% annually, and even though a much smaller rate--7.8%--is expected over the next half decade, shares can't stay this low for long.

Small Cap Roundup: Lindsay (NYSE: LNN) & Manitowoc (NYSE: MTW)

If you are looking for the strongest returns, you may want to consider buying stock in companies below a $5 billion valuation. Lindsay and Manitowoc both target the agricultural market, and the former even provides irrigation equipment (ideal for the climate.) Lindsay has a clean balance sheet with no debt  and a current ratio of 3.7x.  Analysts forecast it growing EPS by 21.3% annually over the next 5 years--about the same rate achieved during the past half-decade.

Assuming Lindsay meets expectations, 2016 EPS will come out to $7.32. At a multiple of 15x, this translates to a future stock value of $110. Discounting backwards by 10% yields a present value of around $68.30, which suggests the stock is around 10% overvalued. Having risen 55% from the 52-week low, shares are looking relatively expensive at 22.4x past earnings.

To put this into perspective, Manitowoc trades at 11.1x forward earnings--still a premium to Deere's. Return on invested capital is 4.2%, which is around 1000 bps below the industry average and certainly the cost of capital. A series of revenue misses later and a 81% pop from the 52-week low later, the company is now getting a tepid outlook from the Street. The company gets 60% of its business from crane sales and the remainder from foodservice products, which include fryers, beverage dispensers, and freezers seen in top restaurant chains like Subway and McDonald's. If there is going to be a near-term catalyst, it will come from the more cyclical segment, cranes, which is starting to show signs of an upswing. Improving housing starts make me bullish on a construction recovery, but it would take considerable growth to justify an investment over Caterpillar, which is already discounted on several different levels. So, ironically, the smaller companies are more expensive and contain less value than Caterpillar.

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