Is the Agriculture Boom Over?
Howard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
For the last few years, farm equipment has been selling faster than cold beer in a hot ballpark. Record commodity prices, driven partly by emerging market demand, brought record income to farmers worldwide. They've continually upgraded and expanded their fleets with the profits, pushing machinery makers to their own record levels. From 2009 to 2012, for example, sales at Deere (NYSE: DE) grew 60%, while EPS mushroomed by 270%.
The upbeat news continued in recent earnings announcements from Deere and its two primary competitors, CNH Global (NYSE: CNH) and AGCO (NYSE: AGCO). Like a small but growing number of observers, however, I believe the most recent results represent a peak, and we could now start seeing fundamentals weaken.
Good news so far this year, but…
Recent earnings from the Big Three seem to contradict that call. Since the end of July, in fact, all reported profits and sales that beat expectations. And all boosted 2013 outlooks.
But headwinds have been building. Deere initially warned of a weak spring after questions about future corn prices and a cool planting season stalled North American sales. As a result its stock has fallen about 3% this year, while the S&P 500 gained 16%.
Market tightening has also resulted in a glut of used equipment in the U.S. and Europe, causing additional slowdowns as dealers push old machinery over new. The overall decline sparked rumors that Deere is cutting production of it combines by 20%, pulling a significant portion of the industry's most expensive — and highest margin — piece off the market.
Despite the glowing recent quarter Deere hints at things to come on its website, where it projects total cash receipts will decline through the rest of the year and into 2014 as corn, wheat and soybean prices drop. Deere further says it expects equipment sales in its current quarter to fall about 5% below last year.
But some still insist “the bloom isn’t off Deere & Co. or American agriculture for that matter,” as Forbes opined after the company's Aug. 14 report. The publication said it believes the recent strong period, especially in North America, lays earlier concerns to rest and suggests the boom has yet to end.
I think they're wrong. Here’s how these manufacturers fared over the last few months, and what I expect we'll see over the next few.
The world’s largest farm equipment maker’s fiscal third-quarter profit rose almost 30% year-over-year and easily topped analyst estimates. The company also raised full-year earnings forecasts. Chairman and CEO Samuel Allen said its Agriculture and Turf sales rose 8% in the period, outpacing overall equipment sales (which also include construction machinery).
Allen attributed the growth to “considerable strength... in North and South America" and noted a significant boost came from Brazilian farmers buying more tractors because of record soybean production and a government-backed financing program. The region’s sales are now expected to outpace those in the U.S. and Canada, which comprise almost two-thirds of Deere's revenue.
Allen also said strong quarterly results were aided by the company's ability to pass along higher prices, resulting in better than expected margins. And he noted that Deere was "keeping a close watch on costs and assets" going forward.
This manufacturer and distributor of a range of agricultural equipment and related replacement parts in more than 140 countries, under brands such as Challenger, Fendt, Massey Ferguson and Valtra, also had a strong showing in its most recent quarter. Net income smashed expectations and was up nearly 3.5% year-over-year despite strong 2012 comparisons. The period's sales were up 13%, also beating expectations.
AGCO attributed gains to growth in all regions, led by South America (responsible for 21% of its sales) and Asia/Pacific (less than 5%). It also noted “low levels of material cost inflation coupled with our marginal improvement initiatives” contributed to strong results.
A full-line dealer of agricultural and construction equipment that operates in about 170 countries, CNH's farm machinery is sold primarily under the Case and New Holland brands and represents about three-quarters of total revenue. For the second quarter, it reported net sales up 9% year-over-year and projected full-year revenue growth of 5%.
CNH generates the biggest chunk of its sales in North America (44%) and benefited from strength there as well as the Asia/Pacific region (10% of sales). But it has a relatively weak presence in South America (15%), and about one-third of its sales come from the long-spotty markets of Western Europe and the constantly challenging ones in Eastern Europe.
The Foolish bottom line
Despite some denial, it seems as if the so-called Agricultural Supercycle is coming to an end, and the farm equipment segment is heading down the same slower path that’s stymied Caterpillar and competing heavy equipment manufacturers.
Deere has the broadest product selection, including a construction line that should produce additional profits as that sector improves. It also has the most innovative technology and is strongest in overall global positioning, which gives it an edge as various regions ebb and flow. However, its huge reliance on North America could prove problematic if a significant downturn does come. CNH is less dependent on North America but also has less of a presence in South America — a detriment should that boom continue — and is probably too reliant on Europe. AGCO is also heavily invested in Europe, but has a big footprint in South America and is less dependent on North America than either of its competitors.
Investors should be cautious about this sector going forward. But if considering one player for the mid-term, focus on AGCO.
The Motley Fool's chief investment officer has selected his No. 1 stock for this year. Find out which stock it is in the special free report: "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.