By Kevin Cook
The megatrend of emerging markets driving increased food demand is nowhere more apparent than in the fortunes of farm machinery maker CNH Global (NYSE:CNH), which just reported blowout first quarter results.
CNH is the number one manufacturer of agricultural tractors and combines in the world, the third largest maker of construction equipment, and has one of the industry's largest equipment finance operations.
The company's two brand families, Case Corporation and New Holland N.V., are sold through dealers and distributors on a worldwide basis and you may be surprised to learn that the company is 90% owned by Fiat Industrial of Italy. This will become important in a moment.
Big Beat From the Farm
On April 30, CNH reported Q1 EPS of $1.33 vs. consensus expectations of $0.95. This upside surprise was due primarily to strong farm equipment sales in Latin America with industry growth in tractors of +24% and combines of +54%. Market share gains also helped the quarter.
Agricultural revenue of $3.9 billion was above consensus of $3.5 billion, but construction revenue of $754 million missed consensus of $942 million.
According to analysts at William Blair:
This dynamic was expected, especially after CNH's largest dealer, Titan Machinery (NASDAQ:TITN), demonstrated results that showed a similar pattern. Farm equipment earned a healthy 11.9% margin in the quarter (30% incremental) but construction equipment lost $26 million on the weaker production and demand.
The company stuck to its full-year targeted revenue growth of 5% and operating margin guidance of 8.5% to 9.0%. Several analysts view the company's guidance as consistently conservative and believe that CNH can probably exceed these targets given that the first quarter operating margin came in at 9.4% and Latin American demand for farm equipment is expected to remain strong.
Again from William Blair, "Essentially, the company's construction outlook is weaker than initially forecast, while the agricultural equipment is stronger than what prior guidance implied. Based on the company's backlog in farm equipment, order boards go out to the third quarter, so there should be some comfort that targets are achievable on the farm machinery side of the equation."
Estimates Boosted and More to Come
Two weeks before the company's report, analysts were raising estimates sufficiently to bump CNH to a Zacks #2 and then #1 Rank. Now those estimates are being quickly boosted again.
As of April 30, the 2013 consensus stood at $4.92. Some analysts on May 1 were already seen raising the full year in a range of $5.07 to $5.25. As these upward revisions filter in, CNH will likely maintain its high Zacks Rank.
So Why the Drop in Shares?
After CNH's report on Tuesday, the stock fell over 9% to $41. This was primarily due to a weak report and guidance from its parent, Fiat Industrial, whose shares dropped as well.
Why should this affect CNH? Until the takeover is complete this year, CNH shares basically trade in lockstep with Fiat Industrial given that CNH's value is determined by the established exchange ratio of 3.8 for the minority stake.
Most analysts believe that Fiat already trades at a steep discount and that this turn of events should not affect CNH shares for long. Combined with the fact that CNH is trading at roughly 8 times 2013 estimates, it might pay to buy this dip.
The real risks to keep in mind with CNH, according to JPMorgan analysts, are its overproduction in agriculture equipment vs. retail sales of 19% in anticipation of stronger demand in Q2 and Q3. Should the demand not materialize, the company would face a tough inventory correction.
Bottom line: Keep your eye on the rising EPS estimates for CNH. If the company's ability to expand farm equipment sales continues to outpace softness in construction, 2014 consensus estimates of $5.28 have upside risk.
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