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Determining Fair Value In The Farm And Construction Machinery Industry

DCF analysis for; AGCO Corporation (NYSE:AGCO), Astec Industries (NASDAQ:ASTE), Caterpillar (NYSE:CAT), Deere & Company (NYSE:DE), Joy Global (NYSE:JOY), Lindsay Corporation (NYSE:LNN), and Terex Corp. (NYSE:TEX)

The farm and construction machinery industry has become a major source of debate between the bulls and the bears. The demand picture from emerging markets (NYSEARCA:EEM) is hazy, at least in the near term, as the BRIC economies (NYSEARCA:BKF) hover around what appears to be a relative bottom, and recalibrate following their prolonged phase of deterioration. Corn prices are falling, and yet machinery sales are increasing, both domestically, and in South America. International monetary stimulus programs are providing traction for new combine and tractor sales in an otherwise uncertain macro environment.

Jim Chanos revealed that he is short Caterpillar, due to a lack of near term growth catalysts, while Deere trumped analyst estimates with a resounding earnings beat, $10.01 billion top line versus the $9.26 billion analyst estimate, and $2.56 bottom line versus the $2.17 analyst estimate. In a statement from Deere's CEO, Samuel R. Allen, the driving force behind sales growth was revealed to be the Americas. Allen is quoted as saying, "Deere's success is a reflection of considerable strength in the farm sector, especially in North and South America." A trend that this analyst predicted in this article ahead of earnings.

Discounted cash flow analysis is used here in order to identify the undervalued, and overvalued, names in the industry, and by means of determining fair value, establish price targets relative to the intrinsic value of future cash flows, and earnings growth of those equities. One is able to slice through a murky demand picture, and incisively calculate potential profitability, using discounted cash flow analysis. The goal is to leverage current price uncertainty into alpha generation.

Fair value calculated using; 10 year growth rate period, 2% terminal value growth rate so as to correspond with the current rate of inflation, 5 years of terminal growth, and 13% discount rate so as to reflect the long term average rate of return from passively investing in the farm and construction machinery industry.

Shown on the table below are the fair value price targets reached by means of DCF analysis, and the 10 year growth rates that current share prices necessitate in order to be considered justifiable by reverse-DCF analysis.

U = Undervalued, N = Neutral, O = Overvalued

Ticker AGCO ASTE CAT DE JOY LNN TEX
Present Value $56.31 $34.50 $83.57 $83.99 $50.48 $75.63 $30.55
EPS 6.08 1.87 6.33 8.80 5.85 5.55 2.00
5yr. Future Growth Rate 12.50% 13.75% 10.85% 9.00% 10.33% 13.35% 9.33%
PEG Ratio 0.76 1.34 1.25 1.07 0.85 1.02 1.65
Expected Growth Rate 6.28% 17.93% 12.36% 6.80% 5.03% 12.89% 14.80%
5-yr. Past Growth Rate 24.93% (6.48%) 20.41% 23.53% 17.19% 41.85% (27.52%)
Fair Value $80.95 $26.82 $76.45 $95.37 $68.53 $77.73 $22.10
Valuation U O O U U N O

AGCO, Outlook: Undervalued, Price Target: $81.00

The valuation call on AGCO is unique in that the 10 year earnings growth rate is 0%, while the company increased free cash flow by 22.8% over the same period of time. In the last 5 years, the company has experienced robust growth across the board, with earnings growth of 21.4%, along with 13% EBITDA growth, 5.7% revenue growth, 13.9% book value growth, and 69.4% free cash flow growth. This stock is trading at a discount to fair value. With an upside of 41.337%, this stock is a buy. Income growth, and operating efficiency statistics are displayed on the charts below.

AGCO EBITDA TTM ChartAGCO Return on Assets Chart

ASTE, Outlook: Overvalued, Price Target: $27.00

In order to justify the present value of ASTE shares, the company would need to have grown earnings, and free cash flow, at a rate of 17.93%. The company posted negative growth, over the past 5 years, of 6.48%, and is therefore fundamentally overvalued. A PEG ratio of 1.34 corroborates this analysis, and further validates the significant downside to this stock. This stock is a strong sell; this stock is not a short sell candidate. Income growth, and operating efficiency statistics are displayed on the charts below.

ASTE EBITDA TTM Chart

ASTE Return on Assets Chart

CAT, Outlook: Overvalued, Price Target: $76.50

Significant exposure to international macro factors and weakening demand for mining machinery continue to plague Caterpillar. The intrinsic value of future earnings and cash flow growth is less than the present value of shares at market. In order to justify the present value of CAT shares, the company would need to have grown earnings, and free cash flow, at a rate of 12.36%. The company posted 4.30% earnings growth over the past 5 years, and is therefore fundamentally overvalued; CAT is a sell. Income growth, and operating efficiency statistics are displayed on the charts below.

CAT EBITDA TTM Chart

CAT Return on Assets Chart

DE, Outlook: Undervalued, Price Target: $95.00

In order to justify the present value of DE shares, the company would need to have grown earnings, and free cash flow, at a rate of 6.80%. The company posted 23.53% earnings growth over the past 5 years, and is therefore fundamentally undervalued. A PEG ratio of 1.07 suggests that Deere has room to grow; currently trading with a 14.11% upside, Deere is a strong buy. Income growth, and operating efficiency statistics are displayed on the charts below.

DE EBITDA TTM ChartDE Return on Assets Chart

JOY, Outlook: Undervalued, Price Target: $68.50

In the past 10 years, Joy Global has increased revenue by 19.2%, increased EBITDA by 31.1%, increased earnings by 43.2%, increased free cash flow by 22.5%, and increased book value by 22.4%. In order to justify the present value of Joy shares, earnings and free cash flow would need to have grown at a rate of 5.22%. Joy outperformed this expected growth rate by a large margin, growing earnings 18.7% over the last 5 years. Offering a long position an upside of 31.89%, this stock is a strong buy. Income growth, and operating efficiency statistics are displayed on the charts below.

JOY EBITDA TTM Chart

JOY Return on Assets Chart

LNN, Outlook: Neutral, Price Target: $78.00

The present value of Lindsay Corp stock is relatively in line with the intrinsic value of future earnings and cash flow growth. The expected growth rate, in order to justify present value, is 13.08%; the company posted 11.3% earnings growth over the last 5 years, and 18.9% earnings growth over the last 10 years. A forward, 5 year (per annum) growth estimate of 10.33% suggests a cooling of the historically robust growth story. The 246.9% positive change in free cash flow over 5 years is significant, but this type of extreme growth looks unsustainable past the near term. A price/book ratio of 2.60, and a price/sales ratio of 1.50, are high, relative to the farm and construction machinery industry, and reflect the barrier to higher share prices that is the intrinsic value of the company's future growth. This stock is trading, at present value, within 1 point of fair value. JOY receives a neutral rating. Income growth, and operating efficiency statistics are displayed on the charts below.

LNN EBITDA TTM Chart

LNN Return on Assets Chart

TEX, Outlook: Overvalued, Price Target $22.00

Terex has a significant downside, and revenue streams appear to be deteriorating. Over the last 5 years, revenues have declined by 4.9%; over the last year, revenues dropped 8.9%. In order to justify the present value of TEX shares, the company would need to have grown earnings, and free cash flow, at a rate of 15.25%. The company posted double-digit, negative changes in earnings and revenue over the past 5 years, and is therefore fundamentally overvalued. TEX is a strong sell; TEX is not a short candidate. Income growth, and operating efficiency statistics are displayed on the charts below.

TEX EBITDA TTM ChartTEX Return on Assets Chart

Ranking: Greatest Upside Potential To Greatest Downside Risk

Ticker Upside/Downside Rating
AGCO 43.76% Buy
JOY 35.76% Strong Buy
DE 13.55% Outperform
LNN 2.78% Neutral
CAT -8.52% Underperform
ATSE -22.26% Strong Sell
TEX -27.66% Strong Sell

Conclusion

Long JOY: Joy Global's strong revenue streams, robust earnings, and free cash flow growth make it the best investment in the farm and construction machinery industry. Joy Global is supreme to AGCO in operating efficiency, by significant margins. AGCO is therefore the runner-up to Joy Global. JOY is an excellent long opportunity at these levels.

Source: Joy Global, Best In Industry With A Significant Upside