- My Guru Strategies are triggering a Trade Alert on AGCO shares.
- The stock has struggled amid falling food commodity prices.
- But its fundamentals are strong, and it has been diversifying into emerging areas.
- With expectations low, it's a good time to buy.
With agricultural commodity prices having declined for much of the past year, it's been a rough few months for agricultural equipment companies like AGCO Corporation (NYSE:AGCO), the Georgia-based mid-cap ($4.8 billion) firm that offers everything from tractors to combines to hay tools to grain storage and protein production systems and beyond. Lower prices mean lower profits for farmers, which means fewer equipment purchases -- in January, a Farm Journal poll showed that nearly 40% of the 1,500 farmers and ranchers surveyed expected to buy no pieces of farm machinery in 2014. Another 25% said they expected to buy only one piece. In addition to softening commodity prices, tax law changes that could put much stricter limits on the amount of equipment purchases that can be immediately written off may be a factor, Farm Journal reported.
AGCO acknowledged headwinds in its February earnings announcement, in which company officials said that 2014 "will be a challenging year for our industry," and projected 2014 revenues that would barely top those of 2013, and earnings per share that would come in right about the same as 2013's. Its shares have been stumbling after the disappointing guidance, but my Guru Strategies are seeing that as a big buying opportunity for a financially solid firm with a strong long-term track record. On March 11, my models triggered a Trade Alert on AGCO, whose products are available in more than 140 countries through a network of 3,150 independent dealers and distributors. These alerts are issued when a stock's fundamentals earn it certain level of interest from one or more of my models. With AGCO, several models were in consensus in triggering the alert, which runs through June 10. My back-testing has shown that historically, stocks possessing similar fundamental characteristics have on average returned more than 10.4% over a three-month period, compared to 3.4% for the S&P 500.
While my Trade Alert on AGCO lasts for three months, I think the stock could be a good longer-term play as well. That's in part because it is more diversified in terms of its regional markets than some of the other big farm machinery companies. In 2013, AGCO got just 25% of its revenues from North America. Nearly 20% came from South America, while over 50% came from the Europe/Africa/Middle East region. Deere, in contrast, got nearly 2/3 of its total sales from North America. AGCO also recently entered into a joint venture with a Russian machinery company, another sign that it is taking strides to tap into high-growth potential emerging market areas.
Inside the Numbers
What really appeals to me right now about AGCO, however, are its fundamentals and financials. After its recent declines, shares trade for just 8.7 times trailing 12 month earnings; using three-year average earnings, which my Benjamin Graham-inspired model does, it trades for 9.0 times earnings. The stock's price/book ratio is also a very reasonable 1.26, another reason that the model I base on the writings of Graham -- who is known as the "Father of Value Investing" -- is interested in AGCO. One more: the company's balance sheet. Graham liked a company to have more net current assets than long-term debt. AGCO has more than $1.7 billion in net current assets and $939 million in long-term debt, passing that test with flying colors.
The model I base on the writings of mutual fund legend Peter Lynch, meanwhile, is very high on AGCO. The Lynch strategy considers AGCO a "fast-grower" -- Lynch's favorite type of investment -- thanks to its impressive 29.7% long-term EPS growth rate. (I use an average of the three-, four-, and five-year EPS growth rates to determine a long-term rate.) Lynch famously used the P/E-to-Growth ratio to find bargain-priced growth stocks, and when we divide AGCO's 8.7 price/earnings ratio by that long-term growth rate, we get a PEG of 0.29. That falls into this model's best-case category (below 0.5). Of course, it appears that growth will be slowing for the company, at least in the short term. But it's worth noting that even if we use analysts' projected long-term growth rate for AGCO (9.7%), we still get a PEG below 1.0, which is acceptable to my Lynch-based model.
Lynch also liked conservatively financed firms, and the model I base on his writings targets companies with debt/equity ratios less than 80%. AGCO's D/E is 31%, another good sign.
AGCO shares also look cheap looking at top-line valuations. That's a big reason that it gets strong interest from my Kenneth Fisher-inspired model. In his 1984 classic Super Stocks, Fisher pioneered the use of the price/sales ratio -- PSR -- as a way to assess value, having found that sales were a much more stable gauge of the company's business than earnings. My Fisher-based model likes industrial companies like AGCO to have PSRs below 0.8; at 0.45, AGCO looks quite cheap indeed. This model also looks at a number of other fundamental criteria, and AGCO doesn't disappoint there either. The strategy likes its reasonable debt/equity ratio; $3.68 in free cash per share; and three-year average net profit margins of 5.8%.
AGCO also has a few other fundamental characteristics that are important to note. For one, it has generated an average return on retained earnings (that is, the earnings it has not paid out as dividends) of more than 15% over the last decade, a figure that impresses my Warren Buffett-inspired model. And it has a return on capital (earnings before interest and taxes/tangible capital employed) of 23.2% and an earnings yield (EBIT/enterprise value) of 17.7%. Those both earn it pretty solid marks from my Joel Greenblatt-inspired model.
Low Expectations, High Returns
Investing is all about expectations. Yes, companies expected to produce gangbusters growth can be quite alluring. But all too often, such companies fall short of lofty expectations, which means that even results that are good but not great can send shares tumbling. Some of history's most successful investors, however -- people like Graham, Buffett, Fisher, and the other gurus I follow -- knew that when short-term expectations are low, it can be a great time to buy shares of good companies. My strategies think that's the case with AGCO right now.