I have long been an owner of Lindsay Corporation (NYSE:LNN). It is a well-run company with top-of-the-line products in a growing industry. However, due to the recent optimism surrounding the company we believe that the shares are currently selling at a premium to the intrinsic value.
This article will not attempt to explain the business and competitive environment surrounding LNN. The other Seeking Alpha contributors sufficiently explain the irrigation industry and its prospects. You can find two very descriptive articles here and here. This article will only discuss the valuation and potential return on an investment in Lindsay Corporation.
To get a better idea of what the company is worth we first want to examine what Michael Mauboussin calls the steady state value. This is what the company is worth if the future performance is identical to the past.
In 1998 LNN had a market cap between $280 and $462mm. Since LLN's earnings are volatile we used the 5-year average free cash flow. In FY 1998 the 5-year average free cash flow was $15mm, and in FY 2013 the 5-year average was $30.4mm. So at the 52-week high LNN was selling for a P/FCF of 30x, and at the 52-week low the P/FCF was 20x.
Over this 15 year time span LNN would have returned 10% annually if purchased at the 52-week low or 5.7% annually at the 52-week high. At a market cap of $1.05B LNN is selling closer to a P/FCF of 30. So at a steady state an investor could expect a return of 5.7% over the next 15 years.
Now the question becomes how much faster will LNN grow over the next 15 years, and how certain are you that the growth will occur? I understand that Markets and Markets believes that micro irrigation will grow 17% annually by 2018, but Lindsay's main product is Zimmatic, which is a lateral pivot irrigation system. Also, I understand that international markets could result in a huge growth opportunity for LNN. However, international growth is difficult to quantify and is therefore speculative. According to Rick Parod, "Large international projects remain difficult to predict, due to the complexity of projects including government approvals and funding availability." (2013 Annual Report).
Finally, I understand that FCF has grown by 17% annually over the past 5 years, and if this growth is sustained LNN's intrinsic value would far exceed the steady state value. Nonetheless, according to the 2013 Annual report, "U.S. growth continued to be driven by positive farmer sentiment toward capital investments, and by strong farm incomes and balance sheets. In addition, the drought of 2012 led to high demand in 2013. According to U.S. Department of Agriculture forecasts, 2013 net farm income of $120.6 billion would be the highest on record and 63% above the 10-year average." The record growth that LNN has been experiencing for the past five years is due to circumstances that should not be expected to continue long term. Net farm income is expected to revert back towards the mean, and therefore on a pure investment basis the steady state value is the best predictor of future returns.
So what is the intrinsic value of Lindsay Corporation? Without any further information it seems as if the best guide to the intrinsic value is the steady state value, which would be about 20x P/FCF or $750mm. In light of this analysis it would be best to rethink your own model to ensure your own assumptions are not over-optimistic.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.