The Farming and Construction Machinery industry is one of the more solid industries in the public equities market. The industry is solid because machinery is more or less used on a continuous basis. It is difficult to find any particularly weak periods for this industry because the world is nearly expanding perpetually.
Whether this expansion is for the greater good of the earth is beside the point. On the other hand, during potentially economic weak periods, machinery stocks tend to underperform the market. Four stocks that illustrate this point are Caterpillar (NYSE:CAT), Deere (NYSE:DE), Agco Corporation (NYSE:AGCO), and Joy Global (JOYG).
To begin I will discuss each company with regards to the current share price and the 52 week highs in order to discern which company, or companies, have performed the best and which would be the best for a long term portfolio.
The first company I will present is Caterpillar. Caterpillar's stock faced the wolves after the July 22, 2011 earnings report. Not only did Caterpillar slightly miss expectations, but also the equity markets plummeted during the next few weeks. Because of this, Caterpillar's stock retreated roughly 26% over the next 12 trading sessions. This led the share price to the current level which is 35.2% below the 52 week high achieved on April 29th. This vastly underperforms the Dow Jones which has given back 14% over that same period.
Deere has underperformed the Dow Jones as well. Deere is off roughly 34% from the 52 week high. Unlike Caterpillar, Deere began the downward slide at the beginning of May. This made Deere's slide more pleasant for investors; if there is a positive regarding a 34% slide. Similarly, AGCO began a long 41% dip around the same time as Deere. This should not be surprising because AGCO and Deere are similar, just as Caterpillar and Joy Global. Joy Global began a 10 day 28% slide on July 25th; which was over a month prior to the company's August 31st earnings report. Joy Global's stock is currently 34% from the 52 week high.
As previously mentioned, all four equities underperformed the Dow Jones by at least 2.4 times. While these drops may have a lot to do with fear of economic weakness, it is important to view the financial results as well. The financial results and forecasts indicate whether each respective company is growing or slowing. A company's forecast is of particular importance because it is one of the main determinants of whether investors will buy or sell the particular security.
Caterpillar has seen an increase in sales over the past four quarters and this trend should continue. More importantly, Caterpillar has forecasted 2011 revenue to be within the range of $54-$56 billion versus consensus estimate of $57.95 billion. By forecasting below analyst expectations, investors feel the stock will be slowing down in the future and may face weakness in the coming months. We will find out around October 24th if this weakness is affecting the company.
It is very possible that Caterpillar will surpass analysts estimates and raise the forecast because thus far, after the first six months of the year, the company reported revenue of $27.18 billion. Therefore, if revenue increases roughly $1 billion over the final two quarters, Caterpillar will beat the street's expectations. This is important because with the stock depressed to the levels we see now, this situation could make Caterpillar a buy. On the other side of the coin, the possibilities of a global recession may negatively impact Caterpillar sales.
Deere & Company Earnings
AGCO's stock has declined the most from the 52 week high. This is due in part to two reasons. First the company is seen as Deere's smaller competitor that cannot keep pace. Secondly AGCO forecasted revenue for the year to be between $8.5-$8.7 billion and EPS at $4.00. Compared to estimates of $8.62 billion in revenue and $4.08 per share. These mixed numbers paint a more negative picture than a positive one. Also, according to the results from the first half of the year, it appears AGCO may fall short of the company's forecasted sales. Currently the company has earned $4.16 billion in total sales which means AGCO will need to pick up sales the second half of the year.
This may be hard to come by because the most recent manufacturing reports indicate slower growth than the first half of the year. One final important note to make regarding AGCO is the increased operating expenses compared to Caterpillar and Deere. According to fiscal year 2010, AGCO's operating expenses were roughly 95% of total revenue. This can be compared to Caterpillar which saw operating expenses drain 90% of total sales. I will get back to this point later, but this is one reason AGCO's stock has been unable to grow to the levels Caterpillar and Deere have.
The final company is Joy Global. Joy Global follows the same fiscal year as Deere which means the current fourth quarter ends in October. Joy Global's stock is 34.2% off the 52 week high. Joy Global has forecasted yearly revenue expectations of $4.3-$4.5 billion; which would be a 30% increase from 2010. This is a sign that the company is still in growth mode and is not slowing down anytime soon. Another positive sign is that Joy Global has the highest percent of revenue going towards income. While Joy Global produces the least amount of revenue, only about 78% is spent during operations. Therefore, as Joy Global expands we will see higher cash flows and net income for shareholders. With that said, it will be difficult to break the stranglehold that Caterpillar has on the machinery and mining equipment market.
Joy Global Earnings
There are two noticeable trends that need to be addressed that indicate how global weakness can effect each stock similarly. First, with regards to Caterpillar and AGCO, each company saw weak first quarter revenue as well as lower operating expenses. One difference is that Caterpillar was able to turn greater operating income and net income than expected, while AGCO produced lower operating income and net income than expected.
Secondly, Deere and Joy Global experienced a weak quarter during each company's fiscal first quarter. This time frame consists of November 1st through January 30th. Therefore, the most probable reason for this is the December holiday season that puts construction at a halt. These similarities are important to spot because it indicates the farming and machinery markets are weak at a particular time. In this case, the markets were not weak per se; the specific markets are simply not at work during the holidays. If the farming or machinery markets were weakening, it would be a sign for investors to sell.
By now you may have chosen your favorite from the above list, or even another company not listed such as Cummins (NYSE:CMI). Please note, I did not list Cummins for one main reason. While Cummins is a machinery manufacturer and producer, the truth is that the company is in the Diversified Machinery industry; not the Farming and Construction Machinery industry.
Nevertheless, as the economy slowly stumbles into 2012, according to the ISM Manufacturing Index, these four stocks may not see strong growth for quite some time. As I digress briefly, the ISM Manufacturing report for September was 100 basis points higher than August, but we are still 980 basis points below the February high. This should be concerning for farming and machinery investors because it represents the economy may be slowing.
With that said, I believe that all four stocks listed above have potential to bring returns to investors. Albeit some carry more risk than reward. Caterpillar is the largest company and the corresponding security is the most likely to post a big gain. However the risks outweigh the rewards regarding Caterpillar's stock. Since the company has a possibility of missing yearly street estimates investors should realize this is a sign of risk. The reward is high, but the risk even greater.
Comparatively, Deere has a much lower risk. Deere's stock has nearly the same reward as Caterpillar, but with the forecast already beating the Street's estimates, investors can sleep easier knowing the stock will not plummet due to an earnings miss. Keep in mind that during cycles of volatile equities markets as we have now, traders and full time investors need to worry about their long positions. With that said, Deere's stock is performing slightly better than Caterpillar by about 100 basis points; which indicates Deere will continue to outperform Caterpillar going forward. An important disclosure note is I do not believe Deere will outperform Caterpillar to an extent that requires switching positions in your portfolio.
AGCO might possibly carry the most risk with the least reward; which is why I consider AGCO a "dark horse" stock with plenty of speculative upside and very little speculative downside. This may sound like a contradiction, therefore I will elaborate.
First, AGCO's stock carries more risk than reward because the company's forecast is behind the Street's estimate with regards to EPS and only 0.9% above for revenue on the upper limit. Therefore, the stock may have this weakness already priced into it and a beat or increased forecast will give AGCO's stock plenty of room to run. However, AGCO's operating expenses are the highest percent of revenue of the four companies listed. Therefore, AGCO will continue to struggle to bring in higher returns of net income. This travels down the line to EPS and could explain a lack of a dividend from AGCO.
Lastly, Joy Global is picking up momentum in the mining market and with strong margins, may eventually bring in strong earnings per share. I must reiterate that Joy Global will have difficulties gaining market share from Caterpillar, but if the company can do so we may see Joy Global turn into a $50 billion a year company over the next decade. Also, Joy Global's stock has outperformed Caterpillar's as of late and it has performed even when compared with Deere. This indicates that investors anticipate the company will continue to produce strong earnings, just as Deere. This is important because momentum may carry the stock higher than the other three companies listed above.
Disclosure: I am long CAT.