The weakness in the wider agricultural landscape has hurt the likes of Caterpillar (CAT), Deere (DE) and AGCO (AGCO). By now, it is apparent that smaller competitor Lindsay (NYSE:LNN) is not immune to the harsh operating conditions either.
There are few triggers visible on the short-term horizon while shares continue to trade at historically high levels. At the same time, revenues are going to be down for the second year in a row, something which makes me very cautious.
Soft Sales Results Amidst Irrigation Weakness
Lindsay posted second quarter revenues of $141.1 million, a 7.7% decline versus the year before. The decline in revenues does not come as a complete surprise after first quarter sales have been down on an annual basis as well.
The fall in sales is entirely due to weaker irrigation revenues which fell by 20.3% to $108.3 million. The weakness has been driven by the domestic irrigation operations which saw revenues fall by 27% to $68.0 million. This is despite a $3.5 million revenue contribution from the Elecsys acquisition.
The international, irrigation activities fared relatively well. While revenues fell by 6% to $40.3 million, the entire fall in sales has been the result of the strong dollar.
One bright spot has been the infrastructure segment which saw revenues increase by 94% to $32.8 million following the Golden Gate Bridge Road project and more demand for safety signs. Despite the shift away from irrigation to the infrastructure business, Lindsay still relies on irrigation for over 75% of total sales.
Margin Troubles
A bright spot has been the fact that gross margins actually expanded by 10 basis points to 28.0% of sales. Irrigation margins fell by three percentage points amidst sales deleverage and lower pricing power. Strong growth at the infrastructure business allowed for margin expansion in that area.
The trouble is that despite a 7.7% decline in sales, the actual operating costs continued to rise. Operating costs actually rose by 15.0%, thereby severely hurting operating margins which fell by 340 basis points to 10.3% of sales. The company attributes the higher costs partially to the acquisition of Elecsys, a million in integration expenses and higher employee health benefits.
These higher costs and lower margins have hurt the bottom line in a large way. Net earnings fell by a third to just $9.0 million as the fall in earnings per share has been limited, thanks to share repurchases.
The Valuation
Lindsay continues to operate with a very strong financial position. The company holds $167 million in cash and equivalents which provides a lot of liquidity. The company now runs the business with $117 million in debt following share repurchases as well as acquisitions. Despite these cash outflows, Lindsay net holds $50 million in cash.
The employment of leverage follows the $67 million acquisition of Elecsys and the fact that the company could borrow at cheap rates. The company's loan is due in 2030 while carrying a coupon of as little as 3.8%.
The 12 million shares which are outstanding following the share repurchase program value the business at $925 million, with shares trading at $77 per share. Subtracting the net cash holdings and operating assets are valued at $875 million.
Looking Ahead
There appear to be very little reasons for optimism following the report and the still difficult operating conditions. The backlog of Lindsay has fallen to $74.3 million by the end of the quarter. This marks a 17% drop compared to last year following the completion of the Golden Gate Bridge project.
One piece of good news has been the fact that the backlog has risen by 9% compared to the end of the first quarter. This increase is entirely due to the acquisition of Elecsys which added nearly $8 million to the backlog.
No specific guidance for the 2015 results have been given. Assuming an 8% decline in annual sales and revenues are seen at $570 million. Operating margins which have ranged between 10 and 15% of sales in recent years, are most likely to come in at the lower end of this range.
This implies that operating profits could come in at $55 to $60 million. Subtract from that $5 million in annual interest expenses and statutory tax rates, and net earnings come in around $30 to $35 million. At the midpoint of these calculated earnings, shares trade at a rich 27 times anticipated earnings for this year.
Other players in the field include of course, Deere and AGCO which are active in the agricultural market, although they focus on machinery rather than irrigation equipment. Deere which is facing a very difficult year has its equity trading at 16 to 17 times projected earnings. AGCO trades at similar or slightly higher levels as well, as Lindsay's shares have traditionally been awarded a higher valuation. Investors liked Lindsay in the past for its superior growth as well as excellent growth prospects for irrigation equipment.
Short-Term Struggles, Long-Term Potential
2015 is not going to be a good year for Lindsay after an already difficult 2014. The company posted record sales of $691 million in 2013, levels of which it can only dream now. Lower prices for soft commodities are hurting agricultural investments as farmer income is depressed across the globe.
Those peak margins of 15% are an illusion as well, with operating margins currently trending at 10% of sales. So while the situation is not that rosy, Lindsay remains quite profitable. The focus on the international irrigation activities and infrastructure should create improved diversification over time.
Currently, we are clearly at a soft point in the cycle and the timing of the recovery is anyone's guess. Assuming that $600 million in revenues would be realistic at an average point in the cycle, to be accompanied by margins of 12.5%, and operating profits of $75 million are possible.
This could result in earnings of $45 million on average through both the good and the bad years. Based on the current valuation of the operating assets at $875 million, the earnings multiple of 19 to 20 times is still rather high.
Final Thoughts
Lindsay is a fine operator as it simply has to deal with very difficult operating conditions at the current time. Despite the headwinds, the company remains profitable and continues to operate with a strong balance sheet. That said, acquisitions and share repurchases have hurt the net cash position of the firm, which remains very strong in either case.
The trouble is that Lindsay's shares continue to trade just 10% to 15% from their multi-year highs. This occurs at a time when sales have fallen by some 10% per year for two years in a row now. Of course, net earnings have fallen even more.
This makes that the risk-reward is not really improving at current times. While a swift recovery in the agricultural sector can result in further upside, the trouble is that shares are more than fairly valued based on "through-the-cycle" earnings. For now there are no immediate triggers in sight, as earnings and sales are still looking for a bottom.
