Verdant Outlook for Art's-Way Manufacturing

There may be “nothing new under the sun,” but many of the best investments over the past five years have been in renaissance sectors: energy, precious metals and agriculture come readily to mind.

Although Art's-Way Manufacturing Co. Inc. (Nasdaq: ARTW) isn’t the newest thing under the sun, it’s a company that's experiencing nothing short of a renaissance. The Armstrong, Iowa-based microcap, named for founder Arthur Luscombe, has existed since 1956, manufacturing and selling portable and stationary animal-feed processing equipment used to mill and mix feed grains into custom animal feed rations. Adjunct businesses include pressurized vessels and tanks and modular buildings for “animal containment and various laboratory uses.”

Farm-equipment manufacturing is notoriously cyclical, as are most businesses tethered to commodities. Art's-Way is affected by factors peculiar to the farm equipment field, including fluctuations in farm income resulting from changes in commodity prices, crop damage caused by weather and insects, and government farm programs, as well as general systematic factors like GDP growth and interest rates.

For the most part, these factors have been cycling to Art's-Way's favor. Interest rates have been cycling down over the past six months, thanks to the Federal Reserve's continual efforts to stimulate a droopy (though still growing) economy. Meanwhile, incomes have been cycling in the opposite direction. In February 2007, the U.S. Department of Agriculture pegged net-farm income for the year at $66.6 billion, up from $59 billion in 2006. By August 2007, the USDA raised its projection to a record $87.1 billion.

The pantry should continue to swell well into 2008. The Association of Equipment Manufacturers outlook survey expects 2008 net farm income to exceed 2007's record levels. Some 62% of respondents said net farm income would be up “modestly,” while 21% expected a “significant” increase. More of this income is expected to be spent on farm equipment. In a separate 2008 business trends survey of U.S. and Canadian agriculture-equipment dealers, Farm Equipment Magazine reported that 90% of the 500-plus respondents said they expected 2008 sales to be as good as or better than 2007 sales.

Art's-Way experienced a bumper-crop year for 2007. For the first nine months of fiscal 2007 (ended Aug. 31), the company reported consolidated revenue of $19.2 million, a 32% increase compared with $14.5 million in the same period a year earlier. Income sprouted even higher, to $1.87 million, or $0.94 a share, in the first nine months, compared with $605,500, or $0.31 a share, in the same 2006 period. A farmer's breakfast portion of the increase to the top and bottom lines was due to Art's-Way Scientific (modular buildings, in other words), which reported net sales of $4.7 million for the nine months. (Art's-Way Scientific was acquired in August 2006.)

Modular buildings are likely to contribute even more to Art's-Way's fortunes in 2008. Although residential real estate activity has softened, spending on private nonresidential construction during November 2007 was estimated at a seasonally adjusted annual rate of $375.8 billion, which tops the year-earlier level by 19.5%

Challenges do exist, though. The recent surge in hard commodity prices has pinched margins on many goods. Steel and copper saw the biggest gains. The result of these commodity increases has been higher prices, which customers have generally seemed to absorb as surcharges, though there is no guarantee they will continue to do so should the economy stagnate further.

That said, Art-Way's gross profit margin in 2007 increased to 31% from 28% in 2006. Sales and net income have grown more than accordingly, outpacing the average growth rates of competitors within the S&P 1500 Construction-Farm sub-index.

Monday's numbers are fully priced in Art's-Way stock, which is up nearly 350% in the past 12 months, and closed at $24.65 on Monday. The stock has ranged between $6.56 and $39.75 over the last 52 weeks. But what about the future numbers? It's no secret that small-cap stocks have sold off hard in the past month in response to recession fears and unending losses in subprime mortgage investments. Many issues have sold off too hard, though, and I think that's the case with Art's-Way, which is trading at a 38% discount to its 12-month high of $39 a share set in mid-December.

So what's changed? Nothing really. In fact, the macro-outlook for the farm-equipment sector looks as verdant as it did in December. Art's-Way's consolidated order backlog in the fourth quarter was $12.5 million, compared with $4.2 million a year earlier, which suggests Art's-Way (ARTW) investors might consider reassessing the behavior of those investors who sold on factors generally unrelated to the company’s business.

Disclosure: none