AGCO: Combines May Be The Story in 2008

Sometimes Wall Street gets ahead of itself, and sometimes it doesn't. The current market looks as if the financials are making a huge turnaround and many commodity stocks are pulling back, even in the face of estimates being raised for
the year. I believe that we made a huge step with respect to write offs in financials, but most likely there will continue to be pain. Anyone that ventures into the unknown now had better have long term targets and /or be an expert in
trading, as the markets tip to the extreme on any comments either positive or negative.

I am unsure as to the gold market and other precious metals, and look somewhat positively on the current coal and steel markets, but most of all I believe that the
agricultural markets will continue to roll. Looking at their current run, many have taken the negative side based only on the belief that nothing goes up forever, but I have not seen anything that points to a slowing of agricultural commodities in
the near term.

Arguments can be made, and I am open to all of them, but the fact remains that overseas markets will pay a premium to get what is not already locked into contracts. I am currently long Potash (POT) and Monsanto (MON), and just recently sold Intrepid Potash (IPI) in favor of a position in Apple (AAPL). That was not done because I believe IPI is headed downward, I just was too heavily weighted in
the fertilizer realm.

I believe all of these stocks are good, but value investors may want to start thinking about companies such as Deere (DE), CNH Global (CNH) and AGCO (AG). These companies have all been hit hard by the construction bear market even though the current environment with respect to farming is robust. When looking at these stocks, the overseas growth numbers are astounding.

The strong currencies abroad and higher corn, soybean and wheat prices have made it affordable for many emerging markets to buy machinery that they would never have been able to afford. Looking at AGCO, its year over year numbers for the first quarter were very good. Net sales were up 34.1%. Gross profit
rose 43.7%. Adjusted operating income increased 106.8%. Adjusted operating margins were up 1.9% and adjust diluted EPS was up 142.3%. Tractor and combine production were up 25%. The company also increased its estimated 2008 production to 12%-14%.

To understand where the majority of these numbers are coming from we must first dissect the areas that are purchasing this machinery. If you want further information about this, check my writing on CNH. Tractor sales were down in the
first quarter in North America for AGCO as the industry saw sales fall 11%, but industry sales of combines were up 12%. AGCO's sales in South America were a different story. Tractor and combine demand were awesome as the only continent with the ability to make a major expansion of farmland is doing just that to help meet the needs of the food consumer. Industry tractor sales were up 45% and combined sales increased 77%.

I believe this is only the beginning, and the best way to substantiate this is to look at the last major agricultural expansion and the time it took to reach fruition after WWII. If this takes just half as long, we could see at least a couple more years, but I think this could continue well into the latter half of the next decade.

AGCO is extremely attractive from a regional standpoint as only 21% of its regional net sales come from North America. Europe, Africa and the Middle East accounted for 58%, while South America 18% and East Asia and Pacific 3%. Year over year
sales increased, but margins continued to improve also. Adjusted operating margins improved from 3.4% to 5.3% showing wide range demand. Since the first quarter of 2006, AGCO has continued to decrease its net debt to capital. At that time debt was $896 million or 36% (debt to capital), and now is down to $719 million in debt or half (debt to capital) of 18%.

Continued success has led AGCO to provide 2008 guidance of 20% to 22% sales growth, diluted EPS of $3 to $3.15, and free cash flow of $175-$200 million.
AGCO is a little more expensive than DE and CNH, but I think it is warranted based on a larger exposure to agriculture on a percentage basis. It is also smaller and more mobile than its competitors. The company has done well with respect to
earnings as it beat estimates for the last four quarters, as high as by 156.7% and no lower than 26.4%. It seems as other players cannot get the machines made fast enough, the company is able to pick up the proverbial slack, and increase market share as a result.

The current PE of 18 is very cheap as analyst estimates are for growth of 35.3% this year and 25.2% next year. I also believe that growth over the next five years will be closer to 20% based on technology growth in emerging markets including GPS operated machinery. Dont get me wrong, I like all three companies with respect to stock price, but prefer AGCO over DE and CNH for the growth investor.

Disclosure: Long POT, MON

Comments

[bear_mkt:]

Good article. AG is the proverbial "Rodney Dangerfield" of the farm equipment sector. It "gets no respect." Big brother DE, with its big US presence, seems to get the good press play.

I like AG for a several reasons. AG's got good international diversification. AG's more of a pure play on farm equipment. I see a lot of DE logos on construction equipment around here. Construction will be weak for a while. Advantage, AG.

Even with recent price swings, grain prices will likely remain above prior years level, giving farmers plenty of incentives, and cash, to buy equipment. IMHO, AG's a good place to be in the farm sector. As with any ag-stock, the ride will be bumpy.

2008 Jul 22 10:04 AM

[Pawel Kaczm...:]

I am bullish on AG from an average cost basis of about $52.

I see AG as an incredible margin expansion story. DE is the "AAPL" of the agricultural business but AGCO has so much potential to keep increasing its margins, earning multiples more EPS vs. sales growth.

2008 Jul 22 12:02 PM

[khovsgol:]

looks like good sound analysis, michael. i found this while looking to buy de. taking some of that gold from underneath my mattress to buy something in agriculture. but i instead bought some ag based on your perspective. this is the highest complement i can give to a finance writer. keep it up.

2008 Jul 23 01:32 PM

[Andy Cole:]

Anyone that buys anything based upon what this guy says is risking nearly everything, literally! Check out his portfolio performance and other stuff here:

www.updown.com/display...

Shocking! If past performance is indicative of what the future holds, just trade the stock the opposite of what Filloon reccomends and you'll be rich.

Seeking Alpha needs to take note!

2008 Jul 25 11:03 AM

[bear_mkt:]

Hey Andy, thanks for the link to the author's portfolio performance, but lighten up. Its just his opinion.

Nobody should buy anything based on a Seeking Alpha post (or a Barrons, Cramer, WSJ, Forbes, Merrill, Goldman or other report/ recommendation) or a gushy press release from corporate management, without doing his/her own due diligence. However, all these sources are good places to pick up ideas to research. Just my opinion.

2008 Jul 26 02:00 PM

[thurx:]

All these companies are dropping because they have to start thinking of liquidation and funds are leaving them. Sell the rallies. They will continue to look attractive as longs if you try to price them as other "growth" companies. But their growth is to be short lived. Maybe they have another year. The price of oil is going to put these companies out of business. Not overnight. Not in 5 years. But their earnings are topping soon. Right now I can't think of better shorts, except fossil fuel burning equipment makers who are LESS involved with agricultural equipment and mining equipment, such as MTW.

2008 Aug 26 02:07 PM