AGCO Corporation - Neeley School of Business

AGCO Corporation
Analyst: Andrew Patten
February 8th, 2012
Recommendation:
Hold
Pros:
•
Ticker
Exchange
Industry
Sector
Classification
Market Cap.
52 Week Price Range
Recent Price
Current P/E
Projected 2015 P/E
Projected 2015 EPS
Dividend Yield
Debt Rating
Beta
AGCO
NYSE
Industrials
Farm Machinery
Appreciation and
Income (low yield)
$5.29B
$38.09 - $54.66
$54.44
10.27 TTM
12x
$6.50
.70%
BBB1.91
•
•
•
Exposure to tremendous long term upside as
emerging markets move towards industrialization
Improving operating margins
Lean balance sheet with low financial leverage
Increasing global crop demand, growing global
population, move towards protein diet
Cons:
•
•
Volatile performance determined by commodity
prices
Gradually losing South American market share via
Deere’s unsustainable price penetration strategy
Porter’s Five Forces
•
•
•
•
•
Threat of Competition: - High
Threat of New Entrants: - Medium
Threat of Substitutes: - Low
Power of Suppliers: - Low
Power of Buyers: - Medium
Brief Overview
AGCO Corporation manufactures and distributes agricultural
equipment and related replacement parts worldwide. The company
offers tractors comprising high horsepower tractors that are used on
larger farms and cattle ranches for hay production; compact tractors for
small farms. Additionally, the company offers grain storage bins and
related drying and handling equipment systems, and swine and poultry
feed storage and delivery, ventilation, and watering systems; produces
diesel engines, gears, and generating sets; precision farming
technologies; and other technology precision farming products. AGCO
Corporation markets its products under the Massey Ferguson,
Challenger, Valtra, AGCO, Fella, Fendt, and Dafeng brands through a
network of independent dealers and distributors. AGCO Corporation
was founded in 1990 and is headquartered in Duluth, Georgia.
1
Portfolio Considerations
Ticker
AGCO
CBI
UPS
Purchase
Date
2/27/2012
11/9/2012
3/31/2010
Cost
Per Share
$51.74
$37.40
$74.08
Holding Cost
Basis
$20,697.20
$25,058.00
$28,520.80
Current
Price
$54.44
$51.86
$82.38
Equity Holding Period
Total Return (%)
4.97%
39.27%
38.72%
Equity YTD
Appreciation Return
(%)
26.69%
37.20%
12.56%
EIF YTD EARNED
RETURN (%)
4.97%
39.27%
16.02%
S&P 500 Holding
Period Return
13.38%
10.64%
37.92%
The EIF currently holds three equities in the industrial sector as a result of a Fall 2012 sell-off of
Union Pacific Railroad (UNP) and a Fall 2012 acquisition of Chicago Bridge and Iron (CBI). The
three industrial equities are logistic-minded UPS, construction and engineering oriented CBI and
Agco Corp, henceforth notated as “AGCO” or “The Company. The three holdings are mildly
correlated, with CBI and AGCO at 60% correlation. Qualitatively however, the focus of all three
firms is well differentiated: AGCO is a pure agriculture and emerging market play, UPS is logistic
based transportation, and CBI constructs energy infrastructure projects.
The fund originally purchased AGCO on February 27th, 2012; currently of just shy of a one year
holding period. The reasoning behind acquiring AGCO was that it would capitally appreciate due to
strong margins in Europe and South America, a positive pricing environment, healthy agricultural
demand and potential for North American growth.
The EIF holds 400 shares of AGCO and commands a holding period return of roughly +5%, 326bp
lower than the industrial sector spider and 560bp lower than the S&P 500.
2
Industry Analysis
How to Think About the Industry 1
The agricultural machinery manufacturing industry is intuitively straightforward, however highly
cyclical. Industry wide, the investment thesis relies on global population growth and accompanied
food demand. Performance can be traced to a few macroeconomic drivers:
1. Strength of the US dollar
a. Determines attractiveness of importing US goods into foreign markets
2. Demand from crop production
a. Determines farmer income and likeliness of equipment purchases
3. World price of steel
a. Determines input prices of equipment
4. Access to credit
a. Determines ability for the customer to finance a purchase
5. Government subsidization
a. Determines farmer income through direct government payments
The end market of agricultural equipment manufacturing is the farmer. A tractor is a heavy
investment for any famer and will only be purchased if the farmer currently has excess capital, can
get easy access to capital. The farmer’s income, and his likeliness to purchase a tractor, is directly
related to how many crops he sells. This is where the industry becomes difficult to forecast; drought
and other natural factors can have a large impact on crop production.
Industry Saturation
The industry has 1,042 companies currently operating and the top two (John Deere and CNH)
account for 55.8% of all revenue. AGCO is the 3rd largest corporation, with 3.9% market share
compared to DE’s 44.2% and CNH’s 11.6%.
1
IBIS World
3
Brief Historical Performance 2
The industry has experienced large volatility in the last five years. Three distinct periods comprise
recent history:
1. Booming growth period: high food prices, increased corn demand derived from ethanol.
2. 2008 recession: tight credit, volatile commodity prices, weak international demand.
3. Recovery: Global demand rising from troughs, cheap credit. Current stage.
Revenue Growth vs. Demand from Crop Production
12
30
10
25
8
20
6
15
4
2
10
0
-10
2015
2014
2013
2012
2011
2010
2009
2008
-5
2007
0
2006
5
-2
-4
-6
-8
Demand From Crop
Production
Revenue Growth
Linear (Demand
From Crop
Production)
Linear (Demand
From Crop
Production)
Shows how revenue growth is related to crop demand.
Critical Industry Issues 3
Global Environment
Population growth and crop demand
As a whole, 1/3 of the industry’s revenue (AGCO is ¾ international revenue) is attributable to
international exports. The industry will see a tailwind to growth as the global economic
environment begins to improve. International revenue growth will further be driven by the
industrialization and population expansion of emerging markets. As countries and areas become
more populated, the demand for food will increase, propping crop prices and increasing farmer
income.
Dollar Strength
As the dollar decreases in strength (from an international perspective) it
becomes easier to afford American made goods. The included picture
is the trade-weighted index. It is a weighted average of dollar exchange
rates with foreign currencies. As the index decreases, American goods
become more affordable. IBIS world expects a mild six year netincrease in the strength of the dollar, making exports less attractive.
2
3
Ibid.
Ibid.
4
World Price of Steel
Steel is the main component of agricultural machinery manufacturing and accounts for a large
portion of COGS. Specifically, steel costs are 60% of industry revenue. Steel is expected to grow at
a moderate pace, after double digit growth in the last 5 years. If China experiences a material
increases in industrialization, steel prices may increase more than expected.
American Farming Environment
Crops are a commodity. Farmers can’t control the pricing environment. Further, there are many
unknowns in farming: weather, government subsidies, changing commodity prices. Because of the
many unknowns, farmers are seeking profitability through efficiency. This is materialized twofold.
Firstly being increased corporatization. There is a movement from small family owned and operated
farms to massive corporately operated farms. Secondly, farmers are seeking increased productivity.
For instance, in America, the arable land is already developed; healthy land is very expensive and
landmass is stagnant. Farmers are looking to squeeze every bit of productivity out of current land.
Farmers are demanding technologically advanced, larger horsepower tractors. This is an attractive
prospect for ag. equipment manufactures, as these tractors offer a higher margin.
Further, these increasingly corporatized farms will have larger buying potential and will go to
equipment wholesalers to purchase their tractors. Equipment wholesalers will generate demand
from the industry as they will have to keep more efficient and updated machinery in stock.
Current Industry Profitability Trends
The industry can only hit a few levers to increase profitability. Keep in mind that steel input prices
(60% of revenue) are determined by the market and while price fluctuations can be hedged, they are
effectively out of management’s control. Management must look to increase profitability through
labor cost, which has decreased for last 5 years and currently 8.8% of revenue. The industry is
devoting cap-ex to increase automation which will combat rising labor costs. Because of this
automation, industry labor has fallen at a yearly rate of 2.9%. Labor costs are only expected to fall
2.7% (20 bp lower than the labor reduction), suggesting that
higher skilled technicians are demanding premium to work.
Labor is also being outsourced to low cost environments like
China.
Long term, profitability may be troublesome. The industry
can increase capacity to reduce the fixed cost per unit and
increase automation to reduce labor expenses. Both actions
seem to be easily replicable, providing a short term tailwind
relative to competitors, and appear to only offer marginal
benefits. That said, at $11billion in revenues (AGCO), even a
percent reduction in cost is material.
This industry is also contracting in number of businesses. To
increase capacity, a firm can either build a new plant or acquire
an existing one. There are 1,024 businesses in this industry
and that number is falling 4% annually. AGCO has
historically driven growth through acquisitions, with its largest
5
in the Fall of 2011, but currently does not have any in the pipeline. AGCO’s CEO stated, “There
are not too many targets available.” Expansion wise, this opens the door for buying partial stake in
an existing company or building a plant themselves.
Industry Health
This is a mature industry. The number of businesses is contracting. Product innovation does occur
but it is mostly focused on improving existing products (ex: GPS guided tractors and low fuel
emission tractors) rather than inventing new ones. IBIS World reports that this industry has a very
low percentage growth in share of the national economy. This is an important distinction to make.
Yes, the industry is mature and the North American market is supersaturated, but there are large
growth opportunities in emerging markets. Those will be discussed in Company Overview.
Products 4
The most important item to notate is the number of product offerings and their weight relative to
total revenue. There are four distinct categories of equipment and replacement parts:
1. Harvesting machinery 24.2%
a. Combines. They’re self-propelled machines that reap crops.
2. Parts sold separately 22.3%
a. Replacement parts. Include parts for machinery no longer being produced.
i. Generally highest gross margin
ii. Most machinery can be maintained for 10-20 years before maintenance cost
is greater than replacement cost.
3. Tractors, other ag. machinery, and attachments 19.5%
a. Commonly thought of ag. machine. Versatile. Varying sizes and horsepower.
Estimated that every US farm has at least one tractor.
4. Haying Machinery and attachments 12.3%
4
Ibid.
6
a. Used to cut and package hay crops for livestock feed.
5. Planting, seeding and fertilizing machinery and attachments 12.1%
a. Self-explanatory. Create rows in the soil, drop seeds in soil, then fertilize the soil.
6. Farm Dairy Equipment, dusters, blowers 9.6%
a. Dairy equipment is used to pump and store milk. Dusters and blowers apply
fertilizers and pesticides to the fields.
Markets
Downstream demand can be traced to five components. If not an export, the markets are
considered American:
1. Exports 32.2%
a. Highest portion of revenue. Increasing.
2. Commercial farms 25.7%
a. Sensitive to crop fluctuations, weather and government subsidies.
3. Machinery wholesalers 21%
a. Sensitive to credit availability. Purchases from the manufacturer to sell to end users.
Retail and household markets.
4. Rental companies 14%
a. Sensitive to credit availability. Tight credit will increase rental company demand as
farmers find it cheaper to rent rather than finance a purchase.
5. Hobby farmers and construction contractors 7.1%
a. Tractors for earthworks and infrastructural improvements. Small tractors residential
tractors.
7
Porter’s Five Forces
Threat of Competition: High
There are 3 major players, with John Deere commanding the largest portion of market share.
Industry leaders compete on product quality. Brand value is very important. A tractor is a 10-20
year investment; farmers must have a reliable product.
A pricing war is currently occurring in Brazil. John Deere is using price penetration to wrestle
market share from AGCO. AGCO CEO responded with, “we could reduce our tractor prices by
15% in America. It wouldn’t kill us…but it would be a big problem for Deere.” 5 He has not
followed up on this threat.
Threat of New Entrants: Medium
Government regulation or licensing is not required to enter the industry. The big limitation is the
capital requirements associated with building/buying a plant and the research and development costs
of designing a tractor.
Once established, the new company would have to compete with valuable brands, start supplier
relationships, and start distributor relationships.
Threat of Substitutes: Low
There isn’t a substitute for agricultural equipment nor is an acceptable alternative under production.
Power of Suppliers: Low
Steel is the main supply input and its price is determined by the market. Suppliers are unable to
dictate prices.
Power of Buyers: Medium
Traditional farmers used to only purchase one tractor at time, but recently the farming industry is
moving towards corporatization. This larger scale gives farmers more buying power. They are able
to negotiate down prices on bulk orders.
5
Deere Starts a Very Interesting Price War
8
Company Overview
Company Description
AGCO was established in 1990 with the purchase of Deutz Allis Corporation from German-based
KHD. 6 Originally Allis-Gleaner Corporation, AGCO is a leading global manufacturer of agricultural
equipment based in Duluth, Georgia. AGCO offers a full line of tractors, combines, hay tools,
sprayers, forage and tillage equipment, which are distributed through more than 3,100 independent
dealers in more than 140 counties. 7
Acquisitions
AGCO has historically grown through acquisitions. Notable acquisitions include the worldwide
holdings of Massey Ferguson in 1994, Fendt acquisition in 1997, Challenger acquisition in 2002,
Valtra in 2004, and GSI in 2011. In 2006 the Company announced a shift in strategy, focusing on
internal product development and implementation of acquired brands. AGCO is currently focusing
on integrating its currently held products into emerging markets like Brazil and China.
Brands
Brand equity is a very important factor when purchasing a tractor. Purchasing a tractor is a large
capital investment for customers and they expect to operate it for 10-20 years, so customers heavily
value quality brands. 8 AGCO operates under four brands: Challenger, Fendt, Massey Ferguson, and
Valtra.
Challenger
• Acquired in 2002 from Caterpillar. Still branded with CAT. Both tracked (think a tank) and
wheeled tractors.
• North American Market. High horsepower. In 2007, a Challenger model broke the world
record for most land tilled in 24 hours. 9
Fendt
• High tech tractors and combine in Europe. Known for innovation and technology. Helps
maximize farming productivity in smaller European farms.
About AGCO via company website
AGCO 2011 10k
8 IBIS World
9 “Maximum width disc harrow: XXL”
6
7
9
Massey Ferguson
• Global brand that is found in: the Americas, Europe, Africa and Asia.
• Known to be easy to use, dependable, and environmentally conscious.
• Currently being produced in the Changzou, China facility. Soon to be produced in Africa.
Valtra
• Sold in Europe and South America.
• Modular tractors that can be customized for many functions.
• Known for customization and Scandinavian design and engineering.
AGCO’s brands are competing with the John Deere brand which was listed in 100 Best Global
Brands 2011. 10 However, AGCO brands are regarded as better in certain markets. AGCO has the
best brand image in South America. 11
Product Segments
AGCO revenue composition is unique when compared to its competitors. In 2011, tractors
comprised 66% of AGCO’s revenue, replacement parts accounted for 15%, combines for 7%,
application equipment for 4%, and other for 8%. This revenue distribution is in sharp contrast to
the industry average found on page 6 of this report.
4%
7%
AGCO Revenue
by product segment
8%
15%
Tractors
Replacement Parts
66%
Combines
Application Equipment
Other
According to IBIS World, tractor sales growth is expected to remain constant amongst other
fluctuating product segment growth.
GSI and Dividend Declaration
In November 2011, AGCO completed its largest acquisition, purchasing GSI
holdings for $932 million. GSI manufacturers grain storage systems (grain silos).
This acquisition helped diversify the revenue stream and added a higher margin
business. The below bar chart describes geographical revenue from GSI.
10
11
John Deere New and Media
Dow Jones Newswires
10
Management is looking to integrate GSI’s higher margin
business into its European, South American and Asian
markets. This is a definite growth opportunity for the
company.
GSI sales grew ~3% in 2012 and increased EPS by $0.38.
Management noted that GSI’s large cash flow directly
contributed to the 2012 dividend declaration. The yearly
dividend is $0.4/share or a .07% dividend yield.
Global Sales
Future Global Outlook 1213
Population growth is set to be on of the defining issues of the 21st century. From
today’s level of 7 billion, the world population is expected to hit 9 billion by 2050.
Population growth is expected to be fueled by emerging markets. Crop yields must
significantly increase to feed the soon crowded world.
12
13
United States Department of Agriculture
World Resources SimCenter
11
To help conceptualize international food production, look at the following heat maps
on global crop production for corn and wheat. North America, South America,
China, India, Russia, Europe, and portions of Africa are currently regions of strong
crop production.
Total Revenue by Region14
AGCO has a strong international focus. In 2012, 26% of revenue was derived from
North American markets, 51% from Europe, Africa and the Middle East, 18.6% from
South America and 4.6% from Asia and the Pacific.
Revenue by Geography
4%
19%
26%
North America
EAME
South America
51%
APAC
There are two important advantages of international diversification. Firstly, a
diversified revenue stream helps to reduce weather related risk. If AGCO only sold to
14
AGCO 4Q 2012 Earnings Release
12
a single area, a drought in that area would do dramatic damage to earnings. Secondly,
AGCO is investing into international markets that are still using inefficient farming
methods. As these markets industrialize, they will purchase advanced machinery.
North America
• 25% of revenue. Generally saturated market. Every farmer has at least one
tractor. Consumers want technologically advanced, high horsepower machines.
• Drought conditions hurt equipment makers in recent months. 62% of U.S.
farms experienced drought in mid-July of 2012. This resulted in a commodity
prices increase but supply level decrease, ultimately netting a reduction in
farming income.15
• Upside is that commodity prices have increased (good for farmers) and
extensive crop insurance payments will boost farmer spending.
• The drought especially impacted earnings for the GSI segment, a recent grain
storage acquisition.
Europe
• Majority of revenue with 51% in 2012.
• Recently suffered from general economic malaise associated with Euro debt
uncertainties. Most of that negative sentiment is expecting to improve.
• Bi-modal tractor market. Meaning, sales are very strong in Germany and
Western Europe but weaker in Eastern Europe.
• Suffering from lingering startup costs from new Fendt plant in Germany.
Analysts are expecting to see weaker Q1 2013 as a result.16
15
16
Stand and Poor’s 2/5/2013 AGCO report
Wells Fargo Equity Research
13
South America
• High growth market. Demand is increasing due to elevated crop sales and
government financing subsidies.
• Currently market leader in tractor sales with 41%.
• Current issues with John Deere “price war”. Since AGCO was last reviewed,
there hasn’t been any material or dramatic response. In 4Q 2012 conference
call, management said they “were participating with the [Brazilian] market.” To
me this means they’re accepting John Deere’s penetrative pricing.
• The following shows historical trends in the Brazilian tractor market. CNH remains
rather flat. Deere’s price penetration strategy can be seen at the start of 2011. 17
17
Wells Fargo Equity Research
14
• The big questions are a) does this trend continue and b) for how long?
o Long term I don’t imagine Deere will continue to sacrifice margin for market
share. Price penetration is not a sustainable tactic.
Asia and Pacific
• Smallest percentage of revenue at 4.5% but rapidly growing. In 2012, increased
revenue to $448mm from $289mm, a 55% y/y growth rate.
• Ag industry comprises 10% of China’s GDP but employs 38% of China’s
workforce. As China looks to release workforce to other sectors, AGCO will
offer efficiency in farming.18
• Currently building a plant in Changzou, China. $300mm investment.
o Expecting growth in domestic Chinese market which will fuel equipment
demand
o Comparatively low labor cost to manufacture. Will export to other
countries. Expecting material export of 30,000 tractors a year.
Understanding Global Farming Efficiencies and Tractor Saturation
It theoretically makes sense that emerging markets are technologically behind the
“developed” world in farming practices. However the extent of technological lag is
very large and unexpected. This graph shows tractor saturation by region. Canada
has 1.8 tractors per farmer,
America has 1.5. However, the
BRICs are incredibly
undersupplied in tractors with
China at .0003 tractors for every
farmer. There is massive room for
growth in the coming years as the
BRICs, and eventually Africa,
become industrialized. Further,
AGCO has the potential to
integrate its grain storage business,
GSI, in these emerging markets.
Grain storage’s niche market will
help differentiate AGCO from
Deere.
18
The Case for Changzhou
15
Forward Strategy
In the face of steep competition, AGCO is looking to differentiate its product offerings through
R&D that will focus on technological advancement. Further, it will integrate its GSI business into
non-North American markets.
AGCO currently has no intention to acquire another company. Instead, it is spending to increase
capacity in China and European markets. 19
The company is taking steps to increase margins through labor cost reductions. Management’s goal
is to have 10% operating margin by 2015. 20
Management is investing $100mm plant in Africa. They are taking over what was a state owned
manufacturer. While the continent’s infrastructure is just now being built 21, Africa is expected to
double in population growth in 30 years. The continent commands 60% of the Earth’s arable
reserves and only 20% of that is farmed today. 22 AGCO will be the first Western Ag. company to
manufacture in Africa. AGCO’s director for Africa and Middle East said, “The only frontier left for
arable land is Africa. We are in for the long-term in Africa. We’re coming here for 100 years and
more.” Analysts expect returns from the continent won’t exceed 10% in the next 5 years due to
region’s underdeveloped infrastructure.
Recent Performance
AGCO vs. Competitors (DE and CNH)
AGCO vs. S&P 500
Bloomberg
AGCO 2011 10K
21 Seeking Alpha
22 CNBC: Squawk Box
19
20
16
Conclusion and Recommendation
The real benefit in holding this equity is AGCO’s strategy: get first mover advantage into markets
that are going to explode in growth. The emerging markets offer tremendous long term upside.
Ultimately, AGCO has excellent placement in growth markets and through cost management, will
increase see higher operating margins.
However there are several downsides to consider. The beta is 1.9. This industry is highly cyclical,
fluctuating because of unpredictable commodity prices. AGCO is a distant third in global market
share and is seven times smaller than Deere. The recent Brazilian price war and specifically
AGCO’s lack of response to Deere’s price cutting is worrisome, but perhaps this is just a short-term,
desperate move.
The investment thesis has not changed since the EIF’s purchase. To see long term benefits, I
recommend a hold.
Hold
Analyst Ratings
Buy
Hold
Underperform
Sell
Average Rating
Last
2 Months
3 Months
Current Month
Ago
Ago
6
6
6
6
9
9
10
10
0
1
1
1
0
0
0
0
2.2
2.31
2.35
2.35
17
Ratio Analysis
Assumptions
Revenue:
I grew the revenue at a 4% rate in 2012, in-line with management’s 3-4% growth guidelines. This
growth in revenue is mainly due to a positive overseas pricing environment. I increased revenue
growth to 7% to account for a non-drought effected environment and increased revenues as AGCO
implements GSI’s grain storage into international markets.
18
COGS:
I maintained the current trend in the yearly reduction cost of goods sold. This reduction continues
into to 2015 to reflect management’s commitment to reduce labor expense through automation.
R&D:
I’ve maintained the very flat 2-3% year expense. Management has not indicated a change in this line
item.
Market Risk Premium:
I used the 80-year historical average difference in stock returns above the 30-year Treasury Bond
rate: 5.7%.
Risk free rate
I used the 10 year Treasury Bond rate as it closed on Friday, 2/8/13.
Dividend:
Management just announced a dividend this quarter. Because there was a lack of historical data to
project a dividend increase, I used a modest growth rate.
Beta:
I used the average beta of 1.91 from my regression.
P/E multiples:
I considered analyst suggested PE multiples but ultimately put weight into the past average multiples
to smooth out what is typically a historically volatile PE. I have large growth expectations for
AGCO and wanted to reflect that in this figure.
19
Sources
IBIS World
“Deere Starts a Very Interesting Price War” article
About AGCO via company website
AGCO 2011 10k
IBIS World
“Maximum width disc harrow: XXL”
John Deere News and Media
Dow Jones Newswires
United States Department of Agriculture
World Resources SimCenter
AGCO 4Q 2012 Earnings Release
Stand and Poor’s 2/5/2013 AGCO report
Wells Fargo Equity Research
“The Case for Changzhou”
Bloomberg
Seeking Alpha
CNBC: Squawk Box
Recent News
AGCO Corp. Significantly Undervalued At 9.5X Earnings With Major Growth Prospects
-SeekingAlpha
AGCO Corporation (AGCO) is a focused play on the rapid growth in food demand (particularly
proteins) and an increase in the sophistication of farming methods in China and Africa. This
macro trend is generally well understood by investors, but the valuation of AGCO's shares does
not appear to reflect the company's superior long-term positioning as the leader in frontier
markets. At about 9 times 2013's estimated GAAP EPS of $5.50-5.75, AGCO shares are a highly
inexpensive way to gain exposure to the developing world's agricultural boom.
Business Introduction
In 2011, AGCO generated about two-thirds of its sales from tractors, 15% from parts, and the
remainder from combines, hay and forage, and other agriculture-related products. With such a
heavy reliance on tractors, AGCO purchased GSI Holdings in November, 2011 for $932 million
to diversify its business and transition into a one-stop-shop for "agricultural solutions." GSI
generates nearly two-thirds of its $700 million in annual revenues from grain-storage products,
and the rest from products related to protein production.
20
The acquisition of GSI, which added $.38 to EPS in 2012, appears to have been well-timed and
intelligent. Though GSI has a presence in frontier markets like Africa and rapidly developing
ones in the Asian-Pacific region, the bulk of its sales are derived from North America, where
AGCO competes fiercely with Deere (DE) for tractor sales. The GSI acquisition gives AGCO
more of a niche presence in the region, while producing easily seen synergies in less developed
areas of the world.
GSI has been able to gain significant market share in AGCO's main regions under the AGCO
name. Though 2012 North American GSI sales fell about 10% due to the record-setting drought,
sales in Europe and the aforementioned markets were up about 20%.
Competition
AGCO competes primarily with Deere and CNH Global (CNH). Of course, Deere is heavily
involved in the forestry and construction businesses, while CNH derives about 20% of its sales
from construction. AGCO truly is the only major pure play on agriculture. All three companies
have similar outlooks and top-line forecasts for their agricultural businesses in 2013. I believe
they can coexist profitably, but as always, the lowest-cost producer will lead the pack.
AGCO's management believes it is well-positioned to take advantage of the necessary and
inevitable growth in the sophistication of farming practices in the developing world, which leads
us into the long-term catalysts.
Catalysts
Population growth & Food Consumption: This is generally a well-understood macro trend, but
its significance and strength is overwhelming and oftentimes understated. Population growth on
the African continent is set to explode over the next several decades, and we'll continue to see
significant growth in protein and grains consumption in Asia. Despite China's rapid economic
growth over the past decade, farming practices are still well behind those of the Western World
(Source: AGCO CEO Analyst Briefing):
(click to enlarge)
I found these figures to be a bit surprising, and they speak volumes about global growth
opportunities. Though the infrastructure is essentially just beginning to be constructed in Africa,
now is the time to invest in the opportunity. John Deere is making similar investments in Africa,
but I like the specific upside in the proteins and grain storage businesses that GSI runs. This is
the "tail" in the AGCO investment thesis; while not a near-term catalyst, longer-term investors
should enjoy this dynamic for years to come.
Margin Growth: GSI's business is a higher margin business with annual operating margins
generally close to 15%. Outside of GSI, AGCO has several initiatives underway to cut costs
while simultaneously growing sales.
21
The company recently completed a $220 million project in Marktoberdorf, Germany, which will
enable it to increase its productive capacity of the Fendt line of agricultural equipment.
AGCO is aggressively beginning to source some of its production in China, where basic
production costs are lower and domestic growth expectations are strong. The Centurion project,
which remodels and expands some of the company's product lines, is expected to produce
between $60 and $80 million in annual income. The Centurion factory in Changzhou, China
should be completed by 2014.
AGCO is aiming for a ~10% adjusted operating margin by 2015 (compared to ~8% currently),
which has the potential to add more than $1 billion to net income over that timeframe.
Increased FCF & Subsequent Shareholder Friendly Practices
Laying the groundwork for success in less developed markets is expensive: R&D spending has
had to increase substantially over the past few years, and longer-term cost-cutting initiatives like
the Centurion project and Marktoberdorf factory have led to higher CAPEX costs.
That said, the extensive and necessary investments that are being made today are expected to
peak in 2014 at about $425 million before falling to less than $350 million by 2016. This change
will have a transformative impact on free cash flow, which should enable management to start
paying a larger dividend (recently initiated at .80% yield) and buying back stock.
Sales & EPS Growth
North American sales were up 19.8% if you back out currency translations and the huge benefit
from the GSI acquisition, quite a feat considering difficult circumstances as a result of the
drought. SA sales were up 10.3%, EAME sales increased 9.%, while APAC sales jumped 65.9%.
AGCO expects record farm income and continued economic growth to increase annual sales to
$10.2-$10.4 billion in 2013, while cost-cutting should add around 75 basis points to the
operating margin. 2013 EPS guidance is $5.10-$5.35, compared to FY 2012 results of $5.25.
This new guidance, which is down from $5.50-$5.75, includes the recognition of $.40 worth of
its deferred tax assets.
Valuation
At about 9.5X times the original guidance and excellent prospects for its bottom line, AGCO is
the cheapest AG play.
Although AGCO is calling for only 2-4% revenue growth in 2013, normalized crop conditions
will be very beneficial for its GSI grains storage business, and the company's APAC and South
American businesses have tremendous upside.
By 2015, the company should be able to generate an operating margin of about 10%. Though
2013 results will have difficult comparisons, 6-8% annual sales growth seems plausible in 2014
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and 2015 as GSI works its way into new markets under the AGCO name, farm income continues
to break record highs, and markets like South America (particularly Brazil) continue to become
more sophisticated. 6-8% sales growth is in-line with AGCO's historical growth.
This projection would result in about $11.9 billion in year-end 2015 sales. If AGCO can operate
at a 10% margin, we're looking at $1.19 billion in net income, or $12.23 per share. Slap a
multiple of 10 on the company and you've got yourself a 100% return in three years.
The key here is clearly the margins. AGCO trades at only about half its massive revenues of
$100 per share. Even slight changes in operating margins can have transformative impacts on the
bottom line.
Recent, aforementioned investments in Germany, China, and specific tractor lines have laid the
groundwork for this cost-cutting, and margins have already begun to improve. Q4 2012
operating margins in North America were up 120 bps and South America saw an operating
margin of 10%.
Conclusions
The current price to earnings multiple of about 9.5 doesn't adequately discount AGCO's growth
outlook and unique positioning as a one stop show for agricultural services.
I concur with the company's presentation of itself as a play on the modernization of farming
practices in many developing regions, and its acquisition of GSI diversified the company's sales
and made its overall product portfolio more unique.
With only $1 billion in net debt compared to net income of more than $500 million, the balance
sheet is lean despite significant recent expenditures.
It's a competitive industry, but AGCO appears to have a unique position in less developed
markets. Generous macro tailwinds, a discounted multiple, a balance sheet that is far stronger
relative to most of its peers, and the aforementioned catalysts make AGCO one of the more
compelling agricultural investments in the market.
The market is completely underestimating the impact that this cost cutting will ultimately have
on the bottom line. If AGCO can come anywhere near the 10% goal shareholders have a great
shot at outperforming the broader market by a wide margin.
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AGCO Stock Hits New 52-Week High (AGCO)
-The Street
NEW YORK (TheStreet) -- AGCO (NYSE:AGCO) hit a new 52-week high Monday as it is currently trading
at $54.02, above its previous 52-week high of $54 with 388,596 shares traded as of 12:25 p.m. ET.
Average volume has been one million shares over the past 30 days.
AGCO has a market cap of $5.06 billion and is part of the industrial goods sector and industrial industry.
Shares are up 5.5% year to date as of the close of trading on Friday.

AGCO Corporation manufactures and distributes agricultural equipment and related replacement parts
worldwide. The company has a P/E ratio of 7.3, below the S&P 500 P/E ratio of 17.7.
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TheStreet Ratings rates AGCO as a buy. The company's strengths can be seen in multiple areas, such as
its revenue growth, attractive valuation levels, increase in net income, largely solid financial position
with reasonable debt levels by most measures and notable return on equity. We feel these strengths
outweigh the fact that the company shows weak operating cash flow. You can view the full AGCO Ratings
Report.
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