Last year’s drought in the U.S. compelled many people to take short positions in the agriculture-related stocks. However, the market was taken by surprise when Warren Buffett announced a stake in Deere & Co (NYSE:DE), the farm-machinery manufacturer. Who was right: The market or Buffett?
The U.S. drought was expected to have an adverse impact on farm-machinery stocks in two ways:
1) Smaller crops meant less income at farmers’ disposal.
2) More importantly, less agricultural activity meant less wear and tear on farmers' existing machines.
However, the bulls believed that the negative impact on farmers' purchasing activity would not be as strong as originally anticipated, thanks to the effects of crop insurance, expiring tax provisions, and financing incentives from the State.
The recent news on the global fundamentals tells us that the bulls were right. Overall, the North American 100HP+ tractor sales were up 16% in 2012 to an all-time record (13% compound annual growth rate, or CAGR, since 2005). Also, the 13,000 units of combines sold represent a 10% CAGR since 2005.
However, after such a fabulous 2012 for this industry, the naysayers have resumed chanting a bearish outlook for 2013. They believe it is difficult to see the peak stretching further given the ongoing drought, lower insurance guarantees, and potentially lower crop receipts. However, they do not understand that the extended and enhanced tax incentives may support U.S. farmers' buying activity. Also, Brazil is beginning to truly benefit farm-machinery stocks. A record expected soybean crop and a weak currency, the Brazilian real, are supporting the farmers' investment.
Moreover, the aversion of the U.S. fiscal cliff is another bullish catalyst for this industry. 50% bonus depreciation was extended for another year, and Section 179 benefits were extended and enhanced; this may support equipment purchase activity for the year, including a possible year-end pull-forward of demand. (To have an understanding of what this means, please go this link.)
The Best Stock in the Industry
The three farm-equipment stocks under my consideration are: