The agriculture industry has been receiving some negative sentiment after Deere & Company (NYSE:DE)’s earnings release, as the giant agriculture machinery producer warned the market about deteriorating fundamentals for agricultural commodities in the near term.
Since then, the company has received a downgrade from Wells Fargo, Barrons, and Goldman Sachs. However, what was interesting to note was that Deere & Company (NYSE:DE) got the maximum punishment — neither AGCO Corporation (NYSE:AGCO) nor CNH Global NV (NYSE:CNH) saw that big a decline since Deere’s fall.
Why has that happened?
Deere’s earnings call and analyst takeaways
Deere’s shares tumbled after management gave a cautious outlook on not just the world economy, but adverse weather patterns.
“Cool wet weather in North America has delayed crop planting, slowed construction activity and hurt sales of turf-care equipment.”
Similarly, Well Fargo’s analyst claimed that U.S. crop cash flow was expected to decline 8% in 2013. Since farmers’ income is positively correlated with farm machinery demand, this is likely to hamper sales of agricultural machinery. Barron’s also pointed out that:
“As goes the North American corn crop, so goes Deere & Company (NYSE:DE)’s stock price.”
Goldman’s analyst further elaborated that recovering commodity inventories point to lower U.S. farm income and capex. He pointed out that U.S. dealer inventories are 17% above historical levels and farmer capex and capital stock are at their peaks. He suggested that though Deere is expected to return cash to its shareholders through 2014 (buybacks worth $2.2 billion), yet it will still bring about an EPS below the consensus estimates. Hence, Deere & Company (NYSE:DE) is recommended as a sell.
What about AGCO?
Deere & Company (NYSE:DE) witnessed a strong Latin American market as the revenue of the company rose 48% in that region. Many have suggest a bullish thesis on Deere given a strong Latin American agriculture market. However, in this context, Wells Fargo analyst commented that if strong Latin American demand is now the bullish thesis, then investors should better invest in AGCO Corporation (NYSE:AGCO) that gives a better exposure to that market.
Deere & Company (NYSE:DE) gets 34% of its revenue from outside North America but it doesn’t disclose how much it gets from Latin America. The Street tells us that its exposure to Latin America is not that high.
However, a strong exposure to the Latin American market might not mean that the stock is a straightaway buy. There are some other things to consider as well.
The company has heavy exposure to agriculture in Europe (~50% of revenue) where the fundamentals are flat to up slightly at best. Since this has been the situation for quite some time, it is quite a chance that softness in that market has already been priced into the stock.
Strong conditions in South America (~20% of revenue) do provide some hope to investors. However, it is interesting to note that AGCO Corporation (NYSE:AGCO) continues to lose share in Brazil, which has been the fastest growing area in that region.
The company has established a phenomenal track record of topping its earnings estimate for the last 27 quarters. Given that management has raised the guidance from $10.2 billion-$10.4 billion to $10.5 billion-$10.7 billion, it is most likely that the company will be able to achieve growth by beating the weakness in both European and North American agriculture market.
Another company with Latin American exposure
CNH Global NV (NYSE:CNH) reported a solid earnings beat on May 3. However, the company gave out a cautious outlook regarding its end markets in Europe and Asia. The company sells both agriculture and construction equipment machinery to Asian and European markets. The weakness in construction markets over there compelled the company to lower its guidance for both the regions.
However, the company remains optimistic about its growth in Latin America where sales of tractor and combines have been at a record high. Experts believe that improving cash flow for farmers in this region will be diverted towards machinery purchases rather than livestock sector.
Overall, I have a bullish stance on the stock. No doubt that the company is expecting weakness in its construction markets, but it has already reduced its guidance for that region. Also, the company is planning to bring some restructuring to that segment that might help it operate above break even, and hence prove that guidance was conservative. Moreover, the company has a solid Latin American exposure that will fuel the growth for the company any way.
A weakening North American market and an improving Latin American market for agricultural products leaves us with the theme of buying companies with high exposure to Latin American market (that are AGCO Corporation (NYSE:AGCO) and CNH Global NV (NYSE:CNH)).
The article What Is Going on With Farm Machinery Stocks? originally appeared on Fool.com and is written by Zain Abbas.
Zain Abbas has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Zain is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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