AGCO - AGCO Corporation: Demand Remains Strong Supporting Earnings Momentum

2023-05-11 09:38:06 ET

Summary

• AGCO reported strong 1Q23 results, surpassing consensus expectations, with an adjusted EPS of $3.51 that was driven by an increase in net sales.
• AGCO's management has provided an optimistic outlook for FY23, raising their sales guidance by $500 million, primarily due to higher volume and improved product mix.
• AGCO benefits from a robust global demand for large-scale agriculture, supported by macro trends.

Overview

AGCO Corporation ( AGCO ) is a producer and distributor of farm machinery. They offer a variety of farm machinery and parts, such as tractors, hay tools, sprayers, and more. The outlook for FY23 was upgraded after a strong 1Q23. Sales increased by 24% in 1Q23, and the EBIT margin was significantly higher than expected. FY23 sales guidance was raised by $500 million which includes a 2% FX adjustment from a prior -1% headwind. I believe this sends a clear signal to the market that management is expecting to see higher volume as pricing is guided to be an 8% increase (1Q23 earnings call). Overall, I continue to see a path for earnings to continue at the current momentum, supported by the guided top line growth. I believe the growth outlook from here is also well supported by the robust backdrop for global large agriculture demand . In addition, valuation is now trading below one standard deviation below its historical average at 9x forward PE, which provides a good margin of safety, in my opinion. All in all, I am recommending a buy rating on the factors and reasons mentioned above.

1Q23 earnings

AGCO reported impressive 1Q23 results, surpassing consensus expectations. The company achieved an adjusted EPS of $3.51, exceeding the consensus estimate of $2.70. This strong performance was primarily driven by a substantial increase in net sales, which rose by 24% to reach $3.3 billion during the first quarter. Furthermore, AGCO's management has provided an optimistic outlook for the full year. They raised their sales guidance for FY23, citing higher volume and improved product mix, with pricing expected to increase 8%. The company now anticipates FY23 EPS to be approximately $14.40, based on projected net sales and an expected EBIT margin of approximately 10.9%. AGCO also shared their production plans for the upcoming year, anticipating a 3% to 5% increase in production hours. Additionally, AGCO plans to invest significantly in engineering, with engineering spend expected to rise by over 20% in 2023.

Demand is still resilient

The industry's resilience strengthens my conviction that AGCO will be able to meet its revised FY23 targets. Given the macro environment, I originally anticipated a decline; however, the confidence of management was a significant motivating factor. Management largely stuck to their FY23 forecast in the presentation, predicting that retail tractor sales would be flat in North America, 0% to 5% growth in South America, and flat in Western Europe. Increasing capital expenditures on machinery in the area and rising planted acreage in Brazil are the primary forces behind South America's growth forecast.

My confidence that AGCO will be able to meet its FY23 targets is bolstered by the fact that the company's order books have remained consistently strong. The order books in Europe are solid through FY23, in North America they are solid through 1Q24, and in South America they are solid through 3Q. As management reported that the South American 3Q23 order board was effectively filled in a single day, I anticipate a similar outcome for the region. The strategic handling of South American orders strikes me as sound; the region is only open for orders one quarter in advance because management values price flexibility. Given that today's order books are still primarily focused on retail, I believe orders remain resilient and we could see a possible surge in demand (due to dealers restocking). I anticipate that as dealers resume more typical ordering behavior, they will represent a more diverse range of demand and, as a result, will need to place substantial orders at the start to replenish inventory.

As I was saying before, there is a strong positive trend in the long-term outlook for agriculture around the world. The rising population, the trend toward higher-protein diets, and increased food security are all promising macro trends. Management also reaffirmed that strong farm fundamentals exist, with grain prices continuing to rise, input costs decreasing, and STUs remaining at historically low levels. It is worth noting that while the demand for large-scale agriculture has shown resilience, the small-scale agriculture sector is experiencing a decline attributed to the impact of rising interest rates. However, considering a scenario where production levels and prices remain stable, management maintains the belief that there are no significant indicators pointing towards drastic changes in the circumstances for FY24.

Financing

It's encouraging to learn that despite the banking crisis, customer financing is unaffected. The fact that management hasn't noticed any major changes in customer financing highlights, in my opinion, the benefits of the more conservative lending policies typically adopted by banks serving the agricultural sector. In addition, although the price of used equipment is decreasing, it is still at elevated levels relative to historical norms, meaning that large farms typically only require a small amount of financing when making trade-ins.

Conclusion

AGCO's strong 1Q23 performance and positive outlook for FY23 indicate a favorable growth trajectory. The raised sales guidance for FY23, driven by higher volume and stable pricing, further supports the expectation of continued momentum in earnings. Additionally, the robust global demand for large-scale agriculture provides a favorable backdrop for AGCO's growth prospects. The company's valuation, trading below one standard deviation at 9x forward PE, also offers a margin of safety for investors. Overall, I recommend a buy rating for AGCO shares.

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