AGCO - AGCO: Spurred By Industry-Wide Growth; Precision Ag Business Remains Strong

2023-07-24 16:16:18 ET

Summary

• AGCO, a global manufacturer of agricultural machinery, has seen a 24.12% YoY increase in revenues in Q1, reaching $3.33bn, and a 53.23% increase in net income to $232.60mn.
• Despite strong competition, AGCO's diverse revenue generation strategy, strong product pipeline, and broad international consumer base make it a 'buy' rating, with room for growth.
• While AGCO's cash flow is highly dependent on downstream agricultural demand and it faces potential supply chain risks due to its international exposure, its diversified presence and premium.

AGCO ( AGCO ) is a Duluth, Georgia-based global manufacturer and wholesaler of agricultural machinery and farming products. This includes tractors, combines, foragers, hay tools, sprayers, agricultural technologies, seeding equipment, and tillage equipment.

Through these activities, in the first quarter, AGCO has seen revenues of $3.33bn- a 24.12% YoY increase-alongside a net income of $232.60mn- a 53.23% increase- and a free cash flow of -$682.40mn, a 6.16% decline driven by decreases in financing and investing cash flows.

Introduction

At the centre of AGCO's investment thesis remains the company's superior machinery products as well as international positioning, which enables the firm to take advantage of broad market demand tailwinds. For instance, AGCO has a prominent consumer base across the Europe and Middle East region, North America, South America, and the Asia Pacific.

The firm's diverse revenue generation strategy, in conjunction with a strong product pipeline, an expanded consumer base, greater ag demand, and an overall undervaluation leads me to rate AGCO a 'buy'.

Valuation & Financials

General Overview

In the TTM period, AGCO's stock-up 38.02%- has experienced superior price action relative to both the NASDAQ Benchmark for Farming, Fishing, Ranching, and Plantations Index-up 1.64%- and the broad market, as represented by the S&P 500 ( SPY )- up 13.39%.

I believe AGCO's relative overperformance reflects the company's exposure to the ag machinery business, which has experienced outsized YoY growth, contrary to the agrifood index, which is more sensitive to temporary commodity price shifts.

However, I expect strong ag machinery and subsequent maintenance demand to persist, with AGCO, well-positioned to capture said growth, as such leading me to price in even more growth for the company.

Comparable Companies

The ag machinery industry remains highly specialized, with few direct operational competitors. Although firms such as John Deere ( DE ) do direct compete against ACGO, the scale difference makes the comparison untenable. As such, rather than ag machinery companies, I sought to compare AGCO to similarly sized outdoor machinery and component companies. This includes Bloomington, Minnesota-based lawn mower, snow blower, and irrigation system manufacturer, Toro ( TTC ), irrigation and farm and construction equipment manufacturer, the Lindsay Corporation ( LNN ), and farm and off-road tire manufacturer, Titan International ( TWI ).

As demonstrated above, AGCO has experienced peerless price growth over the TTM period, likely a result of the aforementioned upward demand pressure for ag machinery, and the second-best quarterly price action, with strong quarterly results.

Despite this, with superior growth capabilities, strong multiples-based value, and an overall solid financial base, I believe AGCO maintains room for growth.

For instance, when considering P/E, AGCO maintains the second-lowest ratios, alongside the second-lowest P/S, P/CF, and P/B.

This works alongside the firm's second-best revenue, earnings growth, and best-in-class PEG to enhance the firm's operational value. Additionally, with the highest book value per share and the second-lowest debt/equity, AGCO maintains a secure financial position.

Valuation

According to my discounted cash flow valuation, at its base case, the net present value of AGCO is $155.07, meaning, at its current price of $136.32, the stock is currently undervalued by ~12%.

My analysis, calculated over 5 years in perpetuity, assumes a discount rate of 8%, rewarding AGCO for its relatively low debt levels in addition to low stock price volatility. On a more conservative level, in spite of an average trailing 5Y revenue growth rate of 9.16%, I assume a revenue growth rate of 6%, anticipating a slowdown in sales growth due to recessionary pressures.

Alpha Spread's multiples-based relative valuation tool more than supports my thesis on undervaluation, estimating the stock to be underpriced by 57%, with the relative value being $315.13.

However, Alpha Spread may overvalue AGCO due to its inability to account for potential declines in demand.

Thus, taking a weighted average of my DCF and Alpha Spread's relative valuation, the fair value of AGCO is $184.34, meaning the stock is currently undervalued by 26%.

Macro Tailwinds & Operational Capabilities Enable Demand Growth

Over the past half year, AGCO has seen significant earnings growth on the back of rising demand for combined and non-tractor farm equipment across all geographic segments. For example, industrywide retail demand for combines in North America, Western Europe, and South America, has grown by 117%, 60%, and 18% respectively. The latter demonstrates AGCO's international presence and ability to leverage said presence to accelerate scalability.

The access to and presence of AGCO across global agricultural activity is well-supported by the firm's state-of-the-art presence across all three of its major verticals, including Fendt, Precision Ag, and Global Parts and Services. Fendt in particular exemplifies the AGCO philosophy, with niche and effective tractors commanding premium prices and spurring profitability.

This joint focus on scalability and margin expansion culminates in AGCO's combined effort of expanding its TAM across all segments while ensuring accretive margin expansion. Best manifested by AGCO's activities in its Precision Planting sub-segment, wherein the firm aims to increase R&D to create more innovative and unique products, expand its product mix beyond the crop cycle, etc.

Wall Street Consensus

Analysts largely agree with my positive view on AGCO, estimating an average 1Y price target of $152.68, a 12.00% increase.

Even with the minimum projected price target of $135.00, analysts only expect a -0.97% decrease, a bullish prospect for investors, with analysts largely seeing exclusive upside due to macro tailwinds.

Risks & Challenges

AGCO's Cash Flow is Highly Dependent on Downstream Ag Demand

As an ag machinery pure play, AGCO is exposed to downstream ag demand more so than its competitors. Lower ag commodity prices may lead to reduced farmer incomes, leading to diminished retail demand levels. This risk is further compounded by rising interest rates, since a majority of clients rely on credit financing for ag machinery purchases.

High Levels of International Exposure Increase Compliance Costs & Supply Chain Risk

While, as previously discussed, the firm's diversification is an inherent strength, it also increases sensitivities to supply chain risk and regulatory complexities. Through a level of supply constraints and demand compression, this dynamic was particularly pronounced in the last few years. Any sustained increase in costs or depressed demand due to regulatory or logistic pressures may reduce the company's cash flows and ability to return capital to shareholders.

Conclusion

In the long run, I expect AGCO's diversified international presence across all major ag machinery verticals, alongside its premium, higher-margin product mix to enable superior price returns.

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