AGCO - The Case For And Against AGCO

2023-07-24 16:15:52 ET

Summary

• We have a neutral outlook on agri-machinery specialist AGCO, as we see quite a few positive and negative factors weighing on the stock's prospects.
• Positive factors include the company's encouraging shift towards precision agriculture which is seeing significant growth, and the potential for solid FCF generation ahead, which could potentially bring rejuvenated buybacks.
• Negative factors include a sub-par industry backdrop, a weaker H2 margin profile, pricey valuations, and unappealing R:R on the charts.

Introduction

AGCO Corporation ( AGCO ), is a global manufacturer and distributor (across 140 countries) of agricultural equipment (mainly tractors which account for 59% of the sales mix) and replacement parts. This year, so far, the AGCO stock hasn't exactly been pulling up any trees, delivering just low single-digit returns, even as the broader markets have fared infinitely better.

Looking ahead, we remain conflicted about the stock’s prospects as there are both good and bad sub-plots that could tilt sentiment either way; thus, we feel a HOLD rating feels fitting. Nonetheless here are some of the key narratives behind our neutral stance.

For AGCO

For much of 2023, the AGCO stock hasn’t received a great deal of support from buyback initiatives, but this could change in H2. For context, despite having the authorization to buyback another $110m of AGCO shares as part of the existing share repurchase program, management chose not to go down this route in Q1.

The reluctance to engage in buybacks was ostensibly driven by what’s happened on the FCF front, where AGCO ended up witnessing FCF outflows to the tune of $682m in Q1 driven by CAPEX and working capital pressures. Despite the disappointing performance in Q1, investors can rest assured that things will pick up from here (as CAPEX is more H1 weighted, and AGCO is also poised to benefit from 8% pricing growth this year) and finish with a bang by the end of the year. After delivering a negative FCF of nearly $700m in Q1, AGCO now looks poised to deliver a positive FCF of around $300m per quarter (or $750-$1000m for the FY). At the mid-point of management’s guidance, that would represent massive YoY growth of 94%, a far cry from what was seen last year.

Besides the traditional expertise of tractor production and the like, we particularly like AGCO’s ongoing thrust to de-risk the operating model and engage in the space of precision agriculture (PA). Something like PA will likely be talked about with increasing fervor as the globe looks to innovative avenues to help bridge its sustainability targets. AGCO’s precision agri tools fuse concepts such as digitization, automation, connectivity etc. in order to provide better farmer outcomes (either by way of better yields or reduced waste).

Currently, this part of AGCO's product portfolio is witnessing tremendous traction, and it does not look like it will abate any time soon. For context, in Q1, AGCO delivered nearly $200m of precision agri sales, translating to impressive YoY growth of 30%. AGCO management believes they can keep up or improve on this $200m run rate as they are targeting $800-$850m of sales for the FY.

All in all, AGCO management believes they could hit $1bn of sales by FY25 (up from $0.8bn previously), which would imply a fairly compelling CAGR of 13%.

Against AGCO

Conditions in AGCO’s underlying markets are unlikely to be as resilient as they’ve been in recent years and this could play a key role in limiting gains for the stock. For instance, in the US markets, after witnessing YoY growth of +16% in FY21, and +49% in FY22, net farm income in real terms is expected to decline by - 16% in FY23.

AGCO as well has suggested that industry tractor volumes this year will likely be flat in two of its largest markets- Western Europe and North America.

In fact in the US, it looks like H1 was already worse than expected with tractor sales down by -10%. Looking ahead to H2, AGCO believes that their production volumes will likely be flat YoY, and this will also be dictated by some preventive maintenance work that will take place in Q3 mostly.

Also note that despite witnessing impressive YoY progress of over 260bps on the operating profit front in Q1, it looks like margins may have peaked and will likely trend lower in H2.

AGCO has benefitted from solid pricing metrics in South America, but management has noted that these tailwinds are unlikely to linger through the year. AGCO is also poised to witness significant engineering and tech investment outlays (poised to grow by 20% for the year) that result in FY margins dropping to 10.9% levels.

It’s also fair to say that compared to its closest peers, AGCO’s long-term outlook isn’t the most resplendent. As per YCharts estimates, AGCO is poised to offer lower earnings CAGR through FY25, compared to Deere & Co (DE). Also note that despite offering similar long-term earnings growth potential to CNH ( CNH ), AGCO is priced at a higher forward P/E of 9.37x (CNH is priced at 8.4x).

It’s also worth pointing out that AGCO’s current forward P/E represents s 11% premium over the stock’s long-term average of 8.48x, making it a somewhat pricey stock to own.

Finally, to conclude, we’d also like to mention that AGCO is unlikely to benefit from potential rotation interest within the agribusiness space. The image below measures the strength of the AGCO stock relative to its peers from the agribusiness universe, and we can see that this ratio currently looks enormously overbought, trading at record highs. We think this ratio is well-poised to mean-revert, thus dampening AGCO’s allure.

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