DE - Why AGCO Corporation Appears Destined To Outperform Its Competition

2023-03-20 15:17:53 ET

Summary

• Supply chain constraints and high input prices (fertilizer & fuel) will ease significantly in 2023, stimulating farmer expenditure.
• AGCO Corporation plans to expand its newly expanded Fendt products globally in 2023.
• Robust farmer income will drive greater demand for farming machinery.
• AGCO Corporation is an industry leader in Precision Planting, which is set to continue transforming the farming business.
• Accommodative farming subsidies in the EU 2023-2027 CAP budget.

AGCO Investment Thesis

I am currently rating AGCO Corporation ( AGCO ) as a buy and overweight relative to its peers in the farm and heavy construction machinery industry within the industrial sector. AGCO is a leading international manufacturer and distributor of agricultural equipment and related replacement parts.

AGCO Corporation has an extensive product line that it plans on expanding globally, as it already has dominance in the European region. Although most of its revenues come from tractor sales, AGCO also diversifies its product mix to replacement parts, combines, grain storage, and protein production. AGCO's relative undervaluation makes it a buy, in my opinion, and using a comps analysis and a p/e valuation model, I have placed a 1-year price target of $139/share on AGCO. AGCO is down around 10% on a 1-year time span and has traded lower than some of its notable peers, like Deere & Company ( DE ) and Caterpillar Inc. ( CAT ).

AGCO Product Offerings and Geographical Exposure

AGCO currently operates under six main brands , including: Fendt, Challenger, Valtra, Massey Ferguson, GSI, and Precision Planting. One of the keys to AGCO's past success and 2023 outlook will be continued growth and penetration of its widely successful Fendt product line, as well as its Precision Planting technology. Optimizing its Massey Ferguson, Challenger, and Valtra brands will also be significant for 2023 because these brands are more niche and mature in the agriculture machinery space. Below is a breakdown of AGCO's revenue mix and geographical exposure by region:

As you can see above, AGCO has a large presence in foreign markets, distinguishing itself from larger producers like Deer and CAT. AGCO has plans to expand into North America due to its higher margin potential, as well as in South America and other developing places in Africa and China. These developing spaces place more of a risk on AGCO due to international trade wars/tensions and well as tariffs; however, these regions present very attractive opportunities for expansion.

AGCO has plans to also expand its Fendt product line, which focuses on power, performance, efficiency, and innovation. AGCO's main goal is to make farmers more successful and efficient with their yields to meet the needs of a growing population, so through its Fendt brand, AGCO plans on globally expanding. AGCO also has transformed the Fendt line past tractors and also into combine harvesters, forage harvesters, and balers. Quality is also something that AGCO stresses more than its peers, and it has not gone unnoticed. Getting awarded is something that management appreciates, and this year, the Fendt 728 Vario tractor won “Tractor of the Year 2023.” This was awarded by 25 different agricultural journalists across 25 European countries, which shows the sheer quality and success of AGCO's Fendt brand. AGCO has tons of other awards and has showcased its success all around the globe numerous times.

Key Growth Catalysts Moving Forward

Macro-Focused Catalysts

As many people know, during 2021 and 2022, we saw greatly elevated commodity prices in the form of corn, wheat, soybeans, crude oil, natural gas, and many more. Many of these commodities are substantial inputs in the farming industry and drive farmer production. With price elevations to historic levels in commodities like corn and wheat for a couple of years, farmers accrued substantial amounts of net income. Although commodity prices have greatly cooled off and corrected at the tail end of 2022 and in 2023, these prices still maintain much higher than 5 and 10-year moving averages. Increase in farming subsidies in Europe will also aid AGCO's market share expansion. AGCO is not only taking global market share from big players like Deer and CAT, but it is also threatening to expand into emerging markets. With subsidies expected to increase from 2023-2027 with a new plan to stimulate sustainable farming, farmers will have increased discretionary expenditure on new farming tech and equipment.

As you can see above, prices have corrected substantially from all-time highs in 2021-2022; however, they still remain elevated from previous levels. This poses an opportunity for farmers as they had an extended period of time when they were selling crop yields at historically high prices and expanding margins. AGCO realizes this and sees increased farmer expenditure as a huge growth opportunity/catalyst. With higher net income, it's expected that farmers will use this discretionary spending to upgrade and improve machinery, which AGCO can provide to farmers all across the world. Moreover, decreases in natural gas and crude oil are critical macroeconomic factors that will also drive farmer demand. These two benchmarks are significant for farmers because natural gas makes fertilizer, and diesel power farming machinery. As prices decrease in these commodities, input expenses also decline for farmers, leading to further expenditure on machinery.

Company-Oriented Catalysts

Two key catalysts moving into 2023 include the globalization and expansion of the Fendt product line and secular growth in Precision Planting. The Fendt product line has proven itself as a high-margin business, and AGCO plans to globalize its whole product line, including tractors, combines, and more. Precision Planting is also another part of AGCO that was stressed on the Q4 earnings call . Farmers continue to utilize discretionary expenditure on AI and business analytics to optimize crop yields. Furthermore, precision ag products from AGCO have been in high demand because the technology offered at AGCO is ahead of its competition. Precision Planting helps improve planting, liquid application, and harvest operations on farms across the world. Precision Planting finds issues that are commonly occurring with farmers and helps correct these costs. These issues are solved by retrofitting current equipment or through a new piece of equipment combined with Precision Planting solutions.

AGCO Relative & Expected Valuation

The valuation of AGCO is what I believe sets it most apart from its competition. Although it has proven growth in its successful brands globally and is expanding into new emerging markets, the stock holds a valuation that is significantly at a discount to its comparables. Below is a comparison matrix illustrating significant metrics that show AGCO's discount.

AGCO trades well below its core peers when looking at medians in EV/EBITDA, P/E, and Leverage ratios. All of these ratios are on a next-twelve-month basis, and it is also important to note that AGCO is trading at an extreme discount to its 5-year averages in EV/EBITDA (~8.5x) and P/E (~25x). AGCO is also the most underleveraged (Net Debt/EBITDA) when looking at its core competitors; however, they are still investing heavily into new technology and using its 75-100% free cash flow conversion targets to fund its operations.

Above is also a P/E valuation model using expectations of future P/E multiples in the next year. The blue range of values is where I anticipate the P/E and EPS falling over the course of the next year. A P/E multiple expansion would be very reasonable from around 9x to just over 10x because investors will see its current discount and be willing to pay more for each dollar of earnings. Also, I anticipate the stock will trade closer to peer medians and move a bit toward 5 and 10-year moving averages. Using the expected 10.25x P/E and $13.57 EPS, I reach an expected 1yr share price of $139, implying returns of 17.55%, including the FWD dividend yield of 0.79%.

Concluding Remarks

Overall, I expect AGCO Corporation to continue its lasting success in the farming tech and machinery space. Although it is really the third player in this industry, behind Deer and Caterpillar, AGCO has strategically situated itself to grow through macroeconomic headwinds and through resilient competition. Higher income and expenditure potential from farmers will be a key driver in AGCO's success over the next couple of years because its expanding Fendt line and Precision Planting technologies will be in high demand.

Overall, an expected share return of 17.55% over the next year is very bullish and reasonable for AGCO Corporation, in my opinion, and can even be higher if there is a special dividend payout, as there has been in May 2021 & May 2022. Even though there are headwinds from foreign exchange risks, hyperinflation in the South American region, and global geopolitical conflict, I believe the catalysts outweigh the roadblocks, and AGCO Corporation is destined to succeed in 2023.

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