2024-01-02 10:11:18 ET
Summary
- AGCO is likely to see an uplift as industrials and agricultural machinery react to reducing inflation.
- Long-term outlook of the precision AG market is bright with space for multiple players.
- AGCO is positioning to compete against the industry leader Deere.
Investment Thesis
AGCO Corporation (AGCO) could see an uptick from improving inflation and its positioning against competition. Long-term growth will be from the growing precision agriculture market.
Introduction
AGCO presents itself as the "largest pure play farm equipment manufacturer in the world". It owns brands like Fendt, Massey Ferguson, Valtra, Precision Planting and Grains & Protein. The undisputed market leader it competes against is the well-known, much bigger peer Deere & Company (DE). Per their 2022 annual report, AGCO promised to continue to innovate and grow those areas that deliver significant value to farmers and margin-rich growth to shareholders:
- Expand Fendt, tractor of the year at EIMA, in North and South America
- Parts and services innovation to maintain leadership in parts fill rate
- Precision agriculture innovation, that is seeing 20%+ CAGR and sees a revised timeline target of $1bn revenue from 2025 to 2023 .
Macro - the tactical angle
Improving inflation scenario could mean consumers have better purchasing power and Industrials that have lagged S&P 500 could see an uptick.
The agriculture and farm machinery sub-index has lagged the MSCI world and this presents a macro-based opportunity when inflation eases.
Precision Agriculture - long-term growth angle
The global population continues to grow and is expected to reach 10 billion by 2050. Farm land is not growing and perhaps decreasing. Thus, the need for higher productivity from the available land. Computing power, the new AI capabilities, when applied to the profession of framing, which is as old as human civilisation, yields a new growth market. Various estimates available , the global Agriculture Equipment Market could have a CAGR of 8.6% till 2031, but precision farming could have a CAGR of 19.2%. There will likely be space for more than one player, but early innovators may have an edge. AGCO shows signs of a company with the intent to innovate in this space - both with internal R&D spend and with targeted smart-farming acquisitions like Trimble.
Competitive position - relative value angle
You cannot talk about farming equipment without talking about DE. Sitting at a market cap of $110+bn it is a mammoth compared to AGCO at $9bn. However, it is bringing the challenge to DE. AGCO's Fendt tractor holds a better position in Europe with the recent award and with the challenge presented in North America. Management's Q3 reply to the analyst's question on "Fendt continuing to build momentum" furthers this belief (in-bold emphasis added by author) :
North America has been a really good margin performance for us, and a lot of that is predicated on that Fendt's market share expansion. We've talked about introducing Fendt to North America and South America. Adding these Fendt dealers and really focusing on that Fendt experience, talked about being very selective on how fast we roll Fendt out into the dealer networks who is able to offer it because they need to deliver on that overall Fendt experience, which includes the Gold Star warranty, the replacement tractors. So we've seen great growth, great share growth in North America .
So, we are talking about two competitors, with the underdog playing well in one geography and catching up in another. Surely this should be reflected in the valuation? To an extent, yes, the last 2 years have seen the move towards valuation multiple convergence.
However, as of this writing, and zoomed in, there is still room for convergence - I'd guess AGCO is mis-priced at 8X and should be more like 10X, reflecting the gains of competition.
Competitive strategy
Is there any clear indication of how AGCO strategy differs from Deere? Hard to say. However, in my eyes, AGCO prioritises precision farming at a low cost - Retrofitting. DE does not mention this in their IR presentation but I can find mentions of this in press . Whilst DE may be targeting retrofitting its own fleet, at a lower priority, AGCO is going after wider application to any existing fleet. Heavy machinery comes at a cost - decommissioning existing when there is good residual value left may not be sensible for the buyer. So that is the market AGCO is differentiating on. On the timeline of innovation, one sees how DE is going wide (including construction) whilst AGCO is narrowing focus (including retrofitting opportunities).
Due Diligence - past financials
AGCO has performed similarly to S&P500 in the past 10Y and the pick-up in the last 5Y is likely reflective of the precision AG business. The cashflows and margins are looking up
Risks
AGCO sits in a highly competitive industry, and declining market share could be a risk. Being in a cyclical industry, a hard landing would see demand decline and stock price crash. Factors out of control for AGCO include supply chain disruption and with advanced computing, now semiconductor shortage. Adverse prolonged weather conditions affecting farming in the geographies which AGCO operates is also a risk.
Valuation
I used a FCF-based DCF to find a price range.
- CAPM WACC is estimated at 9.5%
- FCF growth CAGR is between 10% - 12%
- linear decay of FCF over 10 years to reach a terminal growth rate.
- Two scenarios - one base case (7.5% initial FCF growth) and stress case (5% initial FCF growth and WACC increased to 10.5%)
The price range is $120 - $158. Currently, AGCO is trading at the lower end of this price. This target range is not too different from $112 to $156 per Wall Street.
Overall, the ratings seem to favour buy or hold with favouring buy.
Conclusion
AGCO is well positioned to salvage the long-term precision agriculture growth market. Its investment in innovation is starting to show in margins and cashflows. There is tough competition but also likely room for more than one player. Current valuations and market share growth present a modest short-term upside potential.
For further details see:
AGCO: Tactical Cycle Opportunity And Potential Competitive Value