This week's topic: Construction & Agricultural Machinery
Panelists
Barry Bannister, Research Analyst at Legg Mason
Michael Braig, Securities Analyst at AG Edwards
Q&A
Briefing: What is your outlook for the agricultural machinery group given falling crop prices and economic troubles overseas?
Barry Bannister: The rivalry in this industry is not so much between farm equipment manufacturers, as so many of the analysts and companies would like to
believe, but rather between the US farmer and the overseas farmer, and the struggle between supply and demand. Agricultural commodity prices started coming off
their peaks almost two years ago and at roughly the same time, exports began to decrease. This sounded an alarm for us even though the overall economy was
strong because in a commodity-based industry, pricing is critical. Grain prices falling off a cliff in 1998 were the final straw for these stocks. We re-initiated coverage
on the group after joining Legg Mason in 1998 with a fairly negative farm equipment outlook, which should continues until the next crop year, when poor weather is
the only factor we would expect to have a positive effect on the grain supply/demand balance.
We look at three variables when assessing this group: (a) total dollar value of US agricultural exports as well as underlying unit volume changes; (b) aggregate value
of US agricultural production and; (c) capital goods spending (low interest are needed to encourage spending). As we look for signs of improvement in the sector,
we will be watching conditions improving economic conditions in Asia (Asia took about 42% of 1997 US agricultural exports and of that 42%, Japan took almost
half). We be watching Latin American and European production numbers as particularly Europe is famous for chronic overproduction. We will also be watching the
strength of the dollar.
Michael Braig: Consider the givens: crop prices have indeed fallen from their high mark in the Spring of 1995, but we have seen a slight uptick in prices in recent
weeks; overseas demand is significant to the extent that it has been a marginal buyer for the last several years; agricultural products are commodities and
consequently pricing is always determined on the margin; and most importantly, farm cycle lengths are indeterminate because of weather. Weather is arguably the
most important variable when considering this industry. One spring/summer/fall of poor weather can turn around crop prices. Therefore every spring offers a new
chance to boost crop prices and higher crop prices restores the confidence of farmers, which in turn translates into capital expenditures.
We are negative on the farm equipment stocks in the near-term because we are going into next spring with low equipment demand. We see sales down 15-20% in
the next six-to-nine months. Roughly two-thirds to three-quarters of sales occur in the spring planting and fall harvesting seasons. This year and next spring are
already wiped out so we look to fall 1999 as the first possibility for improvements. An poor weather situation in the spring would certainly increase crop prices and
in this business, high prices are more important than high volume.
Briefing: Which of the agricultural machinery companies are best positioned to weather a sustained long-term economic
downturn?
Barry Bannister: The first question any investor need to consider is why would anyone own a stock that is weathering a downturn when there are other better
investment choices? That aside, the best positioned companies, both in terms of financial and market share, in descending order from strongest are: Deere & Co
(DE), Case Corp (CSE), New Holland N.V. (NV), and AGCO Corp (AG).
Michael Braig: The only company that is really well-positioned to sustain a period of low equipment demand is Deere & Co (DE). Almost all of the other
companies (ie. Ford, Case, Harvester) fall into the number two slot at one time or another, but none hold that position indefinitely. Deere, however, has been the
strongest in the sector for a number of years.
Briefing: Which companies are you recommending and/or avoiding?
Barry Bannister: We are not recommending any of the agricultural equipment companies at this time. We have a Market Perform on the group. We are going into
the second largest corn crop in US history and unless supply/demand comparisons improve in 1999, these stocks will continue to wallow. We like the construction
equipment companies and have a BUY on Caterpillar (CAT), and Ingersoll-Rand (IR) because they are trading at significant discounts and have been over
penalized in the market by cyclical concerns. Our take on the new "paradigm" is that U.S. and European economies are less volatile now, because interest rates and
exchange rates are acting as "shock absorbers" and have taken on more of the volatility. It took companies like Caterpillar 10 years to adapt to that new reality, but
their sales and earnings - which correlate with what is now a less volatile economic environment - are undervalued at a P/E that equates to a 50% discount to the
S&P 500.
Michael Braig: We are not recommending any of the stocks in this group, but we are looking at Case Corp (CSE), New Holland N.V. (NV), and AGCO Corp
(AG). The time to consider these stocks is when the industry is heading south so that one is poised to benefit from the upturn.
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