AGCO Corporation: Our Favorite Pick for the Agritech Boom (NYSE:AGCO)

The worldwide agricultural sector is at a technological turning level. Advances in automation and precision agriculture are quickly disrupting conventional manufacturing processes and forcing growers to adapt to stay aggressive. Whereas small producers who shouldn’t have monetary energy and technological know-how might battle to maintain tempo with quickly evolving applied sciences, this paradigm shift guarantees important productiveness and profitability good points within the agricultural business.

At Stratos Capital Companions, we see this as an opportune time to put money into agricultural know-how (agritech). Challenges associated to local weather change, together with unpredictable climate, temperature and harvests, will solely drive funding to optimize useful resource allocation, enhance productiveness and higher handle threat. Specifically, we consider that main producers of agricultural equipment and gear equivalent to Deere & Firm (DE) and AGCO Company (NYSE: AGCO) are in a great and disproportionate place profit from accelerated adoption of agricultural applied sciences within the subsequent couple of years.

On this article, we evaluate the 2 corporations and focus on why we predict AGCO is our most popular alternative for an agribusiness funding.

Dominance by way of scale

The aggressive atmosphere varies drastically from business to business. From extremely fragmented industries that compete totally on value, to industries with well-differentiated merchandise, to industries dominated by a couple of corporations with economies of scale. The flexibility to differentiate aggressive forces in an business may be helpful in tactically positioning one’s portfolio.

One aggressive atmosphere we notably like resembles an oligopoly, which is outlined as a market wherein a couple of massive sellers management a dominant share of the market. Oligopolistic markets are often characterised by homogeneous merchandise, a small variety of market members, excessive limitations to entry, and inelastic demand. Though agritech as a complete encompasses a wide range of applied sciences overlaying a number of market sub-segments and purposes at totally different phases of the agricultural cycle, the agricultural equipment/gear business as a complete conforms to the traits of an oligopolistic market.

The event of agritech is intently associated to the agricultural gear business, which is dominated by a couple of large corporations equivalent to Deere & Firm, AGCO Company, and CNH Industrial (CNH). In keeping with information revealed by Counterpoint Analysis, these three corporations account for about 70% of the worldwide marketplace for wheeled tractors.

Oligopolistic markets are inclined to favor incumbents as they’ve extra bargaining energy over suppliers, whereas value competitors is much less intense in comparison with extremely fragmented markets. Market leaders additionally are inclined to get pleasure from extra favorable financing phrases from lenders and have bigger analysis and improvement (R&D) budgets than smaller opponents. Furthermore, as a result of there’s nonetheless wholesome competitors amongst market leaders, such industries have a tendency to draw much less scrutiny from antitrust regulators. General, we view investing in oligopolistic market leaders as a horny technique to place our portfolio for the ag growth.

Totally different development paths

In keeping with numerous estimates by business analysts, the agricultural equipment/gear business will develop at a comparatively regular 5%-7% compound annual development price (CAGR) over the subsequent decade. Nonetheless, development charges are prone to fluctuate considerably by market phase and firm measurement.

Whereas we see larger development potential for smaller, progressive corporations, competitors is prone to be intense given the extremely fragmented nature of essentially the most progressive agritech segments. The problem of predicting which corporations would be the final winners or losers makes inventory choosing a dangerous train characterised by a excessive threat, excessive reward profile. Not solely is it unattractive risk-adjusted, however there are often significantly better alternatives to maneuver to alpha. As well as, we anticipate lots of the most progressive and efficient applied sciences to be acquired or rapidly replicated by market leaders. As we talked about earlier, market leaders have a lot bigger R&D budgets, in addition to the monetary energy and suppleness to make acquisitions. Because of this the enormous incumbents will seemingly nonetheless management the most effective know-how.

The economies of scale loved by DE and AGCO additionally permit these corporations to develop their very own agricultural platform as an alternative of utilizing standalone applied sciences. This strategically will increase the community impact of a platform able to working a number of linked applied sciences and purposes.

AGCO, particularly, is dedicated to an open platform construction that enables a number of third-party purposes to be built-in. We see this as an vital benefit for AGCO.

Acquisition of Trimble to develop AGCO and Precision Agritech R&D platform

In a strategic transfer that we see as cementing AGCO’s place within the ag business, AGCO just lately acquired an 85% stake in Trimble’s precision ag property by way of a three way partnership for $2 billion in 2023. The deal, which closed in April final month, will create a compelling precision blended fleet platform with entry to Trimble {hardware}, software program and cloud purposes. The three way partnership will considerably broaden AGCO’s present agricultural know-how portfolio, which spans the whole crop cycle from land preparation to planting after which crop service to reap.

AGCO administration has constantly acknowledged its ambitions to speed up development in areas equivalent to autonomy, precision spraying, linked agriculture, information administration and sustainability. We view the three way partnership with Trimble as an vital step that can assist speed up AGCO’s development plans within the coming years.

The agro-technological business is quickly creating and implementing new applied sciences geared toward full automation of agricultural manufacturing processes. Local weather change, which has elevated the chance of drought in grain-producing international locations, and geopolitical dangers are contributing to a world meals disaster that has U.S. farmers scrambling to spice up yields. Agritech will play an rising position in bettering manufacturing effectivity and in the end rising profitability for producers. And we consider that AGCO is in the most effective place to develop its agribusiness within the coming years.

AGCO as the selection of Agritech Pure-Play gear

Our view that agritech will play a serious position within the improvement of agricultural manufacturing implies that AGCO is our most popular alternative. Whereas DE’s enterprise is extra diversified (20% of income comes from development, street development and forestry), AGCO, then again, is targeted solely on agricultural gear, with agricultural know-how set to be the fastest-growing a part of the enterprise subsequent 12 months. a few years.

AGCO’s newest acquisition of Trimble’s Precision Agritech property will considerably broaden its know-how suite that covers each stage of the agricultural cycle. The acquisition can also be important to AGCO’s prospects, provided that the business expects tractor gross sales to sluggish towards the tip of the 12 months.

Q1 2024 earnings and steerage

Not surprisingly, AGCO inventory has weakened in latest quarters (in 2022, AGCO’s inventory value fell again to close the underside of the market). Administration expects gross sales to say no as a result of very excessive numbers in 2023 and initiatives additional declines by way of 2024. In the meantime, the expectation that rates of interest will stay elevated as a result of delays within the Fed’s price cuts means producers will stay cautious with spending.

The next is an excerpt from AGCO CEO Eric P. Hansotio’s feedback in the course of the newest Q1 2024 earnings name:

International market situations are anticipated to stay tougher in 2024 as a result of decrease commodity costs and decrease anticipated farm incomes. In consequence, AGCO predicts a decline in gross sales in 2024. To mitigate these challenges, we’ll proceed to concentrate on alternatives to scale back manufacturing prices, enhance overhead and common value effectivity, and scale back firm and seller stock.

As well as, AGCO’s rising precision agriculture enterprise, the entire Fendt-branded product line, and our components enterprise are anticipated to assist us ease the agricultural cycle. To raised serve farmers, we’ll proceed our investments in premium know-how, good farming options and superior digital capabilities to assist our farmer-first technique, serving to to sustainably feed the world.

Because the accompanying desk reveals, AGCO’s Q1 2024 outcomes confirmed considerably decrease gross sales and profitability in comparison with final 12 months. Whereas this was largely in keeping with administration’s communication within the earlier quarter, in addition to consensus estimates, buyers however offered the inventory.

We’re happy that administration’s plan to scale back prices by way of higher seller stock administration and decrease manufacturing ranges will assist ease downward stress on earnings within the coming quarters. AGCO’s emphasis on {hardware} and software program upgrades also needs to put the corporate in a great place to climate the downturn, provided that producers are prone to put money into upgrades somewhat than shopping for fully new tractors and gear within the coming quarters.

However extra importantly, we see this as a possibility to look past this downturn and concentrate on AGCO’s long-term fundamentals and development potential.

Compelling valuations are a possibility for Alpha

Some readers might query our resolution to optimize AGCO throughout a downturn. However that is precisely why AGCO inventory is buying and selling at a deep low cost. Whereas short-term buyers might not just like the inventory and like to chase the most well liked development themes, long-term buyers ought to look past the downturn and make the most of the massive low cost to build up.

AGCO at the moment trades at a compelling ahead P/E of simply 8.9x, with consensus earnings estimates already absolutely discounting the influence of a 2024 financial downturn.

AGCO can also be buying and selling about 29% off its 2021 all-time excessive. By comparability, DE is buying and selling at a extra demanding ahead value/earnings ratio of 15.5x and is simply 12% off its all-time excessive.

Threat for Outlook

Agricultural commodity costs will stay a key threat to our bullish outlook for AGCO. If agricultural commodity costs stay low within the coming quarters, this can have a direct destructive influence on producer revenues and, in flip, on AGCO’s gross sales. We don’t try to predict the pattern in agricultural commodity costs, however provided that staples equivalent to corn, soybeans and wheat are at historic lows, we consider the dangers are tilted in our favor.

In conclusion

We see AGCO’s valuations might enhance to a extra cheap ahead P/E of round 13x-15x by the tip of 2025. This represents a possible upside of 68% even when we hold our earnings estimates unchanged.

We provoke our bullish view on AGCO with a Purchase ranking.