Mechanized farm equipment is one of the best investments a farmer can make. Fertilizer and high-yield seeds may lead to bigger harvests, but tractors and combine harvesters allow a farmer to sow, tend, and harvest larger fields much more easily and with fewer workers.
Unfortunately, much of the developing world lacks these tools. The World Bank uses tractors in use per 100 square kilometers of arable land as a measurement of agricultural machinery use. In 1998, the OECD, a group of mostly rich countries, had 437 on average, whereas the global average stood at 196. Developing areas were even lower, with 126 in the Middle East and North Africa, 121 in Latin America, and 107 in South Asia. As far as the available data show, none of these regions has caught up with the global average, much less that of the OECD.
Even in the developed world, there is increasing pressure for farmers to produce more. This year, farmers in the United States are expected to plant more corn than they've ever planted before, despite the dwindling number of actual farmers. Agricultural productivity in the developed world has come to depend on machinery, and unlike automobiles, which can last for more than a decade, agricultural machinery needs to be replaced every three to seven years. While developing markets present a huge growth opportunity, developed markets can be expected to remain somewhat stable even in hard times.
Why buy all three companies?
In order to get the most out of investing in the tractor industry, you need to understand the nuances to the different companies.
Deere (NYSE: DE ) commands a 50% market share in the United States and generates more sales than most of its competitors combined. However, Deere gets 60% of its sales from the U.S. and Canada, where tractor use has basically been unchanged for the past 50 years. The stability of this business, not to mention its steadily increasing dividend, makes it an attractive long-term holding, but also a boring one.
The world's second-largest tractor company, CNH Global (NYSE: CNH ) , isn't much more exciting. CNH is an important player in the European market, which has more tractors in use than the U.S., and the Euro area also has a greater percentage of arable land. Between Deere and CNH, you would have most of the tractor market in the developed world locked down.
AGCO (NYSE: AGCO ) is where things get exciting. It gets a healthy percentage of sales from developed countries, but the largest reporting region is South America at 21%. South America is a rich opportunity for growth in this industry. Not only does it have a relatively low number of tractors, it has a large amount of arable land. Brazil alone is one of the world's largest producers of corn, soybeans, and cotton.
AGCO's merger appeal
Last fall, AGCO also purchased grain storage maker GSI Holdings, citing the opportunities in developing countries, like Brazil, where farmers generally don't have storage capabilities. The acquisition was generally seen as irrelevant to AGCO's core business, but it seems to make sense. Tractors help farmers grow and harvest more crops on more land, but without proper storage, those crops will rot if the farmer can't find an immediate buyer.
At the time of the acquisition, AGCO's CEO mentioned that by diversifying into a tangentially related business, it opened the door to other tangents, like irrigation, milking equipment, and wind energy. The irrigation market is highly consolidated, making Lindsay Corp. (NYSE: LNN ) one of the only likely acquisition candidates, and milking equipment might make sense, but a wind energy acquisition sounds like diworsification to me.
You should be cautious not to rule out such a zany acquisition either. AGCO's important Challenger line of tractors was originally purchased from Caterpillar (NYSE: CAT ) 10 years ago. In a recent interview, AGCO's CEO said he would not rule out letting the company be acquired by Caterpillar if an offer were made or even the possibility of acquiring the much-larger CNH.
The Foolish bottom line
This is one industry where I don't think it's necessary to pick a winner. Each company has its niche and there's enough market to go around. By buying all three, you should benefit from the continuing and growing need for mechanized agriculture throughout the world. That's why today I'm making a broad CAPScall, with outperform calls on Deere, AGCO, and CNH Global.