AGCO Makes a Bold Bet

Over the next three years, AGCO (NYSE: AGCO  ) plans to invest $100 million  building up its manufacturing presence in Africa. This is a significant bet on the future of food and farming, one which AGCO itself admits won't pay off for the next few years, but which will reward investors well for their patience. Emerging markets like Africa represent a big opportunity for farm equipment manufacturers, and AGCO is at the cutting edge.

One of the last frontiers
Farmers in the OECD, a group of mostly rich countries, are among the most productive in the world, managing crop yields that tend to be about 40% higher  than the global average. They have a lot to thank for that, not least of which is the great abundance of agricultural machinery. The World Bank uses tractors in use per 100 square kilometers of arable land as a measurement of agricultural machinery use. In 1998, OECD countries used more than twice  the global average.

Farmers in Africa, however, are not so lucky. The majority of cropland there is plowed, planted, and picked by humans, an inefficient use of both the land and the people. Crop yields are typically about a third  of the averages seen even in other developing regions such as Asia and Latin America. Again, this is partially explained by a lack of agricultural machinery. In 1980, Sub-Saharan Africa had about 20 tractors per 100 square kilometers of arable land. In 2003, it was down to 13. By comparison, the global average is about 200, a massive divide.

Obviously, there's a reason Africa is so far behind. The region is, for the most part, poor and not many farmers have access to banks and credit to finance tractor purchases. To that end, AGCO plans to work with Rabobank, which primarily specializes in international agriculture lending, to expand financing options.

More importantly, however, AGCO recently built a $35 million parts distribution warehouse in South Africa, and has plans to build another plant in Algeria to manufacture its Massey Ferguson line of tractors. Other plans haven't been announced yet, but the company says that it plans to be in Africa "for 100 years and more." The Algerian plant is expected to produce up to 5,000 tractors per year, and as the company brings more manufacturing to the continent, it will increase its foothold.

A missed opportunity
Meanwhile, Deere (NYSE: DE  ) , the world's largest tractor company, seems comparatively unconcerned with emerging markets. It separates its sales into only two regions: the U.S. and Canada, and outside the U.S. and Canada, representing a fairly North America-centric focus. In 2011, equipment sales outside the U.S. and Canada represented only 41% of total equipment sales, and that number dropped to 38% this year.

It's true that the American economy, battered as it is, has fared better than most of the world, but it seems like Deere is wasting the opportunity to spread its brand and gain global share. As a quintessential American brand, Deere is essentially the Coca-Cola (NYSE: KO  ) of tractors -- and yet Coke gets 60%  of its revenues from outside the U.S. Far from resting on its North American laurels, Coke aggressively pursued Africa and is one of the top brands  on the continent, forcing Pepsi to struggle to even enter the market.

Deere is at least expanding in Latin America, but AGCO and CNH (NYSE: CNH  ) are already big players, and AGCO is also expanding. The company aims to increase its sales in the region through last year's acquisition of GSI Holdings, a grain storage business. Farmers in South America aren't particularly low on tractors, but they do lack adequate storage capabilities, which will become increasingly important as the world looks to such countries as Brazil to pick up America's slack during bad seasons like this recent summer. In fact, Brazil will soon surpass America as the world's largest soybean grower.

It's worth noting also that CNH recently accepted a merger offer from Fiat, its majority shareholder. The two companies believe the merger will bring useful synergies, but the disruptive restructuring period may give AGCO a chance to narrow the gap with its closest rival.

The Foolish bottom line
Africa is a frontier market with a lot of risks. But not that long ago, the same could be said of Brazil and China. By investing in the region now, AGCO can get important name recognition and brand loyalty, giving the company an edge over less adventurous competitors.


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