Cherry-Picking the Best Agricultural Companies

The U.S Agricultural Department recently lowered its 2013 net farm income estimates from $128.2 billion to $120.6 billion, stating that record production of crop and soybean could weigh on U.S. farming receipts. However -- even after the lowered estimates -- the predicted 2013 net farm income is about 6% higher than last year's $113.8 billion. Moreover, this amount will be the second highest inflation-adjusted U.S net farm income since 1974. 

This presents an investment opportunity. With U.S. net farm income on the rise, disposable income among farmers should increase. Farmers in the U.S. will have the cash to upgrade or purchase their desired agricultural machinery. So, equipment manufacturers having a significant exposure to the U.S. agricultural sector stand to benefit here.

An outperformer
CNH Global (NYSE: CNH  ) is the world's second largest manufacturer of farm equipment, with operations in about 170 countries. It is also the world's largest manufacturer of farm tractors with 37 manufacturing facilities and 28 development centers across the globe. The equipment behemoth derives 44% of its revenues from North America and its revenues from selling agricultural equipment accounted for 84% of its FY12 revenues. Basic calculations reveal that CNH generates nearly 37% of its total revenues from selling agricultural equipment in the U.S. 

At first glance, CNH Global's TTM capital expenditures of $2.035 billion ring caution bells. However, the picture soon turns optimistic. These huge capital expenditures are due to its recent expansions in Argentina, China, India, North America, Russia, and Brazil, to grow its market share and diversify its revenue streams. On completion, CNH will also have the option to use these facilities for global exports and take advantage of the inexpensive manpower in emerging nations. 

Talking about the ongoing fiscal year, management of CNH estimates that the strong demand from the U.S. can offset the slowing down sales in Europe. As a result, its FY13 agricultural equipment sales volume has been guided to remain flat. However, CNH is also targeting its FY13 operating margins to hover between 8.5% and 9% due to better product pricing and lower input costs. This is higher than last year's 8.37% and the favorable product pricing is expected to catapult its overall FY13 revenues by 5%. 

A troubled peer
On the other hand, Deere (NYSE: DE  ) doesn't appear that attractive. The equipment behemoth generated about 64% of its revenues from Canada and the U.S. (combined), and its agriculture and turf segment represents about 78% revenues. Deere is also the largest agricultural equipment manufacturer in the U.S. But the company has disappointed Wall Street. 

Deere's management estimates that overall cash receipts from crops will be the second highest in U.S. history. But it also believes that Deere's net sales in the fourth quarter could shrink by up to 5%. The unfavorable economic and meteorological conditions in Europe are weighing down on the entire industry. But the recent 27.5% hike in the import duties of Belarus, Kazakhstan, and Russia is threatening Deere's existing market share. 

Deere doesn't have manufacturing facilities in any of the above-mentioned countries, and has to import its equipment to furnish deliveries. So its equipment offerings automatically receive a price increase due to the hiked import duties. However, CNH Global and Kamaz International manufacture tractors in Russia,under a joint venture signed in 2010. So its pricing structure remains unaffected in the country. This makes it easier for CNH to snatch Deere's market share in Russia. 

An unaffected peer
However, investors shouldn't assume that AGCO (NYSE: AGCO  ) will benefit a great deal from the record U.S. farming receipts. The equipment manufacturer is present in over 140 countries and its operations in Europe account for about half of its revenues. Further, AGCO operates with a meager market share in the North America, and it generated around 74% of its revenues from outside of North America. So its financial performance is reliant on economic and meteorological conditions in Europe, rather than the U.S. 

Due to the excessively wet and cold weather conditions in Scandinavia, Finland, and the U.K, crop production in Southern and Northern Europe is expected to be weak this year. Although France and Germany are expected to produce solid crop yields, management of AGCO estimates that production from these nations can only partially offset the declining equipment demand from rest of the continent. With weakness in its largest market, management of AGCO estimates that its FY13 sales can shrink by up to 5% this year. 

Bottom line
It's worth noting that AGCO is a perfectly healthy company growing at a rapid rate on the back of its expansions in emerging markets. But AGCO's financial performance is not heavily reliant on the U.S., so it can't take advantage of the record U.S. farming receipts.

On the other hand, Deere has a gigantic presence in the U.S. But its weak guidance amid robust agricultural conditions in the U.S. has perplexed the Street. Further, there is no evidence to suggest that Deere can address its issues with import duty hikes in the coming quarter, which suggests that its weakness could continue in the next year as well.

So investors should consider taking a closer look at CNH Global. Its exposure to the U.S. provides a short- to medium-term trigger while its expansions in the emerging markets can fuel its growth momentum over the longer run.

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