Morningstar Magazine - February/March 2015 - 68

Strategies

Down on the Farm
Soft farm-equipment sales have
dinged AGCO shares despite its robust
exposure to emerging markets.

BEST IDEAS: EQUITY

Kwame Webb

AGCO AGCO is the most globally diversified
agricultural machinery company that Morningstar
follows, and we believe it is leveraged to
increasing agricultural mechanization and higher
calorie consumption in emerging markets.
For the past decade, the investment thesis for
agriculture was based on a need for increased
farm productivity in developed markets to
satisfy growing ethanol mandates or in emerging
markets to satisfy higher caloric intake and
changing dietary patterns. Globally, the major
ethanol consumers-the United States, Europe,
and Brazil-have reduced the pace of
ethanol consumption because of ethanol's cost
structure and global politics surrounding
the use of food to fuel automobiles. Ethanol
production will not significantly increase the need
for more planted acres and higher acreage
yields, but growing emerging-markets calorie
consumption and dietary patterns will increase the
need for more crops. With nearly 30% of sales
from emerging markets, AGCO is highly leveraged
to changing emerging-markets dietary patterns.
AGCO manufactures a wide range of agricultural
machinery. Sixty percent of sales come
from tractors that it sells under the Challenger,
Fendt, Massey Ferguson, and Valtra brands.
Hay tools, forage equipment, and engines are the
second-largest product line, generating 9%
of sales. Combines, along with grain and protein
production systems, each generate 7% of sales.
An additional 13% of sales originate from
replacement part sales.

68

Morningstar February/March 2015

Products are sold through a large but independent
network of 3,100 dealers. Although AGCO has
an expansive dealer network, it needs to support
multiple subscale brands with limited marketing
and research-and-development budgets.
This limits its ability to more aggressively compete
against its strongest rival, Deere & Co DE.
In North America, AGCO is the third-largest tractor
manufacturer, with a 10% share. In emerging
markets, AGCO has a far more impressive
leadership position. In the high-growth Brazilian
agriculture market, which has benefited from
growing ethanol mandates and higher-calorie diets,
AGCO has a commanding 50% share.
Near-Term Outlook

Our $53 per share fair value estimate reflects
a soft 2015 outlook for global farm income.
However, we expect AGCO's recently announced
aggressive cost restructuring actions to help
the firm navigate that environment. Despite a 2015
outlook for a 5.5% operating margin, we believe
normalized profitability is closer to 7.5%,
yielding attractive longer-term earnings and cash
flow growth from current levels.

to grow 5% to 10% on demand for grain storage
and protein feeding products.
AGCO expects lower working capital and capital
expenditures to yield $300 million of free
cash flow in 2015. At a recent analyst event, the
company also unveiled a new $500 million
share-repurchase plan, which will be a primary use
for 2015's free cash flow. In outlining its outlook
for 2015 earnings per share of $3.00, the
company did not include benefits from the new
share-repurchase plan, which offers some upside
to our EPS outlook.

Relative to the weak sales outlook, AGCO will
aggressively pursue $150 million of cost
reductions over the course of 2015. Approximately
$60 million of the cost reductions will
come from better low-cost country sourcing
and globally coordinated raw materials
purchases, while the remaining cost reductions
will come from staff reductions in virtually all
business functions.
Lacking a Moat
AGCO has generated an attractive 13%

return on invested capital over the past decade,
but we do not believe it has a moat. In
the heavy-equipment industry, we generally
believe an economic moat is a function of
perceived product quality, the quality of the dealer
network, and an ability to leverage a captive
financing subsidiary. These three factors
are usually demonstrated by a manufacturer's

AGCO AGCO
Sector

AGCO's 2015 industry outlook was very similar
to wide-moat Deere's outlook in the European and
South American markets, where industry
sales are expected to be down 5% to 10% and 10%,
respectively. The bigger area of divergence
is in North America, where AGCO only expects
industry unit sales to decline 5% to 10% (relative to
Deere's 25% to 30% estimated decline in farm
equipment sales). We have chosen to revise our
outlook closer to Deere's more conservative
outlook. Nonetheless, AGCO should outperform
Deere in North America as its GSI business is likely

Industrials

Market Cap (Bil)

$4.1

Price

$45.20

Fair Value Estimate

$53.00

Morningstar Rating

QQQQ

Uncertainty

High

Economic Moat

None

Stewardship Rating

Standard

Morningstar Credit Rating

BBB-

Data as of 12/31/2014
Morningstar Magazine - February/March 2015

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