Farm Mechanization Increases in Emerging Markets to Meet Growing Consumption Needs
TWST: Broadly speaking, what are the most important issues impacting the agricultural machine sector?
Mr. De Maria: The broader global theme in the sector is a mechanization of farms in emerging markets to meet the increased consumption needs. The global mechanization in emerging markets to increase production on farms has become a significant change. Farms in emerging markets have had to become more efficient, more productive, as the world consumes more food and uses more biofuels. That is the major global theme that is happening over time.
The more near-term issue is the impact of the weather on production of crops and what that means for machinery and production going forward.
TWST: Traditionally, emerging markets have been challenged financially to upgrade their machinery. How are they able to afford it now?
Mr. De Maria: Right now, we are in a period of high commodity prices, so farmers are generating increased revenue in these markets. The challenge centers more around the ability to obtain financing to purchase equipment, given that financial markets around the world have been somewhat stressed.
TWST: Do these companies provide their own financing or is it generally outside companies funding it?
Mr. De Maria: Some of the companies provide their own financing through captive financing units. Others offer financing through joint ventures or agreements with financing companies. However, not all companies are willing to leverage their own balance sheet in emerging markets in times that are distressed like this.
TWST: Are we seeing strong growth in all emerging markets, or are some better situated than others?
Mr. De Maria: The major emerging markets in terms of growth for increasing horsepower and mechanization on farms is Eastern Europe and Russia, South America, and some other markets such as Turkey and greater Asia.
TWST: Do the companies build these products in the U.S. or do they have plants where their end markets are?
Mr. De Maria: They do it both ways. Farm equipment companies are global companies, and several have global manufacturing capabilities. They also have local manufacturing capabilities in the United States. Companies are setting up distribution and setting up manufacturing capabilities in other regions such as Russia. But then, they are also exporting to the regions as well. So to answer the question, they have some plants outside the U.S., but if the end market does not have a plant close by, they will ship product from the U.S. or other locations.
TWST: You mentioned the weather and its impact on machinery. Does that mean the machines are changing because of changes in the weather?
Mr. De Maria: Well, the weather affects expected pricings, especially the prices of commodities, obviously. So it affects the willingness of farmers to spend money on machinery given the uncertain environment, but also it affects it because the weather has been volatile. Farmers now need to get in and out of fields as quickly — and be as productive — as possible, which suggests more equipment and more horsepower over time. It isn’t that the weather is impacting the machines, but because the weather is impacting the crops, it is changing the need for machines.
TWST: Which companies in your coverage are best positioned right now and why?
Mr. De Maria: CNH (CNH), Titan International (TWI), Blount International (BLT), John Deere and Company (DE), AGCO (AGCO). These are the main ones, but those companies are all involved in global mechanization or in supplying equipment or tires, in the case of Titan International, to farmers in different regions of the world. These companies are really global, so they will all benefit from the major global trends we discussed over time.
Of all of them, Deere may be the best positioned, because it has the opportunity to increase market share and has more scale in the group.
TWST: Does name-brand recognition matter in this sector? Does a name such as John Deere carry more weight than lesser-known names?
Mr. De Maria: It does. Name brands are important because farmers tend to stick with equipment and are very loyal purchasers. So market shares don't shift around too much, but farmers want good reliable equipment that can be serviced effectively.
A company like Deere and others with outstanding reputations are recognized globally for their service capabilities and for the quality of their equipment. Farmers who are making these big investments don’t want to risk buying a product that is not going to last or that is going to need constant servicing.
TWST: What is the status of the supply chain for these companies?
Mr. De Maria: Generally, the companies are managed very well, and while there can be manufacturing hiccups from time to time, companies recognize the need for the distribution networks to have ability to service the equipment in the field, if it is so critical to the production and planning process. So they tend to keep an inventory of critical components really available so that the farmers don't lose any time while they are waiting for a part to come in.
TWST: You recently initiated coverage of Blount, and it is an "outperform." What do you like about that company?
Mr. De Maria: Blount is an interesting and underfollowed story. It has a very recurring and stable revenue stream. The company makes saw chains. Because the business is very stable, the company can reallocate resources into adjacent markets to accelerate its growth, and thus we think that in a moderate organic growth environment, the company can achieve solid double-digits earnings growth over the next few years.
TWST: And who are your other "outperforms" right now and why?
Mr. De Maria: Another "outperform" is Titan International, which manufactures wheels and tires for farm, construction and mining equipment. The company is currently consolidating the global farm tire business for agriculture and is expanding further into mining. So in agriculture, Titan has gone from a U.S. business to a U.S. and South American business, and is now entering Europe through consolidation.
We are also recommending Fiat Industrial (FI.MI), which is the 89.5% owner of CNH, and we do like the CNH subsidiary, but we also have a cyclical growth story. Over the next few years, we believe in commercial vehicles, which gives it a better growth profile.
We watch the entire agricultural value chain, and one interesting company is Titan Machinery (TITN). We don’t cover it and have no recommendation on it, but it is a good read-through for the ag business in North America, in general, because it is a consolidator of the distribution assets of CNH.
TWST: Overall, what is your outlook for the sector?
Mr. De Maria: The overall outlook is slow growth but positive outlook. We believe North America will be flat next year due to some trepidation with the drought and because that market has been so strong recently. But overall, outside of North America, we do expect further growth particularly in South America and a bit slower growth in Europe.
TWST: Is there anything you're particularly worried about in terms of the sector?
Mr. De Maria: Yes. We're always concerned about inventory levels and the ability of companies to finance equipment purchases. For example, if Eastern Europe were to slow down or could not get financing, that could end up backing up equipment and used equipment in Western Europe. So we closely watch used equipment prices in North America, and we take their values to make sure that trading values are strong to send devices to farmers to continue to train their equipment in and have a good return on investment on new equipment.
And overall, we're watching whether to see the impact of the weather on farmer sentiment into next year as that plays out over the winter.
TWST: Thank you. (LMR)
Note: Opinions and recommendations are as of 09/21/12.
Lawrence T. De Maria
Co-Group Head, Global Industrial Infrastructure
William Blair & Company, L.L.C.
222 W. Adams St.
Chicago, IL 60606
(800) 621-0687 — TOLL FREE