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On Feb 22, we downgraded our recommendation on AGCO Corporation (AGCO - Analyst Report) from Outperform to Neutral. The leading manufacturer and distributor of agricultural equipment and related replacement parts witnessed the downgrade on soft demand for grain storage and protein production equipment, start-up issues at the Marktoberdorf plant and increased engineering expenses to meet Tier 4 requirements that will weigh on near-term results. AGCO retains a short-term Zacks Rank #3 (Hold).

Why the Downgrade?

AGCO Corporation’s revenues in the fourth quarter increased 7.4% year over year to $2.7 billion, mainly driven by higher sales in South America and the Asia-Pacific. However, fourth-quarter 2012 adjusted earnings declined 31% year over year to 99 cents per share.

AGCO expects adjusted earnings per share for 2013 to be in the range of $5.10-$5.35, based on higher crop prices and stable equipment demand. Its earnings forecast include a year-over-year increase in income tax expense of 40 cents per share. The company is targeting revenues in the band of $10.2 $10.4 billion, factoring in pricing benefits and neutral currency impact.

According to the U.S. Department of Agriculture, U.S. farm income will be a record $128.2 billion in 2013, up 14%. This will be driven by high market prices and crop insurance payments that will offset losses from the drought.

Prices for corn, wheat and soybeans are projected to remain historically high and above the pre-2007 levels. AGCO expects that elevated agricultural commodity prices in 2013 will support healthy farm income and sustain stable equipment demand.

The company remains committed to its plans of expanding in the Commonwealth of Independent States (CIS), China, and Africa given considerable growth prospects in these markets where immense areas of farmland are currently under cultivation with less efficient machinery.

Backed by a sound balance sheet and strong demand for farm equipments, AGCO is in a position to return cash to shareholders more efficiently. In Jul 2012, AGCO introduced share repurchase of up to $50 million of its common stock and in Jan 2013, its board initiated a quarterly dividend of 10 cents per share starting in Mar 2013.

On the flipside, EAME results were negatively impacted by lower production and start-up issues related to the recent expansion of capacity at its Fendt facility in Marktoberdorf, Germany. The expansion is expected to increase the annual capacity from 15,000 units to 25,000 units.

However, transitional issues are negatively impacting efficiency, hampering both shipments and profitability metrics. This is expected to be a headwind in the first quarter of 2013 as well.

AGCO is experiencing softness in demand for grain storage and protein production equipment as a result of lower crop production volumes due to the droughts in North America. Furthermore, margins will be under pressure as engineering expenditures are expected to increase as the company strives to meet Tier 4 emissions requirements.

Other Stocks to Consider

Other farm machinery makers with a favorable Zacks rank are Lindsay Corporation (LNN - Analyst Report), which retain a Zacks Rank #1 (Strong Buy) and CNH Global NV and Deere & Company (DE - Analyst Report), which retain Zacks Rank #2 (Buy)

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