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Why the Agricultural Equipment Market Is Looking Up

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Agricultural equipment is concerned with not only the tractors, harvesters, planting and irrigation equipment, sprayers, hay equipment and all the other things that make farming possible but also the basic processing equipment that enables the produce to reach end markets.

The strongest factor driving the industry is the rising global population, which is increasing demand for food and also other items. Moreover, since food is a necessity, governments are taking every measure possible to bring food security to populations. This has often led to lenient regulation and financial assistance for producers that helps them invest in agricultural equipment.

The other major factor driving equipment sales is the advent of “precision agriculture.” This is the use of auto-guidance systems to match field data (such as topography and soil conditions) with crop yields. The goal of precision agriculture is to develop scientific methods of farming that maximizes the yield on inputs with minimal environmental impact.

A common theme across geographies is the rising cost of agricultural labor because of the pay differential between the agricultural and industrial sectors. This is the secular driving force behind the demand for agricultural machinery.

In addition, the explosive population growth in Asia is increasing equipment demand and this trend is expected to continue over the next few years. However, since land holdings and farmer income are quite small in big agricultural markets like India, the nature of equipment demand differs from that in the west.   

In Australia there is significant land available for agriculture but declining agricultural labor as they continue moving toward higher-paying jobs. At the same time, there’s huge demand for Australian agricultural produce in Asian countries like China. This has led to government support in the sector as well as steadily rising mechanization.

In Europe, the situation is quite different. This is one of the most advanced markets for agricultural equipment with low available agricultural land necessitating intensive farming measures. Here too, agricultural labor remains in secular decline, with the inequality between farm labor and industrial labor income continues to push more people out of farming.

The rising labor costs are also driving producers to consolidate holdings to save cost and increase their operational efficiency through mechanization. COVID has exacerbated the situation because seasonal labor was prevented from crossing borders from Eastern and Central Europe, as well as Africa.

In South America, the increasing availability of land is making manual operations more and more difficult, which is driving more farmers to mechanization. The region is also enthusiastically adopting precision farming measures, which is a positive for the industry.

Mechanization is a central part of agriculture in North America, primarily Canada and the U.S. Increasing farm size, labor shortage, adoption of precision ag methods and government support drive the Canada market.

Times have been really tough for farmers in the U.S. and COVID has only made matters worse. After several years of bad weather including droughts and hurricanes, farmers found that the higher production of things like wheat in the Black Sea region and soy, corn and cotton in South America were also affecting commodity prices. Then there was the trade war and retaliatory tariffs. So there was rising cost on the one hand and lower return on investments on the other, also leading to greater loan delinquencies.

When COVID came along, farmers had to deal with even lower corn demand due to the reduced consumption of biofuels. And as restaurants and eateries cut back demand, there was also some misalignment in demand and supply. Government assistance did come in handy, but relatively resilient exports (because of relatively inelastic demand for food and largely ocean transport) also helped. In the first seven months of 2020 for example, U.S. agricultural exports declined just 3.5% while non-agricultural exports dropped 18% (USDA data).

The demand for tractors and other forms of mechanization has always been strong in the North America market because of the large-sized farms. Today, farms are deploying more sophisticated tractors/machines that are using AI for decision-making. However, the scope for further expansion in demand is significant and being a more advanced user of machinery, there’s also significant demand for replacement parts.

So the overall outlook for the agricultural machinery segment is robust and longer-term drivers remain in place. The only pinch, if you can call it that is the cost of modern machinery, which tends to impact replacement cycles. There’s also some concern about the environmental impact of the increased use of machinery in agriculture.

Not all of the top players in the industry have a Zacks #1 (Strong Buy) or #2 (Buy) rank right now. But that isn’t necessarily because their long-term prospects have deteriorated. Take #3 (Hold)-ranked AGCO Corp. (AGCO - Free Report) for example. The company is one of the largest suppliers of agricultural equipment, including tractors (57% of 2019 revenue), replacement parts (15%), grain storage and protein production systems (11%), Hay Tools and Forage Equipment, Implements & Other Equipment (10%), combines (3%) and Application Equipment (3%). Its business is also geographically diverse with North America accounting for 24%, South America 8%, Europe and Middle East 60) and Asia Pacific 8).

With a Growth Score of B and Value and Momentum Scores of C, the company is expected to grow earnings at a double-digit clip both this year and in 2021. What’s more, its 2020 earnings estimate jumped 31.2% and 2020 estimate jumped 18.5% after the company reported solid September quarter results, wherein it beat the Zacks Consensus Estimate by 104.9%.

However, while the shares look inexpensive, most of the good news is currently priced in. So in the absence of a catalyst, they may continue to trade sideways.

Three companies that are doing well and are also expected to see share price appreciation are-

Deere & Company (DE - Free Report)

Deere is currently the world’s largest producer of agricultural equipment, manufacturing agricultural machinery since 1837 under the iconic John Deere brand with its signature green and yellow color scheme. Illinois-based Deere is the only agricultural and farm machinery player in the S&P 500 Index.

After beating the Zacks Consensus Estimate by 66.0% in the October quarter, the Zacks #1-ranked Deere & Co saw 2021 and 2022 estimates jump 22.5% and 24.9%, respectively (the company’s fiscal year ends in October).

Revenue is currently expected to grow 11.6% and 8.8% in these two fiscal years while earnings grow 46.0% and 21.0%.

There’s currently a Value score of C on the shares although both Growth and Momentum scores are at B.

At 19.41X forward earnings, the shares are trading above their median value over the past year. But the growth prospects seem to indicate further upside potential, especially since the shares are still well below the annual high of 32.36X earnings.

 

Alamo Group, Inc. (ALG - Free Report)

Alamo Group is a leader in the design, manufacture, distribution and service of high quality equipment for infrastructure maintenance, agriculture and other applications. Its products include truck and tractor mounted mowing and other vegetation maintenance equipment, street sweepers, snow removal equipment, excavators, vacuum trucks, other industrial equipment, agricultural implements and related after-market parts and services.

The Zacks Rank #2 stocks has a Value Score B, Growth score A and Momentum score D.

There’s only one analyst providing estimates on this stock, so there aren’t a whole lot of numbers to mention. The analyst currently expects earnings to decline 6.4% this year and grow 31.2% in the next, when EPS is expected to be significantly higher than in 2019. After topping the Zacks Consensus Estimate by 27.5% in the last quarter, estimates for the current and next years are up 7.8% and 6.0%, respectively.

The shares are trading above their median P/E, but there’s room for further appreciation.

 

Lindsay Corp. (LNN - Free Report)

One of the pioneers in the automated irrigation segment, Lindsay Corporation provides a variety of proprietary water management products (72% of revenue) and road infrastructure products and services (28%).

The company beat the Zacks Consensus Estimate by 28.6% in the last quarter, after which estimates for the current and following years increased 11.7% and 12.6%, respectively. Earnings are currently expected to decline 11.2% this year before growing 16.0% in the next when the EPS should be above the 2019 level.

The shares also don’t look expensive given their growth prospects and the fact that they’re trading well below their annual highs.

 

No wonder this is such an attractive industry at the moment, with a Zacks Industry Rank of 8 (top 3%).

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