Sunday, April 12

Week 197 - Farm Tractors

Situation: You’ve no doubt noticed that we prefer to blog about food and agriculture. And we’ve told you why, several times. But even though such companies enjoy certain advantages, and the relatively strong and stable earnings that come from those advantages, their stocks still don’t fit into retirement portfolios very well. You’ll need to be selective, and be willing to trade stocks as opposed to forgetting about them (confident that they’ll keep doing well over the long term). For example, fertilizer companies produce a commodity and may depend on an expensive commodity like natural gas to make fertilizer. But commodity markets, always and everywhere, are a font of volatility. Companies can go out of business if they depend on a commodity and haven’t hedged its future cost. Farmers also have to do that, to be sure they’ll get the right price for their grain at the end of the growing season. 

So, we have to look at the inputs to food production as well as outputs which, in a stepwise process, result in packaged food on the grocery store shelf. You have to break down the economic value of each participant. This week we’ll look at farm tractors, one of the main inputs to agriculture. In future weeks we’ll look at others: farmland rents, harvesters (combines), seed, animal feed, irrigation systems, insecticides, herbicides, fungicides, farm labor, and property taxes. A key point to remember is that farmers won’t spend any more money on these inputs than they have to unless they made out very well at the end of the last growing season. In other words, they sold their crop or their animals into a market characterized by scarcity of those items: prices were high. Those shortages only happen when farm production has fallen precipitously in one of the world’s important producing countries (Australia, Brazil, Argentina, Ukraine, China, India, Canada, or the US). When crops are abundant in all those places, prices fall to a point where farmers are doing well to break even. Those farmers will not be replacing their old tractor soon. That’s why these stocks have such a high beta (see Column I in the Table). They also performed poorly in the Great Recession (see Column D in the Table), but farmers’ lack of interest in buying tractors was for reasons external to the prices they received for farm commodities (which held up well). 

Tractors are sold worldwide by several companies but farmers in different parts of the world prefer certain tractor brands over others. Deere (DE) is the leading tractor producer and a big name in the US and South America, but AGCO tractors(the 3rd leading producer) are the first choice in parts of Europe and Asia. Case-International Harvester (CNHI) tractors run second. And, tractors have many uses so there need to be companies that provide the various accessories; Tractor Supply (TSCO) has done well in that area. As the standard tractors become more complex (i.e., digitized) they’ve become more expensive (sometimes costing $300,000 or more). That leaves a market for smaller and simpler tractors; Kubota (KUBTY) has done well in that area. You’ll see financial metrics for all these brands in this week’s Table. Caterpillar (CAT) is also on the list, even though it no longer makes farm tractors, because it produces tractor-like construction equipment (end-loader/backhoes for example) that are useful on large farms. 

Bottom Line: If you want to invest in production agriculture, you’ll need to first consider buying stock in one of the companies that make farm tractors. Warren Buffett has caught on to the value of making such an investment, recently buying $1.7B more stock in Deere (DE). Indeed, several of our favorite valuation measures (see Columns G through S in the Table) make DE look like the best choice of group. You can read more about the unique value of production agriculture investments by checking out our previous blogs on the topic (see Week 165 and Week 184).

Risk Rating: 6

Full Disclosure: I own shares of DE.

NOTE: In the Table, the metrics highlighted in red denote underperformance relative to our key benchmark, Vanguard Balanced Index Fund (VBINX). All metrics are current as of the Sunday of publication.

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