Sunday, January 22

Week 290 - Farm Tractors

Situation: The “green revolution” started in the 1920s with the introduction of mechanization to agriculture. Tractors replaced mules, along with large cadres of farm workers. After 100 years of improvements, tractors have evolved into internet laboratories designed to optimize crop yields, and fitted-out like a home-office. Competition is fierce, with tricked-out models costing 10 times more than basic tractor models. Dealerships for those basic models, like the Mahindra Tractor made in India, are starting to pop up in the US. Remember that manufacturer’s name because it’s the top-selling tractor worldwide. However, there will soon be an even more stripped-down model coming to market, one built in Cuba by an American company (Cleber), named the Oggun 1.0, to be priced at $10,000.

Mission: Standard spreadsheet to lay out important metrics to consider before buying stock in one of the main tractor companies. Detail performance of commodity futures and the Dow Jones Commodity Index, and combine that with earnings projections for tractor and combine producers.

Execution: see Table.

Administration:  Deere’s most recent quarterly results: year-over-year (y-o-y) declines in both profit and revenues but both beat projection and both are projected to be down less in 2017. 

Caterpillar’s most recent quarterly results: y-o-y declines for both revenues and profit; missed projections for both; downgraded revenue and profit projections for FY16.

CNH Industrial’s most recent quarterly results: y-o-y decline in revenues but y-o-y increase in profit; full year guidance “reaffirmed.” Interestingly, I live near a CNH Industrial plant at Grand Island, NE, that produces New Holland combines. The plant has been idled for the past 2 yrs but recently started running one shift. New Holland combines are going onto flatbed trucks at the rate of several a day.

AGCO’s most recent quarterly results: showed slight improvement y-o-y in revenues but a 90% fall in profits: “Lower global demand for farm equipment is expected to continue to negatively impact AGCO’s sales and earnings in 2016.” 

Kubota’s most recent results: revenue fell 5.9% in the first 9 months of 2016 vs. 2015. 

Commodity futures (see Lines 19-22 in the Table) document a strong negative trend in pricing for corn, soybean, wheat, and beef contracts over the past 5 yrs, likely due to overproduction that has resulted from favorable weather and the buildout of “precision agriculture” technology.

Bottom Line: Incomes for both farmers and ranchers have been falling worldwide because of an increase in the efficiency of production (“precision agriculture”), and favorable weather from “El Nino." El Nino will soon be replaced by La Nina, which will likely result in drier conditions. Farmers may then have the resources to buy up-to-date machinery. Actually, they’ve already started. And, the Dow Jones Commodity Index has resumed its upward trend after recently bouncing off the low set in 1999. But you should read the fine print!

caveat emptor: Five sectors support agricultural production: a) farm machinery (e.g. tractors and combines); b) fertilizers that replenish nitrogen, phosphorus, and potash in the soil; c) chemicals that insure a good crop yield, in terms of bushels per acre (herbicides, fungicides, and insecticides); d) transportation assets (trucks, highways, and railroads); e) financial services (short-term loans, mortgages, and commodity markets based on brokerages, which are regulated in the U.S. by the Commodity Futures Trading Commission). Worldwide weather patterns introduce an element of uncertainty that affects companies in all 5 sectors. When investors buy stocks issued by those companies, they have to allow for an extra dose volatility. So, which sectors are least impacted by weather? Probably the transportation sector, railroads in particular: Those monopolies are sanctioned and regulated by the government to be certain that their profits will be large enough to ensure adequate and safe maintenance of tracks and yards. Railroads also have clients other than commodity producers, which dilutes risk of loss from weather-related events. 

Risk Rating: 7 (where 10-Yr Treasury Notes = 1, the S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I own shares of Caterpillar (CAT at Line 3 in the Table) and offset that risk by owning shares of Union Pacific (UNP at Line 9 in the Table).

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 13 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K ( Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 26 in the Table. The ETF for that index is MDY at Line 12.

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