Value Play: AGCO Corp. (NYSE: AGCO)

AGCO Corp. (Nasdaq: AGCO) is the third-largest farm equipment company in the world –behind Deere (DE) and CNH Industrial (CNHI) – and sells tractors under the iconic U.S. brand name Massey Ferguson, as well as Fendt (Europe) and Valtra (South America). That’s an advantageous position in which to be when you realize that the world’s population will rise to more than 9 billion people by 2050 from 7 billion today (an increase of at least 30 percent). Food demand is expected to rise even faster–2.4 times as fast (a 70 percent increase in the rate of growth)–due to shifts in consumption among the growing middle class in emerging markets toward meat and dairy (which require more grain than basic foodstuffs). According to the Rise of the State: Profitable Investing and Geopolitics in the 21^st Century:

Only about 5 percent of Chinese are considered middle class, but this share is forecast to grow to 56 percent by 2030. Chinese eat two times as much meat as Indians and 40 percent more than they consumed in 1990. A similar expansion of the middle class in the rest of Asia and other developing regions would place even more strain on [grain and] freshwater supplies.

This additional food demand cannot be met without a substantial investment in additional food production capacity. Agricultural output must double by 2050. This is quite a challenge since most of the world’s productive agricultural land is already being farmed. Furthermore, the number of people available to work on farms is dwindling as the world’s population shifts to urban areas (urbanites surpassed 50 percent of the total population in 2010 and will hit 70 percent by 2050).

The bottom line is that simply adding more basic farm machinery won’t get the job done. Instead, the key to feeding the world’s growing population is more productive farm machinery. Many analysts forecast that agricultural productivity must increase by 25 percent per year to meet demand.

The company has sustained its excellent financial performance thus far in 2014. AGCO’s recent first-quarter earnings report beat analyst estimates and the company affirmed guidance of full-year earnings per share of $6.00. At a current stock price of $54.54, AGCO is darn right cheap at less than 10 times forward earnings. However, some analysts believe that the farm equipment cycle has peaked and that AGCO faces declining earnings in 2015, so that the low P/E ratio is justified. Agricultural economist Robert Hill recently stated:

The big surge in capital expenditures on farm equipment and land is behind us. Three main factors may explain this draw down on capital expenditures. First is the fact that the farm fleet has been substantially upgraded during the surge of the past 3 to 4 years. Second is that the tax advantages of year-end purchases are disappearing. Third is that prospects for net farm income are down from historical highs. Farmers now are entering a cycle driven more by ‘replace as needed’ for their equipment.

Similarly, Goldman Sachs forecasts price drops during 2014 in corn, wheat, and soybeans. AGCO CEO Martin Richenhagen recognized the softening industry fundamentals in the Q1 report, but said the company was neutralizing the slowdown with efficiency improvements and a shareholder-friendly stock buyback:

Global industry demand is expected to soften in 2014 compared to 2013. Modest declines are anticipated for Western Europe and North America with more pronounced declines in South America. We are focusing our efforts on increasing productivity and reducing material costs throughout our operations to offset these market headwinds. We also demonstrated our commitment to return cash to stockholders by making meaningful progress with the $500 million share repurchase program announced in December of 2013.

The $500 million stock buyback is a shareholder-friendly move and is significant because it represents almost 10% of the company’s $5.2 billion total market capitalization. The company also announced a 10% increase in its quarterly dividend, which is another way to return cash to shareholders. The payout ratio (dividends/earnings) is only 7%, so there is plenty of runway for future dividend increases.

AGCO is also geographically diversified, with only 25% of its sales coming from North America. Its largest market is Europe with 50% of sales, and South America accounts for another 20% (where it holds a 50% dominant market share in Brazil). AGCO’s 2011 acquisition of GSI, a leading global manufacturer of grain storage and protein production systems, has also provided the company with product diversification.

Although AGCO faces industry headwinds, I believe the company’s stock price is so cheap right now at an EV-to-EBITDA ratio of 5.5 that an investor who buys now can outperform the market over the next couple of years. An AGCO insider – director Mallika Srinivasan – has consistently bought large chunks of the stock and is now the largest individual shareowner with an 8.2% stake, which comprises almost the entire insider ownership percentage of 9.1% (page 16). Srinivasan is the CEO of Tractors and Farm Equipment Limited (TAFE), the second-largest tractor manufacturer in India.

Interestingly, AGCO returns the favor by owning a 23.75% ownership stake in TAFE. In the company’s recent 10-K filing (page 32), the relationship with TAFE is described this way:

TAFE manufactures Massey Ferguson-branded equipment primarily in India and also supplies tractors and components to us for sale in other markets. Mallika Srinivasan, who is the Chairman and Chief Executive Officer of TAFE, is currently a member of our Board of Directors. During 2013, 2012 and 2011, we purchased approximately $90.7 million, $104.5 million and $80.4 million, respectively, of tractors and components from TAFE.

The cross-holdings between TAFE and AGCO have raised analysts’ eyebrows. While the two companies are collaborating on the development of a small-sized brand of “world tractors” (50 to 125 horsepower) to sell in emerging markets where farm sizes are smaller than the agri-farms in the U.S., this does not explain why Srinivasan is personally buying so many AGCO shares. Some speculate that the companies may be preparing for a merger or Srinivasan simply views AGCO as tremendously undervalued. Others suggest that Srinivasan simply wants to use the voting power of her AGCO shareholdings to ensure that AGCO continues to buy tractors and equipment components from TAFE. Whatever the case, AGCO is undervalued and has a bright future of growth in the emerging markets, not only in India through its affiliation with TAFE, but also in Russia through a joint venture with Russian Machines, as well as in Africa thanks to $100 million in investments.

The company is nicely profitable (15% return on equity), sports a strong balance sheet with low debt at 33% of equity, and a five-year PE ratio-to-growth (PEG) ratio of 1.02 suggests growth at a reasonable price. All these financial indicators point to AGCO as a “strong buy.”

AGCO Corp. is a buy up to $63; I’m also adding the stock to my Value Portfolio.

Momentum Play: Vipshop Holdings (NYSE: VIPS)

According to China-based iResearch, Vipshop Holdings is China’s leading online discount retailer for brands as measured by total revenues in 2013 and the number of monthly unique visitors in December 2013. The company’s business model is to offer high-quality branded products to consumers in China through flash sales on its vip.com website. Flash sales represent an online retail format combining the advantages of e-commerce and discount sales through selling a finite quantity of discounted products or services online for a limited period of time (page 42).

The company’s U.S. initial public offering (IPO) occurred back in March 2012 at $6.50 per share. With the stock now trading at $154, price momentum has been tremendous. If you can believe the company’s financial reporting, fourth-quarter revenues were up 117% and earnings were up 300%. Many analysts are bullish including Zacks and Credit Suisse. Most recent price- target boost occurred on May 5^th when Nomura raised its price target on the stock to $210.

In March, some insiders cashed out in a secondary offering at $143.74 per share, but new investors purchased five-year convertible bonds with a conversion price of $201.24. The stock’s all-time high price of $182 occurred on March 4^th and if the stock were to revisit that level, the gain from the current $154 price would be 18.2%.

The company is profitable (32% return on equity), has 18% insider ownership, virtually no debt, and sports a low beta of 0.90. Looks like a “quality” momentum stock assuming Chinese accounting is accurate.

Under my new price-momentum model, Vipshop scores a very-high momentum rating of 383.07:

• Price gain between 12 months ago and 3 months ago = 421.22% (100 percentile)
• Price gain over the past 2 months = -7.11%
• Price gain over the past month = 15.09%
• Roadrunner Momentum Rating: 421.22 – (-7.11) – (3*15.09) = 383.07

Vipshop Holdings is a buy up to $175; I’m also adding the stock to my Momentum Portfolio.