AGCO Corporation: Our Favourite Value Pick For The Agritech Boom (NYSE:AGCO)

The global agricultural sector is at a technological tipping point. Advances in automation and precision farming are rapidly disrupting traditional production processes and forcing producers to adapt to stay competitive. While small-scale producers who lack financial strength and technological know-how may struggle to keep pace with rapidly evolving technologies, this paradigm shift promises to meaningfully enhance productivity and profitability across the agricultural industry.

At Stratos Capital Partners, we view this as an opportune time to invest in agricultural technology (agritech). Problems associated with climate change, including unpredictable weather, temperature, and harvests, are only going to spur investments to optimise resource allocation, enhance yields, and better manage risks. Specifically, we believe that leading agricultural machinery and equipment manufacturers such as Deere & Company (DE) and AGCO Corporation (NYSE:AGCO) are well-positioned to disproportionately benefit from the accelerated adoption of agritech in the next couple of years.

In this article, we compare these two companies and discuss why we think AGCO is our preferred pick for investing in the agritech theme.

Dominating Through Scale

The competitive environment varies tremendously from industry to industry. From highly fragmented industries that compete predominantly on price to industries with well-differentiated products to industries dominated by a handful of companies that possess economies of scale. The ability to discern the competitive forces within an industry can be helpful in tactically positioning one’s portfolio.

One competitive environment that we particularly like resembles an oligopoly, defined as a market in which a few large sellers control a dominant share of the market. Oligopolistic markets are generally characterised as having homogenous products, few market participants, high barriers to entry, and inelastic demand. Although agritech broadly encompasses a variety of technologies spanning multiple market sub-segments and applications across different stages of the crop cycle, the agricultural machinery/equipment industry generally fits the characteristics of an oligopolistic market.

The development of agritech is intimately linked to the agricultural equipment industry, which is dominated by a handful of giant companies such as Deere & Company, AGCO Corporation, and CNH Industrial (CNH). According to data published by Counterpoint Research, these three companies make up around 70% of the global market share for connected tractors.

Oligopolistic markets tend to favour incumbent leaders as they have more bargaining power over suppliers, while price competition is less intense compared to highly fragmented markets. Market leaders also tend to enjoy more favourable financing terms from lenders and have bigger research and development (R&D) budgets versus smaller competitors. Moreover, as there is still healthy competition between the market leaders, such industries tend to attract less scrutiny from antitrust regulators. Overall, we see investing in the market leaders of an oligopolistic market as an attractive way to position our portfolio for the agritech boom.

Different Tracks of Growth

Various estimates from industry analysts see the agricultural machinery/equipment industry growing at a relatively stable 5%-7% compounded annual growth rate (CAGR) over the next decade. However, growth rates are likely to vary substantially depending on market segment and company size.

Although we see greater growth potential for smaller innovative companies, competition is likely to be intense given the highly fragmented nature of the most innovative segments of agritech. The difficulty in predicting which companies will be the eventual winners or losers makes stock picking a risky endeavour characterized by a high-risk-high-return profile. Not only is this unattractive on a risk-adjusted basis, but there are usually much better opportunities to pursue alpha. Furthermore, we expect many of the most innovative and impactful technologies to be acquired or quickly replicated by the market leaders. As we have mentioned previously, market leaders have much larger R&D budgets and the financial strength and flexibility to pursue bolt-on acquisitions. This means that the giant incumbents are likely to end up controlling the best technologies anyway.

The economies of scale enjoyed by DE and AGCO also allow these companies to develop their own agritech platform instead of pursuing standalone technologies. Doing so strategically enhances the network effect of a platform capable of running multiple connected technologies and applications.

AGCO, in particular, is pursuing an open platform structure that allows it to integrate multiple third-party applications. We view this as a critical advantage for AGCO.

Trimble Acquisition To Boost AGCO’s R&D And Precision Agritech Platform

In what we view as a strategic move to secure AGCO’s foothold in agritech, AGCO recently acquired an 85% interest in Trimble’s precision agritech assets through a joint venture for $2 billion in 2023. The transaction, which closed last month in April, will create a compelling mixed-fleet precision platform with access to Trimble’s hardware, software, and cloud-based applications. The joint venture will significantly enhance AGCO’s existing agritech portfolio, spanning the entire crop management cycle from land preparation to seeding, followed by crop maintenance to harvest.

AGCO’s management has consistently communicated its ambitions to accelerate growth in areas such as autonomy, precision spraying, connected farming, data management, and sustainability. We view the joint venture with Trimble as a critical move that will help fast-track AGCO’s growth plans in the coming years.

The agritech industry is racing to develop and introduce new technologies aimed at fully automating agriculture production flows. Climate change, which has increased the risk of drought in grain-producing countries, and geopolitical risks are fueling a global food crisis, with U.S. farmers scrambling to boost crop yields. Agritech will play an increasing role in driving production efficiencies and ultimately increased profitability for producers. And we think AGCO is in the best position to grow its agritech business in the coming years.

AGCO As A Pure-Play Agritech Equipment Pick

Our view that agritech will play a major role in driving agricultural production means that AGCO is our favourite pick. While DE’s business is more diversified (with 20% of revenues coming from construction, roadbuilding, and forestry), AGCO, on the other hand, purely focuses on agricultural equipment, with agritech applications becoming the fastest-growing part of the business in the next couple of years.

AGCO’s latest acquisition of Trimble’s precision agritech assets will significantly enhance its technology stack, which covers every stage of the crop cycle. This acquisition is also crucial for AGCO’s outlook, given that the industry is expecting tractor sales to slow through the rest of the year.

Q1 2024 Earnings & Guidance

It should come as no surprise that AGCO’s stock has been languishing in recent quarters (AGCO’s stock price has fallen back to levels near the market bottom in 2022). Management has been expecting weaker sales coming off from extremely strong numbers in 2023 and is guiding for further weakness throughout 2024. Meanwhile, expectations for interest rates to remain elevated due to delays in rate cuts from the Fed means producers will remain cautious with spending.

Below is an abstract from AGCO CEO Eric P. Hansotia’s comments during the latest Q1 2024 earnings call:

More challenging global market conditions are expected to continue in 2024 due to reduced commodity prices and lower farm income expectations. As a result, AGCO is forecasting lower sales in 2024. To mitigate these challenges, we will remain focused on manufacturing cost reduction opportunities, driving increased SG&A expense efficiencies and lowering company and dealer inventory.

In addition, AGCO’s growing precision ag business, full-line Fendt branded products and our parts business are expected to help us dampen the ag cycle. To better serve farmers, we will continue our investments in premium technology, smart farming solutions and enhanced digital capabilities to support our farmer-first strategy while helping to sustainably feed the world.

As the accompanying table shows, AGCO’s Q1 2024 results showed meaningfully lower sales and margins versus a year ago. Although this is largely in line with management’s communication in the previous quarter as well as consensus estimates, investors have nonetheless sold down the stock.

We are comfortable that management’s plan to cut costs by better managing dealer inventories and reducing production levels will help to alleviate downward pressure on earnings in the coming quarters. AGCO’s focus on equipment and software upgrades should also put the company in a good position to weather the downturn, given that producers are more likely to invest in upgrades rather than purchase brand-new tractors and equipment in the coming quarters.

But more importantly, we see this as an opportunity to look beyond this downturn and focus on AGCO’s longer-term fundamentals and growth potential.

Compelling Valuations An Opportunity For Alpha

Some readers may question our decision to turn bullish on AGCO during a downturn. But this is precisely why AGCO’s stock is trading at a huge discount. While short-term investors may dislike the stock and prefer to chase the hottest growth themes, long-term investors should look beyond the downturn and take advantage of the deep discount to accumulate.

Currently, AGCO is trading at a compelling forward P/E multiple of just 8.9x, with consensus earnings estimates already fully discounting the downturn’s impact for 2024.

AGCO is also trading at around 29% off its all-time high recorded in 2021. For comparison, DE is trading at a more demanding forward P/E of 15.5x and is only 12% away from its all-time high.

Risk To Outlook

Prices for agricultural commodities will remain a key risk to our bullish outlook for AGCO. Should agricultural commodity prices remain soft in the coming quarters, this will have a direct negative impact on producer incomes and, in turn, AGCO sales. We do not attempt to predict the trend for agricultural commodity prices, but given that core commodities such as corn, soybeans, and wheat are at historically low levels, we believe that the risks are skewed in our favour.

In Conclusion

We see the potential for AGCO’s valuations to improve to a more reasonable forward P/E of around 13x to 15x by the end of 2025. This translates into a potential gain of 68% even if we keep earnings estimates constant.

We initiate our bullish view on AGCO with a “Buy” rating.