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Monday, November 26, 2007

AGCO -- is there any upside left?

The agricultural equipment sector has been strong this year and appears to be one of the sectors that may provide some relief for stressed investors in this difficult market.

The John Deere Company (DE) recently reported strong earnings that gave the whole market a boost on the day the numbers were announced. Sales in agricultural equipment were very strong though construction equipment sales were somewhat under pressure. Deere provided solid forward guidance despite the risk of a falloff in the market for building construction equipment.

Everyone is familiar with Deere but a lesser known player is AGCO (AG).

AGCO company background --

Here are a few excerpts from the AGCO company profile at Yahoo Finance:

"AGCO Corporation manufactures and distributes agricultural equipment and related replacement parts worldwide. The company's products include tractors, combines, self-propelled sprayers, hay tools, forage equipment, and implements, as well as a line of diesel engines. ...the company provides precision farming technologies that enable farmers to gather information, such as yield data by utilizing satellite global positioning systems... The company markets its products under various brands, including AGCO, Challenger, Fendt, Gleaner, Hesston, Massey Ferguson, New Idea, RoGator, Spra-Coupe, Sunflower, Terra-Gator, Valtra, and White Planters."

What is significant is that AGCO is more of a pure play on the agricultural equipment sector than Deere. Whereas Deere is somewhat dependent on its analysis that housing will hit bottom in 2008 and construction equipment sales will firm, AGCO has no exposure to this sector. AGCO is focused exclusively on agriculture where a commodities boom has been playing out and providing a solid underpinning for strong sales.

Looking at the chart below, it can be seen that in recent months AGCO has outperformed Deere, the industry bellwether.

Also evident in the chart above, it can be seen that the stock gapped upward at the end of October. This is when it reported Q3 EPS of 77 cents and revenues of $1.61 billion. Analysts had been expecting 47 cents and $1.36 billion. The CEO said that robust farm equipment markets drove strong sales growth and improved operating results. Management also guided FY07 EPS to $2.10-2.20, versus analyst consensus of $1.77 and versus AGCO own expectations back in July of $1.55 to $1.60 per share.

Can the stock go higher?

It would appear AGCO is hitting on all cylinders. Still, there are a few questionable aspects. AGCO is a complicated company, made up of numerous acquisitions. When looking at quarterly financial statements, there is a fair amount of inconsistency. You can see how in Q3 net income surged compared to Q2 yet operating income and revenues were lower in Q3 than in Q2. The quarter was saved by lower interest expense and lower taxes in the United Kingdom and Germany. Are we running into a problem with organic growth?

The other factor that worries me about AGCO is that its stock price is up so much more in percentage terms than the agricultural commodities indexes. Commodities have been in a strong bull market this year. Using either the PowerShares DB Agriculture ETF (DBA) or the PowerShares DB Commodity Index Tracking Fund ETF (DBC) as proxies, it appears commodities are up around 25% in 2007. On the other hand, AGCO is up close to 90% so far in 2007. At some point, it would make sense for a company that is so closely tied to the profitability of the agricultural markets to more closely track those agricultural markets.

Given the negative tone of the markets in general, the questions around organic growth and the strong possibility the stock has gotten ahead of itself and the agricultural markets, I think we may have seen the highs for AGCO.

Disclosure: author owns no shares of AG, DE, DBA or DBC

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