by Jason Jenkins, Investment U Research
Friday, December 21, 2012
It’s been almost two years since The Economist put out their report regarding the “nine billion people question.” In short, by the year 2050, it’s likely there will be nine billion people in the world. That’s an increase of about two billion people in 37 years.
With a population explosion of such magnitude, the question is: Will we be able to feed everyone? For this to be possible, all food production must double.
As this reality comes to fruition, there should be a strong demand over time for new tractors and combines, as well as land for cultivation.
And one of my favorite plays on this massive long-term trend is AGCO Corporation (NYSE: AGCO). Since hitting a 52-week low of around $38 per share this summer, the stock has been in a somewhat steady uptrend. And I expect this to continue for some time.
So What is AGCO?
AGCO manufactures and distributes agricultural equipment and related replacement parts all over the world. It sells anything from tractors, combines, self-propelled sprayers and hay tools to forage equipment and implements. The company also makes and distributes grain storage and handling equipment systems, along with protein production systems. Its products are sold under a variety of brands, such as Challenger, Fendt, Massey Ferguson and Valtra.
So here’s what ties all this together. I saw AGCO CEO Martin Richenhagen on CNBC’s Squawk Box last week. He was talking about his company’s favorable positioning in the midst of the drought while navigating through a cyclical industry. Richenhagen said his outlook was positive because, “It’s the growing population, renewable fuels and changing diets in countries like India and China that are driving greater food production and demand for farm equipment.”
He went on to add, “As emerging market affluence increases and diets move toward higher protein foods like meat, instead of chicken and grains, farmers must plant six to eight times the crops they would otherwise.”
Global demographics have Mr. Richenhagen smiling about his company’s future.
Emerging Markets Show Promise for Agricultural Machinery
Not only is AGCO bullish on the industry’s future, competition such as Deere (NYSE: DE) also looks optimistic regarding the long-term opportunities for farm machinery. Deere forecasts that gross farm output has to go up a full percent – to 3.4% – every year over the next decade compared to the last decade if we’re to meet future food needs.
AGCO and Deere both forecast greater demand from emerging markets like Latin America. AGCO believes it’ll see a bump of about 5% to 10% in South American sales in 2013, due to an increase in the sale of tractors in Brazil to harvest sugarcane.
Keep in mind, there are also promising long-term opportunities in Eastern Europe. That part of the continent underinvested in equipment, and crop yields are now below those in the West.
Two Reasons to Like AGCO Going Forward
1. AGCO is better situated to take advantage of emerging markets than its biggest competitor.
Deere may have the name recognition, but it doesn’t seem positioned to take advantage of emerging markets like AGCO is. The tractor leader splits its sales into just the U.S. and Canadian regions. Last year, equipment sales outside of these two countries represented only 41% of total equipment sales. And numbers this year seem to indicate that the percentage has fallen even more.
2. The African continent will be a game-changer over the next four decades.
AGCO is the first in the industry to bet heavy on Africa, and Mr. Richenhagen appeared to be very excited about it. Here’s why this move looks so promising:
- AGCO recently acquired a factory in Africa, making it the first manufacturer from the West to start making tractors there.
- This initial footprint was established because the African population is forecast to double to two billion people.
- The vast majority of farmland in Africa is plowed, planted and harvested by humans. Crop yields usually range about one-third of those in other emerging markets, like Asia and Latin America. Rather than using hand tools and domesticated animals, African farmers will have to upgrade to machinery to meet the new demand.
- According to Richenhagen, “To help improve crop yields, AGCO has set up a farm in Zambia to teach Africa’s farmers about Western techniques and how to use the equipment. It is also helping to arrange financing.” The region is extremely poverty stricken, so many farmers don’t have access to financing. To solve this problem, AGCO formed a partnership with Rabobank, which specializes in global agricultural lending.
- And this may be the most attractive reason for the endeavor in Africa: The African continent possesses 60% of the global reserves of tillable land. And only 20% of this land is currently used. The growth potential is enormous, to say the least.
The company sees an opportunity, and is beginning to set up an infrastructure in Africa that will be the beginning of a long-standing relationship. AGCO just constructed a $35-million parts distribution warehouse in South Africa. And it has additional plans to build another plant in Algeria to manufacture its Massey Ferguson line of tractors. The official word from the company is that they expect to be in Africa “for 100 years and more.” The new Algerian plant is expected to produce up to 5,000 tractors annually.
AGCO expects revenue to grow in the range of 3% to 5% for 2013 with earnings per share coming in around the neighborhood of $5.50 to $5.75. The company also forecasts for next year a 1% increase in the operating margin to 9%.
In short, with global population trends and a first-mover advantage in Africa, this company looks to be a great position for long-term investors to profit.