Telematics a Rare Bright Spot at Ag Show

We recently attended the Farm Progress Show in Boone, Iowa. The annual show is one of the major events in the North American agricultural industry, where farmers and agricultural equipment manufacturers come together to assess the latest product offerings. Following the show, we view wide-moat  Deere (DE) and no-moat  CNH Industrial (CNHI) as undervalued and reiterate our $97 and $9 fair value estimates for the respective shares. Although the agricultural sector remains tough, we believe both stocks offer an attractive margin of safety relative to a difficult near-term outlook.

Reflecting recent weakness in crop prices, overall sentiment seemed dire among buyers; however, there did appear to be some divergence in buyer appetites based on location. According to anecdotes from farmers and management teams, North American agricultural demand remains depressed. While there is some optimism that there will have to be a refresh cycle to replace worn-out combines, there were few near-term indications that demand is improving. Europe, which had been expected to grow in 2016, now appears on track for modest sales declines as French and German farm income is below expectations and uncertainty surrounding Brexit (farm income transfer payments are the European Commission’s biggest expense) has probably damped the appetite to proactively buy equipment. On the basis of recent sales trends as well as orders, there is some optimism that South America could resume sales growth in 2017. Due to a combination of strong farm income, easy prior-year sales comparisons, and a potential resolution in Brazil’s political turmoil, farmers may look to upgrade and expand equipment fleets again in the region--a positive development for  AGCO (AGCO), which is the largest player in the market.

Similar to the 2015 show, manufacturers increasingly emphasized the value and versatility of their product lines relative to diminished farm income levels in North America. AGCO prominently featured its Challenger 1000 tractor, which offers high horsepower for speed but a smaller-than-average turning radius, allowing more land to be cultivated and the elimination of potentially two pieces of equipment on the farm. CNH Industrial spotlighted how it has reduced the number of components on some of its products to reduce the total product cost, enabling it to deliver a $30,000 lower price point on some of its higher-horsepower tractors. The continued emphasis on value is a change from 2013 and 2014, when farm income was relatively high and most manufacturers were highlighting their biggest, fastest, and most expensive products.

Precision agriculture also received a lot of attention at the show, with all of the major tractor makers--AGCO, Deere, and CNH--putting the leaders of their precision agriculture strategies on display for investors. Deere’s decision to give a nearly three-hour overview of its precision agriculture strategy highlights how mainstream these productivity tools are becoming in the marketplace. Aiming to truly stand out, CNH Industrial unveiled a fully autonomous tractor that it believes could be brought to market in three years if the regulatory environment is accommodating. It also appears that regulators are starting to pay attention to the space. Deere announced the purchase of Precision Planting, a maker of high-speed planters, in November 2015, but now the Department of Justice is suing the company to block the acquisition. Despite Deere’s challenges to acquire Precision Planting, most show attendants agreed that the trailing equipment market remains highly fragmented and that current asking prices make it ripe for further consolidation.

The show reiterated our bullish sentiment on precision agriculture and telematics. Despite continued sales declines at the large tractor and combine makers, productivity solutions makers like Climate Corp. and  Trimble Navigation (TRMB) said sales for their software and hardware productivity tools have either stabilized or resumed growth.