AGCO Corporation (NYSE:AGCO) is a good company, but it is looking overvalued in today’s current market environment at 34.7x TTM P/E. The company’s profitability is cyclical along with the agricultural industry, but even taking this cyclicality into account would only yield an Investors’ Adjusted ROE of 4.3% at current prices. This article will discuss the things to like about AGCO and why to keep it on your watchlist while also pointing out how expensive the valuation is.
Introduction to the Company
AGCO is a global leader in the design, manufacture, and distribution of agricultural solutions that generated sales of $9.0 billion in 2019. With multiple brands in their portfolio, the company makes tractors, combine harvesters, seeding & tillage equipment, and balers, to name a few key items. For me as a city-dweller, the most recognizable of their brands is Massey Ferguson, but the portfolio also includes Challenger, Fendt, and Valtra among their major brands. As can be seen in the graph below, the majority of AGCO’s sales come from Europe at 58% followed by North America at 24%, South America at 9%, and the rest of the world at 9%.
Source data from 2019 annual report
Profitable, Growing, and Cyclical
AGCO’s strong product offerings and global footprint have allowed the company to achieve an average return on equity (ROE) and return on invested capital (ROIC) of 10.7% and 8.4%, respectively, over the past decade. However, as is evident from the graph below, profitability has been noticeably dropping over the past decade in a rather alarming trend. As will be discussed later, this drop in profitability in recent years can be attributed to cyclicality and should not necessarily worry long-term investors.
Source data from Morningstar
While the long-term average level of profitability is below my rule of thumb of 15% ROE, in my opinion, the company should be able to maintain its intrinsic value over a business cycle as witnessed by the economic ROIC of 8.4%. With ROE only slightly higher than ROIC, it also shows to me that the business should potentially be using financial leverage more aggressively to increase returns to shareholders.
Dissecting the Decline in ROE through DuPont Method
Using a DuPont analysis to help understand the decline in AGCO’s return on equity, we can see that both net income margins and asset turnover have been falling over the past decade. Financial leverage has been slowly rising from 2.05x to 2.83x to partially make up for the fall in net income margins and asset turnover. The fall in net income and asset turnover looks to be attributable to falling revenues which reached a decade high of $10.8 billion in 2013 but only sit around $9.0 billion for 2019 and the TTM period.
Source data from Morningstar
No Revenue Growth… but Large Share Buybacks
AGCO’s revenues have not been growing over the past decade as can be seen in the graph below. However, the company has also been buying back large amounts of shares to help support EPS. As can be seen in the graph below, since 2010, the company has managed to decrease its outstanding shares by 21.9% from 96 million to 75 million today, for an annual average compound repurchase rate of 2.4% per year. Combined with the company’s current 0.7% dividend yield, this average repurchase rate would bring total shareholder yields up to 3.1%. Throughout COVID-19, AGCO maintained the quarterly dividend, but after $55 million of share repurchases in the first quarter, they suspended repurchases in the second and third quarters.
Source data from Morningstar
We cannot analyze AGCO’s revenue declines in isolation though as it may be related to agricultural industry cycles. In order to get an idea of how AGCO is performing compared to industry competitors, let’s take a look at Deere’s (DE) revenues over the past decade as well. To make things comparable in the below graph, both companies’ revenues have been laid out in a horizontal common sizing analysis that shows revenue as a percent with each company’s 2010 revenues acting as the baseline. As can be seen, AGCO’s revenue declines have been in line with industry leader Deere and can be attributed to cyclicality in the agriculture industry.
Getting a Sense of Valuation
For a cyclical company, I always like to examine the relationship between average ROE and price-to-book value in what I call the Investors’ Adjusted ROE. This relationship is especially important for cyclical companies and is something I consider similar to Shiller’s CAPE ratio, but a little simpler to calculate, in my opinion. It examines the average ROE over a business cycle and adjusts that ROE for the price investors are currently paying for the company’s book value or equity per share.
With AGCO earning an average ROE of 10.7% over the past decade and shares currently trading at a price-to-book value of 2.48x when the price is $93.20, this would yield an Investors’ Adjusted ROE of only 4.3% for an investor’s equity at that purchase price, if history repeats itself. This is well below the 9% that I like to see, and adding a 3% growth rate to represent the company’s growth alongside global GDP could only increase this potential total return up to 7.3%.
AGCO is a good company with solid levels of profitability over the agricultural cycle. However, with only a 4.3% Investors’ Adjusted ROE and trading at 34.7x TTM P/E, the company looks expensive in the current market environment. It might be time to harvest profits in this cyclical name and put it on your watchlist.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: While the information and data presented in my articles are obtained from company documents and/or sources believed to be reliable, they have not been independently verified. The material is intended only as general information for your convenience, and should not in any way be construed as investment advice. I advise readers to conduct their own independent research to build their own independent opinions and/or consult a qualified investment advisor before making any investment decisions. I explicitly disclaim any liability that may arise from investment decisions you make based on my articles.