Why Farm Equipment Manufacturers Could Face a Dry Spell

Why Farm Equipment Manufacturers Could Face a Dry Spell

After rising to record-high prices in 2012, corn became one of 2013's worst-performing commodities. The trend is expected to continue in 2014, which does not augur well for farm equipment makers such as Deere & Company and AGCO Corporation .

Corn prices struggle

Corn prices surged to a record high level of $8.49 a bushel in August 2012, driven by one of the worst droughts in U.S. history. The record high price of corn in 2012 prompted farmers to plant 97.4 million acres of corn for the 2013 growing season, the most planted since 1936.

Not surprisingly, this pushed corn prices down sharply. Corn futures for March delivery are currently hovering around $4.275 a bushel on the Chicago Mercantile Exchange, down around 50% from the August 2012 record high. More importantly, prices are expected to remain at this level in 2014.

According to estimates from the U.S. Department of Agriculture, farmers are expected to collect an average of $4.40 a bushel for the year ending Aug. 31, 2014. Another factor that is expected to keep corn prices down is a proposed lower ethanol mandate.

With corn prices expected to remain under pressure, the outlook for farm equipment manufacturers is gloomy heading into 2014.

Tough times ahead
Demand for farm equipment has a strong correlation with prices for corn and other farm commodities. The high price of corn in 2012 had boosted equipment demand, benefiting companies such as Deere and AGCO Corporation. However, farmers are expected to plant fewer acres in 2014 due to lower prices, and as a result, they will likely spend significantly less on equipment.

The weakness in the farm economy was also highlighted in the fourth-quarter results Deere released back in November.

Deere's worldwide net sales and revenues fell 3% in the quarter, with net sales of the worldwide equipment operation falling 5%. Sales at Deere's Agriculture & Turf division fell 4% in the quarter. For full-year 2014, Deere expects sales of agriculture and turf equipment to fall by around 6%.

The company noted that although commodity prices and farm incomes are expected to remain at healthy levels in 2014 by historical standards, they are expected to be lower than in 2013. Deere expects this to have a negative impact on demand, primarily for large farm equipment. It forecasts industry sales for agricultural machinery in the U.S. and Canada to drop between 5% and 10% in 2014.

While AGCO Corporation had posted higher profits in its third quarter back in October, the company's earnings for the fourth quarter missed Street estimates. The company also said that it expected modest growth in North America for the remainder of the year. AGCO Corporation will release its fourth-quarter results in February 2014, and I expect them to once again disappoint, since the company is likely to feel the negative impact of lower corn prices.

Valuation attractive but I am bearish

Both Deere and AGCO Corporation are attractively valued at the moment. Deere, which also manufactures construction equipment, is currently trading at a P/E ratio of 10. Rival AGCO Corporation, which has gained more than 20%, is currently trading at a P/E ratio of 10.47. Caterpillar , which competes with Deere in the construction equipment space, is currently trading at a P/E ratio of 17.30.

Despite the attractive valuation, I am bearish on Deere and AGCO due to the weak outlook for farm equipment sales. Given the uncertainty in the U.S. housing market due to higher mortgage rates, I don't expect Deere's construction equipment division to offset weakness in the agriculture equipment division. While both Deere and AGCO Corporation recorded higher profit in their most recently reported quarterly results, they are likely to face negative earnings pressure going forward due to weaker sales.

The article Why Farm Equipment Manufacturers Could Face a Dry Spell originally appeared on Fool.com.

Varun Chandan Arora has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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