AGCO stock might be a good pick for investing
On the Right Tractor
By Jack Hough Published: June 9, 2005
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EVERYONE LOVES THE granola peddlers. Whole Foods Market's (WFMI) stock trades at 49 times this year's projected earnings; Wild Oats Markets' (OATS) stock, 549 times. Yet shares of the companies whose tractors and equipment keep these stores stocked with produce can't seem to climb higher than 10 times earnings.
We understand the attraction of Whole Foods. But we wouldn't pay $118 for one of its shares if it came with a dried-fruit-and-nut tray and $20 change. Analysts expect the company to boost its earnings by 20% annually over the next five years. That gives its shares a current price/earnings-to-growth, or PEG, ratio of 2.4. The Standard & Poor's 500 index's PEG is about 1.6. The tractor maker we're looking at today carries a PEG of 1.0. Judge its stock relative to its sales rather than its earnings and it looks even cheaper; it turned up recently on our price/sales screen.
Earnings are the main driver of share price gains. So why bother screening for price/sales ratios? We can think of two reasons. The first is reliability. Sales appear at the top of a company's income statement, before expenses have been subtracted, and before accounting adjustments have been made for the carryover effects of past transactions. That makes them less subject to bookkeeping judgments than earnings are.
Sales also tend to have a smoother quarter-to-quarter flow than earnings. Earnings can be highly levered to things like the cost of raw materials. One aberrant quarter can throw a company's P/E ratio out of whack for a year. Its price/sales ratio, in that case, may give investors a truer sense of its valuation.
A global designer, manufacturer and distributor of agricultural equipment and related replacement parts.
Wednesday's Close $18.29
Market Value $1.7 billion
Trailing 12-Month Sales $5.4 billion
2005 P/E 10
Proj. Long-Term EPS Growth 10%
Earnings | Financials | Key Ratios | Ratings | Insiders
Some argue that sales are a better predictor than earnings of share price movements. We're undecided. But the results of our price/sales screen are promising. We featured pharmacy benefits manager Express Scripts in a price/sales screen in March ("Check Your Prescription?"). Its shares have since gained a quick 11%, vs. a 1% dip for the S&P 500.
Use our stock screener and recipe of criteria anytime to run our search for yourself. Recently it produced a list of seven companies. Let's look at our tractor company.
We last wrote about Duluth, Ga.-based Agco (AG), the world's third-largest maker of agricultural equipment, in an October 2003 bottom-fishing screen ("Bobbing for Bargains"). The outlook for the stock was poor, according to most on Wall Street. Commodity prices were weak, dampening demand for equipment in Europe and North America. And Agco had just agreed to buy a Finnish tractor maker for $672 million: half stock, half cash. Of the potential for stock dilution from that deal, we noted: "If you're crinkling your nose now at shares, this will make you look like you're riding shotgun on a manure spreader."
But we liked the stock on the whole. We believed the company's bad news had been "bought and paid for with a 30% drubbing since August." And we found "good reason to believe shares may be too cheap right now." Since our story the stock is up 18%, vs. 15% for the S&P 500 index.
The outlook for the company's European operations now looks brighter, but that for South America stinks. First-quarter numbers, reported May 3, showed overall sales increasing 13% year-over-year ó 5% from volume, 4% from currency and the rest from pricing. Sales in Europe improved 11% year-over-year to $666 million. Those in North America jumped 34% to $393 million. Sales in South America slipped 13% to $152 million. Sales in the rest of the world were flat at $46 million. That was enough to send earnings 14% lower to $21.5 million. Excluding a penny per share restructuring charge, earnings of 24 cents matched estimates.
Double-digit earnings declines aren't something we usually go out of our way to find. But as with the last time we looked at Agco, we see some reasons for bargain hunters to consider holding their noses and buying shares.
Agco's management noted in the first-quarter earnings release that it expects earnings for all of 2005 to be flat to up 5% vs. 2004. Analysts project that South America sales will remain sluggish through the rest of 2005, and rebound slightly in 2006. But European growth might be enough to drive the stock. Margins there started rising in the second half of 2004. Legg Mason analyst Barry Bannister figures that each percentage point increase in European operating margin for Agco will add 20 cents to its 2005 earnings per share. European operating margin in the first quarter improved to 6.8% vs. 4.2% last year. Higher margins, according to Bannister, could earn the stock a higher P/E ratio. (Bannister doesn't own shares in Agco; Legg Mason doesn't have an investment-banking relationship with the company.)
"Agco's low profit margin produces income volatility, since a miniscule change in basis points leads to a large change in profits," wrote Bannister in a May 4 research note. "This, in turn, creates a low P/E, and higher margins would, we believe, not only reduce the volatility of the arithmetic for margins but could also lead to a higher P/E multiple."
Analysts project that Agco will earn $1.82 a share this year, and $2.18 next year. Bannister thinks the company will earn $3.50 in 2008. By then, he figures, it should be worth 11 times earnings (up from 10 now), or $39. Shares fetch around $18 now.
Agco survived our screen with a price/sales ratio of just 0.3. The average for farm-equipment makers is 0.8. The S&P 500's median P/S ratio is 1.7. Whole Foods, if you're curious, carries a P/S ratio of 1.8. Trendy, Agco shares are not. But the numbers suggest they have plenty of potential to sprout.
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ALWAYS remember to remove the spark plug wire from the plug before sticking your hand in the machine!!!! The fingers you save could be your own.