Down on the Farm. Industry Outlook and Boone, IA Farm Progress Commentary

Transcription

1 G.research, LLC One Corporate Center Rye, NY Tel. (914) September 12, 2016 Gabelli & Company Down on the Farm Industry Outlook and Boone, IA Farm Progress Commentary Sources: Deere & Co, CNH Industrial Companies Ticker Price Exchange Borg-Warner Inc. BWA - $ NYSE CLARCOR Inc. CLC - $ " CNH Industrial CNHI - $ " Dana Inc. DAN - $ " Deere & Company DE - $ " Donaldson Inc. DCI - $ " Tenneco Inc. TEN - $ " Matthew T. Paige Gabelli & Company 2016 (914) Please Refer To Important Disclosures On The Last Page Of This Report-

2 G.research, LLC One Corporate Center Rye, NY Tel. (914) September 12, 2016 Gabelli & Company EXECUTIVE SUMMARY We traveled to Boone, IA last week to participate in the annual Farm Progress Show. This event allowed us to get up close in person with the latest technology in farming. Additionally, we were able to speak to industry leaders and executives with Deere & Company and CNH Industrial to learn more about the state of the agriculture equipment market. Although the industry is excited about new technology introduction, low commodity prices continues to hamper demand of both new and used units, creating a glut of inventory on dealer lots. We expect manufacturers to continue to underproduce retail demand at least through 1H 2017, and potentially longer should commodity prices experience further weaknesses or inventory reductions not progress according to plan. Many of the names within our universe have already experienced pressure due to weak agricultural demand, and we expect more of the same in the near-term. NEW TECHNOLOGIES The main goal of presenting companies at Farm Progress was intended to showcase new product innovations that are taking hold on today s farm equipment. The predominant technology that we saw was precision farming; allowing planting to occur at almost double the speed without sacrificing quality (10 mph vs ~5mph on traditional machines). This technology is key on sprayers/planters as it allows farmers to complete their tasks within optimal time horizons that can vary based on uncontrollable factors such as weather. In meeting these targets, farmers can improve yield. Currently, the leaders in this field are Deere & Co and Precision Planting (owned by MON, pending sale to DE). Precision is a supplier for retrofit as well as OE supply to other industry leaders such as AGCO and CNH Industrial. Deere & Company Deere also demonstrated its connectivity and data solutions technology, John Deere Field Connect. This technology goes hand in hand with sprayers, planters and combines to allow farmers to access real time data from any platform regarding planting, fertilizing and yield data. Over time, these features can be used to determine the best seed hybrid and fertilizers for particular areas (even specific portions of an individual farm) and allows for better efficiency and less waste, reducing cost. When paired with equipment, dealers are able to better interact with their customers, and predict maintenance needs in order to reduce machine downtime, especially during busy periods. Exhibit 1 Deere Sprayer Source: Deere & Company Exhibit 2 JD Connect Field Source: Deere & Company Exhibit 3 Case IH Autonomous CNH Industrial Another technology we saw introduced was CNHI s autonomous farming concept. While not ready for production, the company purports to have working prototypes shown in a demonstration video. With a shortage of qualified farm workers, this technology would allow to Source: CNH Industrial free up high-skill-labor. CEO Rich Tobin believes this technology will be available (at the earliest) in three years, with a likely first application on vineyards (low HP), before moving to row-crop uses. -1-

3 CYCLE COMMENTARY After experiencing rapid industry sales growth from 2006 until 2013, unit sales of 4WD tractors and combines have fallen precipitously in recent years, a trend that we expect to continue for the next few years, albeit at a decelerating pace. While smaller tractor units (used primarily for livestock) have been relatively stable, larger tractors and combines are where machinery manufacturers make the majority of their money. Due to a recently replaced fleet and reduced farmer cash receipts, these units have been the most pressured, as shown in Exhibits 4 and 5. Exhibit 4 Annual 4WD Tractor Unit Sales (U.S.) Exhibit 5 Annual Combine Unit Sales (U.S.) Source: Association of Equipment Manufacturers Source: Association of Equipment Manufacturers KEY DRIVERS- CROP PRICES, FARMER CASH RECEIPTS Three years of so-called bumper crops in conjunction with lower demand have kept key crop (corn & soybeans) stocks-to-use ratios high and prices at historic lows. These low prices have led to falling farm cash receipts, which are expected to be $401 billion in 2016 vs $424 billion in 2015 and $470 billion in 2014 (see Exhibit 6). There are numerous drivers of increased crop production that include increased planted acreage and higher yield from both ideal growing conditions and new seed and pesticide technologies. With another favorable growing season in 2016, we do not see any driver of increased farmer income in the short term. In fact, farmers are increasingly storing grain instead of selling at current prices. The glut of inventory will then require extra time following a weak harvest in order for prices to fully recover. Without increasing commodity prices, we do not foresee any improvement in farmer cash receipts (and therefore equipment sales). Exhibit 6 Total Farm Cash Receipts ($ Billions) Exhibit 7 Monthly Corn Prices ($ per Bushel) Source: United States Department of Agriculture Source: United States Department of Agriculture -2-

4 STATE OF THE FLEET High horsepower tractors (>100 HP) are the newest they have ever been, with 16.1% of the fleet aged five years or less in 2012, per the USDA Ag Census (conducted every 5 years). This compares to 12.4% in 2007 and 12.9% in Due to the high percentage of the fleet that is so young, we do not anticipate replacement demand of significant enough magnitude to offset weak cash receipts. It remains entirely possible for both of these (currently) negative trends to reverse course concurrently, resulting in a surge in demand of large agriculture equipment. Table 1 Active Units Aged Five Years or Younger (United States) Total Fleet 5 Years Old Total Fleet 5 Years Old Total Fleet 5 Years Old Total Fleet 5 Years Old Total Fleet 5 Years Old <40 HP 2,827, ,734 2,673, ,522 1,415, ,715 1,280, ,117 1,107,528 98, HP NA NA 1,808, ,756 2,066, ,945 1,998, ,743 1,886, ,338 >100 HP NA NA 915, ,062 1,110, ,558 1,111, ,242 1,184, ,065 Source: USDA Census INVENTORY CONCERN Of course, before any recovery can be seen, equipment manufacturers and their dealers will need to reconcile the amount of inventory in the field and current demand with production levels. As tractor inventory levels have risen to over 122k units as of June 30 th (vs 114k units in 2015), many manufacturers, including both Deere and CNH Industrial, have spoken at length during 2016 about reducing production levels below retail demand. Even while CNHI states that they feel its inventory situation is the best in the industry, one of its major dealers, Titan Machinery, continues to look to reduce inventory through its 10/31/2017 fiscal year end. FUTURE PRODUCTION CUTS LOOMING OEMs will need to produce well below retail demand in order to fix this supply imbalance. Of course, should unit demand continue to fall, production will need to be drastically lower in order to meet that mandate. Both CNHI and DE expect demand to flatten into 2017, leading to smaller cuts in production YoY given current rates, with Deere even expressing optimism for sequential improvements through the next year. However, given the expectations for another record year for crop productions, corn and soybean prices will remain near record lows pressuring farmer cash receipts. Given this dynamic, we see no catalyst for an increase in demand, at least through 1H 2017 when farmers begin to look at the current year s harvest and potential harvest equipment (ie combines) capex for use in the fall. IMPACTS TO NAMES IN OUR COVERAGE While we do not currently cover any names that are pure-play agriculture names, a number of our names are impacted by the Ag industry. We have laid out these impacts in our list of companies below: Borg-Warner Inc. (BWA - $ Buy): BWA is a leading supplier of powertrain components, principally to the light-vehicle market. However, 4% of sales are to off-highway applications which include agriculture and construction machinery and marine applications. Given the minimal exposure to the agriculture industry, we do not see any material impacts to BWA due to future severe cuts in equipment production. -3-

5 CLARCOR Inc. (CLC - $ Hold): CLARCOR, through its Engine/Mobile segment ($580 million of $1.4 billion in FYE 11/30/16 sales), supplies filters to the heavy agricultural machinery market. CLARCOR has already felt the impacts of lower agriculture equipment builds, as of the last quarter described stabilization in the market, albeit with limited visibility beyond the current fiscal year. Given its relatively large exposure to Ag, we would expect further deterioration of sales to its agricultural equipment customers. Dana Inc. (DAN - $ Buy): Dana derives ~$1 billion of its $6 billion (~17%) of sales from Off-Highway markets, which includes Agricultural markets (largest customers being Deere and AGCO), as well as construction, mining, forestry and rail. As we stated in our last note regarding DAN, Off-Highway sales have remained weak with no clear bottom in sight for any of its primary end markets. With further demand deterioration and production cuts ahead, we would expect Off- Highway segment sales to continue to decline barring any improving in other end markets. Donaldson Inc. (DCI - $36.62-Hold): We project Donaldson s sales to Off-Road products to make up $214 million of $2.2 billion of 2016E sales. DCI has felt the weakness of the Agricultural industry, and similarly to its peers, we would expect further production cuts to continue to pressure sales. Of course, Donaldson is also a supplier to other off-road markets (such as construction and mining) and should either see a meaningful pickup in sales, it is possible for DCI to overcome Ag weakness. Tenneco Inc. (TEN - $ Buy): Tenneco is a supplier of emission control and ride performance products and systems for light and commercial on-road vehicles as well as off-road equipment. We estimate Off-Highway to make up a small portion of overall TEN sales (CV and Off-Highway combine for 15% of TEN sales to OEMs). In recent reports, Tenneco has noted weakness in Off- Highway markets; however this has been mostly contained to South America and China. Additionally, due to stringent emission regulations we believe TEN to be less dependent on unit volume growth than peers. Given the relatively limited experience to Ag and secular emissions growth, we do not estimate much impact from continued decrease in ag equipment production. -4-

6 Companies Mentioned AGCO (AGCO - NYSE) Deere & Company - NYSE) Borg-Warner Inc. (BWA - " ) Donaldson Inc. - " ) CLARCOR Inc. (CLC - " ) Monsanto Company - " ) CNH Industrial (CNHI - " ) Tenneco Inc. - " ) Dana Inc. (DAN - " ) Titan Machinery - NASDAQ) BorgWarner Price Performance CLARCOR Inc. Price Performance Source: Public data. As of September 12, 2013 BWA was rated HOLD, changed to a BUY on February 14, 2014, a HOLD on August 1, 2014 and to a BUY on October 14, 2014 Dana Company Price Performance Source: Public data. As of September 12, 2013 CLC was rated HOLD Donaldson Company Price Performance Source: Public data. As of September 12, 2013 DCI was rated BUY. Tenneco Price Performance Source: Public data. As of September 12, 2013 DCI was rated HOLD, changed to BUY on May 21, 2014 and to HOLD on November 21, Source: Public data. As of September 12, 2013 DCI was rated BUY. I, Matthew Paige, the Research Analyst who prepared this report, hereby certify that the views expressed in this report accurately reflect the analysts personal views about the subject companies and their securities. The Research Analyst has not been, is not and will not be receiving direct or indirect compensation for expressing the specific recommendation or view in this report. Matthew T. Paige (914) Gabelli & Company 2016 Important Disclosures ONE CORPORATE CENTER RYE, NY GABELLI & COMPANY TEL (914) FAX (914) Gabelli & Company is the marketing name for the registered broker dealer G.research LLC, which was formerly known as G.research, Inc. Gabelli & Company ("we" or "us") attempts to provide timely, value-added insights into companies or industry dynamics for institutional investors. Our research reports generally contain a recommendation of "buy," "hold," "sell" or "non-rated. We do not undertake to "upgrade" or "downgrade" ratings after publishing a report. We currently have reports on 576 companies, of which 48%, 35%, 3% and 14% have a recommendation of buy, hold, sell or non-rated, respectively. The percentage of companies so rated for which we provided investment banking services within the past 12 months is 0%, 0%, 0% and less than 1%. Ratings Analysts ratings are largely (but not always) determined by our private market value, or PMV methodology. Our basic goal is to understand in absolute terms what a rational, strategic buyer would pay for an asset in an open, arms-length transaction. At the same time, analysts also look for underlying catalysts that could encourage those private market values to surface. A Buy rated stock is one that in our view is trading at a meaningful discount to our estimated PMV. We could expect a more modest private market value to increase at an accelerated pace, the discount of the public stock price to PMV to narrow through the emergence of a catalyst, or some combination of the two to occur. A Hold is a stock that may be trading at or near our estimated private market value. We may not anticipate a large increase in the PMV, or see some other factors at work. A Sell is a stock that may be trading at or above our estimated PMV. There may be little upside to the value, or limited opportunity to realize the value. Economic or sector risk could also be increasing. We prepared this report as a matter of general information. We do not intend for this report to be a complete description of any security or company and it is not an offer or solicitation to buy or sell any security. All facts and statistics are from sources we believe to be reliable, but we do not guarantee their accuracy. We do not undertake to advise you of changes in our opinion or information. Unless otherwise noted, all stock prices reflect the closing price on the business day immediately prior to the date of this report. We do not use "price targets" predicting future stock performance. We do refer to "private market value" or PMV, which is the price that we believe an informed buyer would pay to acquire 100% of a company. There is no assurance that there are any willing buyers of a company at this price and we do not intend to suggest that any acquisition is likely. Additional information is available on request. As of August 31, 2016 our affiliates beneficially own on behalf of their investment advisory clients or otherwise approximately 5.84% of Dana Corp., 2.41% of Tenneco, 2.06% of CLARCOR, 1.99% of Donaldson and less than 1% of all other companies mentioned. One of our affiliates serves as an investment adviser to Dana or an affiliated entity and has received compensation within the past 12 months for these non-investment banking securities-related services. Because the portfolio managers at our affiliates make individual investment decisions with respect to the client accounts they manage, these accounts may have transactions inconsistent with the recommendations in this report. These portfolio managers may know the substance of our research reports prior to their publication as a result of joint participation in research meetings or otherwise. No part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. In addition, the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report. The analysts who wrote this report, or members of their households, owns no shares of the above mentioned companies. -5-