We expect AGCO Corp. (AG) to report second quarter EPS of $0.90, up 34.3% y-o-y, amid continued strong profit growth in the South America and EAME regions. We expect North American operations to report a profit rebound in the second half of FY08 on the back of favorable currency translation and double-digit sales growth.
The global demand for biofuels and animal protein should result in record corn plantings and increased farm equipment purchases. We reiterate our Hold recommendation on shares of AG. Our target price is $51.00, which is about 14.9x our 2008 estimate of $3.42.
There is a likelihood of greater demand for combines in North America (NA) as a result of higher corn prices. This should lead to increased sales for the Massey Ferguson brand. Given the increased need for ethanol in U.S. gasoline, the demand outlook for corn appears favorable. As a result, the long-term demand for North American combines is likely to increase along with higher corn plantings. The sharp rise in corn prices should boost farm income.
An increase in farm income creates conditions for a better-than-expected upgrade cycle for farm equipment. Higher corn, wheat, and soybean prices have led to increased NA farm income that resulted in increased equipment purchases.
The company will also benefit from future productivity gains driven by several initiatives being implemented until year-end 2008. These projects would result in annual cost savings of $14 million or $0.15 per share. Importantly, AG continues to produce positive free cash flow.
However, these strategic initiatives are a drag on near-term EPS growth. The management noted that strong global demand for industrial and farm equipment is putting pressure on AGCO's supply chain. The company expects this situation to persist in 2008. Finally, while the fundamentals remain extremely positive, the valuation is rich.
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