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CNH Global Makes Its Case

Posted: Oct 06, 2008 09:09 AM by Will Ashworth

Tickers in this Article: TEX, CAT, DE, KUB, AG, CNH

My original idea for this article was to write about AGCO Corporation (NYSE:AG), parent company of Massey Ferguson, once a proud Canadian business but now very American.

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As a child, my grandfather had a weekend place down the road from the Harris farm, descendants of Alanson Harris, one-half of the team that introduced the first self-propelled combine in 1938. Originally, Massey Harris, it became Massey Ferguson when it merged with Harry Ferguson Limited in 1953. That's enough of the history lesson. As I began to explore AGCO, I realized i was interested in the wrong company. CNH Global (NYSE:CNH) was the real value play of the sector .

CNH was formed in 1999 when New Holland Tractors and Case International Harvester merged; the combined entity has gone on to become a wonderful company, one whose history can match that of the great Canadian icon.

From One Car Company to the Next
New Holland's roots date back to 1895 in rural Pennsylvania. Eventually, it would become part of Ford (NYSE:F) until it was sold in 1991 to Fiat, who now control 89% of CNH’s stock. Case International Harvester got its start in Racine, Wisconsin way back in 1846.

Originally known as the Racine Thrashing Works Company, its name changed to Case in 1863; then Case IH when it acquired International Harvester in 1985. Once the merger was complete, management would go to work transforming two operations into one, well-oiled machine. A decade later, the results are impressive. (To learn more about mergers, read The Merger - What To Do When Companies Converge).

Back in the Black
One year after the merger with New Holland, the combined company went into a four-year slump losing money every year between 2000 and 2003. As management worked out a restructuring plan, business slowly improved culminating in a profit in 2004. Since then, it's been mostly clear sailing. Revenue has grown from $10 billion in 2003 to $15 billion in 2007 and net income from a loss of $157 million in 2003 to a profit of $559 million in 2007.

Driving this turnaround is an incredibly buoyant agricultural equipment division, whose sales were $9.9 billion, up 27% from $7.8 billion in 2006 with all four regions producing gains. In terms of profits, net income in 2007 was $559 million, an increase of 91% from $292 million in 2006. Most of the gain is due to strong agricultural equipment business worldwide as well as construction equipment outside of North America.

Assisting in padding the top line is a financial services division that contributed just 6.6% of revenue from its $20.6 billion managed portfolio of receivables but 26% of trading profits under International Financial Reporting Standards. It helps when you can derive so much from so little!

Stock Hurting
I'm having a hard time understanding investor rationale for driving the stock down more than 60% over the last 52-weeks, most of the decline coming since January. AGCO, the company I was going to initially write about, had the ninth biggest gain in 2007 of any Fortune 500 company, producing a 120% increase in its stock. Not bad until you realize CNH's performance was twenty percentage points higher, returning 140% in just twelve months. Then, as the calendar turned, all of the tractor stocks, including Deere & Company (NYSE:DE) and Kubota (NYSE:KUB) fell off the mountain and into the sea.

The meltdown was most severe for CNH, and in my opinion, it was the least deserving of the bunch. All signs point to a fully functioning, profitable, diverse business model. Sure, the construction business is wilting under tough economic conditions in North America and Western Europe, but the segment accounts for only 31% of overall sales. Not helping its cause was Terex's (NYSE:TEX) cutting of its earnings projections in early September, sending CNH spiraling down from $35 to where it sits today. Once again, we're talking about companies that are completely different; I think the market got this one wrong.

Bottom Line
CNH is catching up to Caterpillar (NYSE:CAT) and Deere in terms of profits and net margins and it is miles ahead of AGCO. In July, it announced second quarter results that were the highest quarterly results in its history. Net income was $347 million, up 52% from the second quarter in 2007. Strong agricultural equipment sales helped increase overall revenues 29%, to $5.3 billion. Earnings surprised 28.7% on the upside.

In September, it even announced it was expanding a 223,000 square foot plant it originally was going to close because business is so good. Its price/sales, price/book and peg ratio are all well under 1 and are lower than its other competitors. If firms like Sterne Agee want to place a 'hold' rating on the stock, that's fine by me. I just wouldn’t want to be the analyst when their clients ask why in six months from now.

To learn more, check out Surprising Earnings Results.

By Will Ashworth

Will Ashworth lives and works in Toronto, Canada. He's worked in and around the financial services industry for much of his adult life. He loves investing and is passionate about helping others learn how to put their money to work.

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