Stay Clear of Terex, But Not the Whole Industry

by Will Ashworth | June 18, 2013 2:52 pm

Heavy-equipment manufacturer Terex (TEX[1]) watched its shares get slashed yesterday after the company cut its 2013 forecast thanks to slower growth in North America, coupled with continuing weakness in other parts of the world.

At one point yesterday, TEX had shed almost 19%, knocking out almost all of the stock’s year-to-date gains; Terex remains up about 2% vs. 16% for the S&P 500.

Is this bad news for the broader construction and equipment industry? Well, while you can expect Terex and many of its peers to struggle, I still see one clear winner in the space. Let’s take a closer look:


To start with the bad news, let’s examine Terex. The aforementioned downward earning guidance revision from Monday makes me wonder whether TEX’s 108% total return in 2012 was a little overdone. Now, I think investors are rotating out of Terex to jump into blue-chip plays like Caterpillar (CAT[2]).

The trouble with Terex is that its five segments are all somewhat reliant on a strong and growing economy. Worse, one-third of its business comes from Europe, which shows little sign of pulling itself out of an economic mess. The company even paid $1.4 billion in 2011[3] to buy Germany’s Demag Cranes just as the European industrial market was coming undone. While the acquisition might have increased revenues, it did very little for profitability.

By dropping its earnings forecast for 2013 by 20%, Terex is showing that, overall, it has no idea about future profitability. Case in point: Analysts were expecting 82 cents per share in Q2, but the company now expects as little as 50 cents per share. That’s a 40% difference in the wrong direction.

If you’re a glass-half-full kind of person, I’m sure you can overlook Terex’s weaknesses. Normally, I am such a beast, but in this instance, I don’t think it’s a good idea. Where there’s smoke, there’s fire. Long-term, I think Terex will be OK, but in the next six months to a year, it could be a very bumpy ride.


I am a glass-half-full person in the case of Deere & Co. (DE[4]), though.

Sure, if you look at Deere’s total returns over the one-year, three-year, five-year, 10-year and 15-year periods, one thing is abundantly clear: Big Green has consistently underperformed its farm & construction equipment peers. And this even holds true year-to-date, despite Deere’s record second-quarter earnings[5] and a 12th consecutive quarter with increasing revenue.

But there’s no doubt that Deere’s ability to generate consistent earnings and revenue growth[6] is first-rate. Otherwise, Berkshire Hathaway (BRK.B[7]) wouldn’t have acquired 4 million of its shares last November.

So why the disconnect? Two things come to mind.

First, Deere’s construction and forestry division is thought to be at a cyclical peak in terms of earnings … meaning its 37% drop in operating earnings over the first six months of fiscal 2013 might be just the beginning. Fortunately, construction and forestry accounts for just 16% of its overall revenue.

The second concern is corn prices. Heavy rain this spring in North America[8] has delayed planting while easing fears of another drought. Unfortunately, this puts downward pressure on corn prices, reducing the cash flow of farmers and curbing their desire to spend on large equipment purchases. With 45% of its overall revenue coming from North American agricultural and turf equipment sales, any slowdown is likely to affect its overall profits.

So, sure, the horizon is dark and stormy. But that can change on a dime. In the past two summers, we’ve seen corn prices spike only to come marching back down before the fall harvest. This year, it looks like we’re going to have a stress-free season where drought isn’t a concern and corn prices remain moderate. To me, that’s a good thing, even if it temporarily delays purchases by farmers. Eventually, they have to buy.

And in regards to Deere’s underperforming stock: During the past decade, DE has achieved an annualized total return of almost 15%, while its net income increased at a compound annual growth rate of 19%. Over the long-term, stock prices generally follow earnings, and more often than not surpass them. In Deere’s case, its stock has trailed earnings by a significant amount over an extended period of time. And if you use EPS instead of net income, the CAGR increases to almost 22% annually — an even bigger disparity.

I believe Deere is on the precipice of a new era … one where its stock price catches up with its earnings growth.

As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.

  1. TEX:
  2. CAT:
  3. paid $1.4 billion in 2011:
  4. DE:
  5. record second-quarter earnings:
  6. consistent earnings and revenue growth:
  7. BRK.B:
  8. Heavy rain this spring in North America:

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