September 16, 2014 / 6:53 AM / 4 years ago

As U.S. farm cycle turns, tractor makers may suffer longer than farmers

CHICAGO (Reuters) - Farm equipment makers insist the sales slump they face this year because of lower crop prices and farm incomes will be short-lived. Yet there are signs the downturn may last longer than tractor and harvester makers, including Deere & Co (DE.N), are letting on and the pain could persist long after corn, soybean and wheat prices rebound.

People look at OXBO harvesters at the 47th Annual World Ag Expo in Tulare, California in this February 12, 2014 file photo. REUTERS/David Mcnew/Files

Farmers and analysts say the elimination of government incentives to buy new equipment, a related overhang of used tractors, and a reduced commitment to biofuels, all darken the outlook for the sector beyond 2019 - the year the U.S. Department of Agriculture says farm incomes will begin to rise again.

Company executives are not so pessimistic.

“Yes commodity prices and farm income are lower but they’re still at historically high levels,” says Martin Richenhagen, the president and chief executive of Duluth, Georgia-based Agco Corp (AGCO.N), which makes Massey Ferguson and Challenger brand tractors and harvesters.

Farmers like Pat Solon, who grows corn and soybeans on a 1,500-acre Illinois farm, however, sound far less upbeat.

Solon says corn would need to rise to at least $4.25 a bushel from below $3.50 now for growers to feel confident enough to start buying new equipment again. As recently as 2012, corn fetched $8 a bushel.

Such a bounce appears even less likely since Thursday, when the U.S. Department of Agriculture cut its price estimates for the current corn crop to $3.20-$3.80 a bushel from earlier $3.55-$4.25. The revision prompted Larry De Maria, an analyst at William Blair, to warn “a perfect storm for a severe farm recession” may be brewing.


The impact of bin-busting harvests - driving down prices and farm incomes around the globe and depressing machinery makers’ worldwide sales - is aggravated by other problems.

Farmers bought far more equipment than they needed during the last upturn, which began in 2007 when the U.S. government — jumping on the global biofuel bandwagon — ordered energy firms to blend increasing amounts of corn-based ethanol with gasoline.

Grain and oilseed prices surged and farm income more than doubled to $131 billion last year from $57.4 billion in 2006, according to USDA.

Flush with cash, farmers went shopping. “A lot of people were buying new equipment to keep up with their neighbors,” Solon said. “It was a matter of want, not need.”

Adding to the frenzy, U.S. incentives allowed growers buying new equipment to shave as much as $500,000 off their taxable income through bonus depreciation and other credits.

“For the last few years, financial advisers have been telling farmers, ‘You can buy a piece of equipment, use it for a year, sell it back and get all your money out,” says Eli Lustgarten at Longbow Research.

While it lasted, the distorted demand brought fat profits for equipment makers. Between 2006 and 2013, Deere’s net income more than doubled to $3.5 billion.

But with grain prices down, the tax incentives gone, and the future of ethanol mandate in doubt, demand has tanked and dealers are stuck with unsold used tractors and harvesters.

Their shares under pressure, the equipment makers have started to react. In August, Deere said it was laying off more than 1,000 workers and temporarily idling several plants. Its rivals, including CNH Industrial NV (CNHI.MI) and Agco, are expected to follow suit.

Investors trying to understand how deep the downturn could be may consider lessons from another industry tied to global commodity prices: mining equipment manufacturing.

Companies like Caterpillar Inc. (CAT.N) saw a big jump in sales a few years back when China-led demand sent the price of industrial commodities soaring.

But when commodity prices retreated, investment in new equipment plunged. Even today — with mine production recovering along with copper and iron ore prices — Caterpillar says sales to the industry continue to tumble as miners “sweat” the machines they already own.

The lesson, De Maria says, is that farm machinery sales could suffer for years - even if grain prices rebound because of bad weather or other changes in supply.

Some argue, however, the pessimists are wrong.

“Yes, the next few years are going to be ugly,” says Michael Kon, a senior equities analyst at the Golub Group, a California investment firm that recently took a stake in Deere.

“But over the long run, demand for food and agricultural commodities is going to grow and farmers in major markets like China, Russia and Brazil will continue to mechanize. Machinery manufacturers will benefit from both those trends.”

In the meantime, though, growers continue to flock to showrooms lured by what Mark Nelson, who grows corn, soybeans and wheat on 2,000 acres in Kansas, characterizes as “shocking” bargains on used equipment.

Earlier this month, Nelson traded in his Deere combine with 1,000 hours on it for one with just 400 hours on it. The difference in price between the two machines was just over $100,000 - and the dealer offered to lend Nelson that sum interest-free through 2017.

“We’re getting into harvest time here in Eastern Kansas and I think they were looking at their lot full of machines and thinking, ‘We got to cut this thing to the skinny and get them moving’” he says.

Editing by David Greising and Tomasz Janowski

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