It appears that heavy equipment manufacturers are in a bubble. I wrote four articles this week on Caterpillar (CAT, Financial), John Deere (DE, Financial), CNH Industrial (CNHI, Financial) and Agco (AGCO, Financial). In reality, my research shines a light on something that no one in the main stream financial press and research firms seems to be saying: the bottom has fallen out of the heavy equipment market and that these stocks are way overpriced.
In the previous four articles, I researched sales at the auction house Ritchie Brothers (RB, Financial). Having bought a small amount of equipment at Ritchie Brothers, I am familiar with the process. Basically, the seller takes in their equipment, Ritchie Brothers has a facility and huge marketing presence, and the seller pays about a 15% commission (it could be less for higher priced equipment).
The results from recent auctions across the U.S. show time and again that farmers, miners, construction companies and others that may want to buy heavy equipment slightly used for about half-off what is brand new. This does not portend good things for the equipment manufacturers.
I encourage you to look up a piece of newer equipment and find what it is selling for at auction and then find what it is selling for brand new. Remember, heavy equipment buyers do not care if there are a few scratches. They are looking for functionality. My simple rule of thumb is that 1,000 hours on a piece of heavy equipment is about 20,000 miles on a used car.
So what does this portend for financial markets? Caterpillar is a component of the Dow Jones Industrial Average and is way overpriced. This could affect the Dow, which is a huge indicator of the overall economy. It is also held by thousands of mutual funds and pensions. Its 3.73% dividend yield is illusionary. Dividends come from free cash flow and free cash flow comes (in part) from positive net income. Why would heavy equipment buyers purchase a $300,000 brand new dozer when they can get one slightly used at auction for half off? I am talking one with a few hundred hours of time on the odometer, or whatever they call an odometer on a dozer.
Also, how many billions of dollars in fixed income is outstanding from the heavy equipment manufacturers? $100 billion in the U.S. alone? It is not a bad guess. And most of that debt only yields a few percentage points. I recently found 10 year Cat Financial debt yielding not even 2.5%. No, thanks. We liquidated quite a bit of our CNH Industrial debt (but not the shorter term maturities). We also kept our Agco debt because Agco has a more pleasant balance sheet than the other three mentioned. We sold stock in Deere, CNHI and Agco this week at Osborne Global Investors. Including dividends, we broke even on the three (luckily).
Ever see the movie the Big Short? I feel like I am in a Big Short moment. If I owned a hedge fund (which I do not) I would short these stocks (which I am not). Of course, the reverberations of heavy equipment will not spill over into the global economy like housing, but there are sure to be deleterious effects.
I am going to list as many heavy equipment manufacturers that I can so that they might link to this article: Titan (TITN, Financial), Gencor (GENC, Financial), Joy Global (JOY, Financial), Terex (TEX, Financial), Manitowoc (MTW, Financial), Astec (ASTC, Financial), H&E Equipment (HEES), Komatsu (KMTUY), Kubota (KUBTY), Doosan, Hitachi Construction (HTCMF, HTCMY) and Wacker Neuson (WKCMF, WKCMY).
I Googled “heavy equipment selling much less used than new” under News and about the only thing I could find was my article on Yahoo Finance, which I wrote for GuruFocus yesterday. I did find an article posted by Aggregate Research that discussed the slowdown of new equipment sales in China. Of course, everyone knows that the heavy equipment manufacturers have lost sales. Here is an article from China Daily that states that the heavy equipment manufacturers are wanting to partner with auctions houses in China. What I do not find anywhere is this half-off phenomenon. I see no reason to buy new heavy equipment whatsoever. Only a fool would hold these stocks at these prices. A bigger fool would hold debt at these prices.
Disclosure: We own debt in Agco and CNHI.
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