Undervalued by 25%, This Dividend Stock Is an Attractive Long-Term Buy

A global producer of heavy machinery, CNH Industrial has seen weak demand for its agricultural and construction equipment this year, and we expect demand headwinds to persist in the short term. Long term, however, we see opportunity in this undervalued dividend stock. We expect the narrow-moat company to generate revenue from replacing aging fleets; we also think it’s well positioned to benefit from the trend toward using technology to improve efficiency, cost-effectiveness, and environmental awareness in agriculture. CNH is among our analysts’ favorite 33 Undervalued Stocks this quarter; it is also one of Morningstar chief US market strategist Dave Sekera’s 5 Undervalued Stocks to Buy During Q4.

For generations, CNH’s agriculture equipment has garnered intense loyalty among farmers with its Case IH, New Holland, and Steyr brands. Customers value the company’s high-quality and strong-performing products and its robust dealer network. In developed markets, CNH helps customers reduce the total cost of ownership through improved fuel efficiency, limited machine downtime, and consistent parts availability. The ag business appears well positioned to compete with peers, but we think the construction business will need to optimize its dealer network, product portfolio, and manufacturing operations to be competitive. CNH’s end markets have attractive tailwinds. In agriculture, we think demand for crops will be resilient. In construction, we think increased infrastructure spending in the US will be a benefit. Looking further out, we believe precision ag will be an incremental value driver for CNH.

Key Morningstar Metrics for CNH

• Fair Value Estimate: $14.70
• Star Rating: 4 Stars
• Economic Moat Rating: Narrow
• Uncertainty Rating: High

Economic Moat Rating

We believe CNH has a narrow economic moat underpinned by intangible assets and switching costs. CNH has played an important role in mechanizing crop production and boosting farmers’ productivity, which has led to strong brand loyalty among farmers, stretching back generations. The company has consistently provided customers with reliable, high-quality products while working to reduce the total cost of ownership. Farmers are very familiar with the product portfolio, know what repairs to expect, and have built long-standing relationships with dealers, who help limit the downtime of equipment. We do not believe customers will switch to a competitor based on individual product performance and features.

Read more about CNH’s moat rating.

Fair Value Estimate for CNH Stock

CNH’s second-quarter revenue and earnings per share were modestly above FactSet consensus estimates, but management’s lower outlook for full-year revenue, adjusted earnings per share, and free cash flow fell below our prior projections. After updating our forecast for weaker near-term results, we lowered our fair value estimate by about 4% to $14.70 per share. Demand has been held back for a few reasons. First, farmers are contending with declining commodity prices, which weigh on farm incomes. Second, high interest rates have pushed more farmers to question taking on expensive financing to purchase new equipment. The company is also being prudent when it comes to dealer inventories. Our near-term demand outlook remains constructive, however, as average fleet ages for large ag equipment are still high. We think this means that replacement demand will slightly offset weakness in new retail demand.

Read more about CNH’s fair value estimate.

Risk and Uncertainty

The most substantial risk is a declining commodity environment, given CNH’s exposure to crops. During 2014-16, lower crop prices forced farmers to pull back on new equipment purchases, causing CNH’s agriculture revenue and EBIT margin to drop. But just a few years earlier, the reverse was true when prices spiked after a US drought decreased crop yields and global supply. The potential for increased electric vehicle adoption could reduce demand for ethanol (for which corn is an input) used in internal combustion engines. We believe the impact from climate change will be incremental, as methods to grow crops in warmer climates are being studied. In construction, we think increased infrastructure spending in the US and emerging markets will spur growth, but a slowdown in economic activity can quickly reverse investment.

Read more about CNH’s risk and uncertainty.

CNH Bulls Say

• Higher crop prices increase farmers’ profitability, allowing them to purchase new agriculture equipment, which substantially boosts CNH’s revenue growth.
• CNH will benefit from solid replacement demand even as agriculture commodity demand moderates, encouraging farmers to refresh their machinery fleet.
• CNH can improve the construction business by optimizing the product portfolio and dealer network. Additionally, increased infrastructure spending in the US and emerging markets leads to more construction equipment purchases.

CNH Bears Say

• China could pull back on agriculture imports, weakening global demand for crops. This would lead to lower crop prices, largely due to higher supply, pushing farmers to delay equipment purchases.
• Challenging weather conditions reduce crop yields and pressure crop prices, which we believe would lead to lower demand for new agriculture equipment.
• Turning around the challenged construction business could be difficult, as retiring underperforming products and dealers takes time.

This article was compiled by Susan Dziubinski and Sylvia Hauser.