Friday, June 20, 2008

Steel Nabs Another one - Lindsay Corporation (LNN)

As we've outlined in the past, there are a lot of concerns on MY end (not Wall Street's apparently) on the rising input costs and the effect on margins in the coming quarters (i.e. note crunching sounds to profits). It appears steel [May 17: WSJ - Fast Rising Steel Prices Set Back Big Projects] nabbed another one [May 14: Deere Earnings - Why I'm Avoiding Equipment Stocks] in Lindsay Corporation (LNN) - which has turned into yet another tangental "agriculture play" - they have 2 main lines of business but the sexy one everyone was jumping on was the large scale irrigation systems.

Once again, someone needs to eat higher costs - producer or consumer. I did not even think the earnings report was that bad (in fact for a normal stock it would of been great), but a small reduction in gross margin set off a firestorm - but I suppose when your stock has moved to such an extent and trades at such a high multiple you need perfection. The stock dumped from $130 to $90s in 1 day... ouch. But frankly this is the fate of every high multiple stock sooner or later - once you achieve that premium valuation you need to nail home runs to justify it.
  • Lindsay Corp (LNN), a maker of irrigation equipment, infrastructure and road safety products, posted a lower-than-expected third-quarter profit as infrastructure and irrigation product margins were crippled by higher costs.
  • Third-quarter gross margin at the company, which is grappling with record high steel prices, was 25.8 percent compared with 26.2 percent a year earlier.
  • "It is a high multiple stock where expectations for margin expansion in earnings are obviously set very high and the company did not deliver on those expectations," said Joe Giamichael of Rodman & Renshaw Inc.
  • Shares of Lindsay, which makes irrigation systems, corrosion resistant pipelines, chemical injectors and soil moisture sensors, trade at more than 31 times forward earnings. (whodda thunk an irrigation maker would be trading at 30x+ forward estimates a few years ago?)
So why do we care, and what can we take from this? First, as always I am usually early but as I wrote in April

I sold my agriculture equipment makers to focus on fertilizer back in January 2008. Just easier to play the same trend in a more focused manner with the fertilizer. Input costs are rising for the equipment makers with costs of their raw goods rising.

And so we are now starting to see that. I still don't think Wall Street gets it, or is even close to getting this trend. Hence we are going to see some ugly surprises in the next few quarters as companies who have exposure to any petrol based product (there are a lot of them) and steel report some disappointing numbers. And we know what happens to stock when they disappoint. So we need to be cautious, and respect a trend we see developing.

Think it does not matter? A rising tide lifts all boats? Well it does - relatively speaking. BUT, we want to find the best boats (stocks) even if the tide is rising. Bespoke blog has an interesting look at an ETF for agriculture that we highlighted as a no nonsense easy way to play agriculture if you were so inclined [Sep 7: This MOO for You? An ETF to Play the Global Agriculture Boom] I much prefer (in most cases) to pick specific stocks rather than go to an ETF, but if you don't have an aspiring mutual fund manager running your money - than an ETF is a good choice. But instead we focused mostly on fertilizer, and dropped even the equipment exposure early this year. Good choice? Looks like it, per Bespoke. Below are MOO's holdings, and in the far right are the year to date returns. Note MOO itself is doing great in a very tough market - up 14% YTD.

(click to enlarge)

Takeaway? The fertilizer producers we own have been the top performers - Mosaic (MOS) #1 @ +67%, Potash (POT) #2 @ +64% and tied for third is CF Industries (CF) @ +52%. How are the equipment guys doing? Deere (DE) -15%, Agco (AG) -14%, CNH Global (CNH) -36%; not so good after a very nice 2007 for these names.

Conclusion: It's important to get the sector right (the rising tide) i.e. agriculture, but to get maximum effect you want to the speedboats and not the pontoons. Case in point, my decisions in solar have been ALL pontoons, no speedboats - even though I have the sector correct. If I had even 1 speedboat from solar and enjoyed one of these crazy 60% gain in 3 weeks type of moves, our performance would be that much more sterling. Ah, the pursuit of perfection....

Keep in mind, one day these fertilizer stocks are going to disappoint as well - they too have rising costs (but not to the degree of the equipment makers), but at some point analysts who have missed the boat the past 2 years are going to raise estimates to a point where these companies miss, and all hell will break through because if you make $4.32 instead of analysts expected $4.33 you know what that means? Your stock is trash. ;) Or so it is on Wall Street.

Long Mosaic, Potash, CF Industries in fund; long Mosaic in personal account

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