Easy To Like Everything About Kubota Except The Price

By Stephen D. Simpson, CFA | August 22, 2013 AAA

There's a lot working in Kubota's (OTC:KUBTY) favor these days. The lower value of the yen makes its products cheaper, while rising incomes across Asia make its agricultural equipment more attainable. Add to that a recovery in the U.S. housing market (where the company sells a lot of lawn equipment) and a stated goal to expand the dry land business, and there are multiple attractive growth drivers. The problem? It's just not possible to run an attractive valuation on a discounted cash flow basis, and I can't reconcile the idea of paying a 40% to 100% premium (in forward EV/EBITDA terms) for Kubota compared to Cummins (NYSE:CMI), Deere (NYSE:DE), AGCO (Nasdaq:AGCO), or CNH (NYSE:CNH).

A Growing Presence In Asia
Kubota gets about two-thirds of its revenue from agricultural equipment (nearly 90% of which is tractors), with another quarter coming from pipes, pumps, and valves used in municipal water businesses and about 10% from construction equipment. While the water business is a different twist, the split between agricultural and construction equipment should be familiar to investors who know Deere and CNH.

SEE: Deere Benefits From Strong Farming

While about one-third of Kubota's ag business comes from Japan, a growing portion is coming from the rest of Asia as rising farmer incomes make Kubota's superior equipment more accessible. Thailand is a major market for the company today (and a major exporter of rice), while countries like China and Indonesia are only just starting to emerge as real opportunities.

In North America, Kubota has market-leading share in small (<40 HP) tractors, but only about 20% of sales go into the agricultural sector. Far more important is the homeowner market, as about 50% of Kubota's sales are to homeowners with above-average incomes in the form of lawn equipment (riding lawn mowers and so on).

Looking To New Businesses For Growth
One of the key long-term plans for Kubota management is to grow the company's presence in dry-land agriculture. Only about 5% of the company's North American sales go to grain farmers, and worldwide the amount of land devoted to dry-land crops is about seven times that of rice.

How the company will get there has yet to be fully determined. Kubota is entering the large tractor market (100HP+) and the company has made gaining share in the 40+ HP categories a priority, but Deere has considerable market share here. Kubota may also look to leverage its past acquisition of Kverneland, a European manufacturer of dry-land equipment for plowing, cultivation, seeding, spraying/spreading, and so on.

Part of the challenge is scale and credibility. Kubota just doesn't have any reputation or track record with North American farmers in equipment like combines, and the size of the purchase involved makes that a much more challenging sale. What's more, while management has talked about spending up to $2 billion on deals to accelerate the process, it would take a lot more than that to secure a deal for a company like AGCO or Claas.

Several Attractive Drivers
All told, there is a lot to like about Kubota today. As farm incomes in Indonesia, China, and Vietnam improve, Kubota should see meaningfully higher equipment sales (machinery makes up only about 20% of Asian farming capital stock right now). What's more, outsourcing production to markets like Thailand and China should also help the company's margins.

Outside of Asia, the move to dry-land agriculture should significantly expand the company's addressable market and revenue potential, even if it is likely to require years of investment. Last and not least, it looks like the U.S. housing market is on healthier footing, with both Home Depot (NYSE:HD) and Lowe's (NYSE:LOW) recently reporting strong sales of outdoor powered equipment.

The Bottom Line
Unfortunately, all of that opportunity needs to be put in the context of valuation. Even if I forecast significantly higher growth rates for Kubota compared to Deere, the discounted cash flow model just doesn't work.

Now, it's not all that uncommon for Japanese stocks to look expensive by DCF, but the EV/EBITDA analysis isn't much better. You have to be willing to pay almost 9.5x FY15 EBITDA just to match today's price on Kubota shares, and that 40% to 50% more than you would pay for Cummins and CNH, and almost double would you would pay for Deere and AGCO.

I'm willing to support the argument that Kubota has more appealing growth prospects than Deere and less near-term risk. But I'm not nearly so willing to say that it's a good idea to pay twice as much on an EV/EBITDA basis for the shares.

Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.

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