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Value Investor
Wealth Building Opportunites for the Active Value Investor

November 30, 2023

New Buy – CNH Industrial (CNHI)

We are recommending shares of CNH Industrial (CNHI) as a new Buy. The company is a major producer of agriculture (80% of sales) and construction (20% of sales) equipment for customers around the world and is the #2 ag equipment producer in North America (behind Deere). It also provides related supplies, services and financing.

The shares have slid over 40% from their peak at the end of 2021 and now trade essentially unchanged over the past 20 years. A major reason for the price decline is concerns that the ag and construction cycle has peaked and is slipping toward a downturn. These worries were heightened when the company missed estimates for the most recent quarter, guided for weaker-than-expected fourth-quarter results and offered an uninspiring preliminary outlook for 2024.

While investors see an average cyclical company at the cusp of a downturn, with a complicated history and share structure, we see a high-quality and financially strong company that is improving its business prospects and is simplifying itself yet whose shares are trading at a highly discounted price.

CNH generates over $20 billion in revenues, supported by its high-quality brands that include Case IH and New Holland. The company is highly profitable, with earnings expected to be $2.1 billion this year. Free cash flow for its Industrial operations will be over $1.2 billion. The Industrial segment balance sheet carries $3.7 billion in cash compared to its $4.6 billion in debt. CNH’s financial segment, whose only business is providing financing for end customers and dealers of its equipment, is conservatively capitalized (9.7% equity ratio) and generates a 12-13% return on equity.

The ag equipment industry is seeing weakness overseas and will likely see some weakness in North America. A global downturn is likely in 2024. However, we don’t anticipate a deep downturn, given the stability of commodity prices, enduring demand for crops, and the growing need for more efficient equipment.

While its products have lagged technologically, CNH equipment is catching up quickly. Its field equipment has always been competitive yet lacked newer precision technologies that help farmers become more efficient. It relied on Trimble (TRMB) for much of its technology. Now, however, CNH is bringing much of this capability in-house, helped by two acquisitions. This shift should boost its competitiveness while potentially increasing its margins.

Under relatively new leadership, Scott Wine, the CEO who previously led Polaris (PII) to success, is implementing efficiency programs totaling about $800 million (nearly 4% of revenues) to make CNH more profitable at all points in the cycle. Removing the legacy inefficiencies from its Iveco era is a key component of these programs.

CNH Industrial has a complicated history, which has led to American investors avoiding the stock, and has fostered the inefficient cost structure. Its roots are in two ag equipment companies, J.I. Case and International Harvester, which merged in 1985. This company was then acquired by Italian company Fiat in 1999 and was combined with Fiat’s New Holland business to become Case New Holland (CNH). In 2012, Fiat added its Iveco truck, bus and engine businesses to create CNH Industrial, but this move was reversed in 2021. Today, CNH Industrial is purely an agriculture and construction equipment company. This clarity should eventually lift the shares’ valuation.

Further burdening investor interest is that CNHI shares trade in Milan (a legacy of its Fiat days) and New York. However, the company is de-listing its shares from Milan and transitioning all of its share trading to the New York Stock Exchange, effective in early 2024. This should remove the two-country overhang. Near term, this transition is likely weighing on the share price as Milan traders unwind their positions, so CNH is implementing a $1 billion share buy-back program, with a completion date of March 31, 2024. For perspective, the $1 billion would repurchase about 7% of the company’s shares.

We would like to see more clean-up of the company’s legal structure. Its operational headquarters are in Illinois, near Chicago, while its legal headquarters are in London and its registration is in the Netherlands. Ideally, the company would centralize all of these in the United States. Also, we would like to see the dividend changed from a single annual dividend to a recurring quarterly dividend to better correspond to American standards.

Adding credibility to the company and our thesis is the presence of two major investor-friendly shareholders. The Agnelli family, who controls Fiat, remains a 28% owner and is highly regarded for its investment savvy. Harris Associates, a noted value-focused American investment management firm, holds a 9.3% stake and recently added to its position.

The company’s shares trade at 6.1x per-share earnings. This compares to 12x for Deere and Caterpillar and 7x for Agco. On an EBITDA basis, assuming only book value for the financial segment, CNH’s shares trade at 4.2x EV/EBITDA – also a sizeable discount to its peers. The shares offer an attractive 3.7% dividend yield that looks well-supported by cash flow and the balance sheet.

CNHI shares carry risks that potential investors should know about. The major risk is that equipment cycles can be unpredictable and deeper than expected. A deep cycle could drag the company’s earnings much lower and push the shares to perhaps $6. Other risks include production costs, new trade barriers, currency changes and general execution.

All-in, the shares look attractive and we are recommending them as a Buy with a $15 price target. Investors may want to gradually build their positions – establishing a partial position now and adding on any further weakness, particularly around earnings reports.