Two Wall Street looks at this business.

Mitch Quain sees improved profitability for Deere, Case IH. John McGinty expects more consolidations,

How does the farm equipment industry look today to the watchers from the financial community? The question is more than casual. Not only do these financial analysts advise investors

when to buy, hold and sell shares of stock, they sometimes play important roles in various acquisitions, mergers, divestments and sell-offs. And since they tend to dig very deeply into the doings of the companies that interest them, they often speak with considerable authority about where an industry is headed.

With that in mind, let's review what a couple of veteran watchers of this business are saying. One is Mitchell Quain of Wertheim Schroder; the other is John McGinty of First Boston Corp. Both specialize in capital goods industries for their companies, which are important financial houses in New York City.

Quain likes Deere

In a recent report "Deere & Co. and the Farm Equipment Industry," Quain provided a rundown of the major companies in the field, Here are some extracts:

Deere & Co."On a consolidated basis, Deere has gained significant market share, One way of illustrating Deere's superiority (as perceived by the farmer) is the used equipment value of its machines. Deere's machines sold in 1979 still have more than 90 percent of their original value.

Resale as Pct.

1979 Model of 1979 Price

Deere 4440 91

Allis-Chalmers 7020 75

J I Case 7290 65

IH 1086 60

"Deere has consistently (since 1980) invested 5 to 8 percent of sales for R&D, compared to 3-5 percent (on a lower sales base) for its competitors. A new line of equipment expected to be introduced in early 1989 could widen Deere's competitive advantage. Accordingly, market share gains could continue through 1990. More important, pricing could get significantly better, boosting the profitability of the industry.

"...Deere's market share exceeded International Harvester's permanently in 1969. Deere was capacity-constrained through 1981, resulting in very stable shares. Since then, its market share has surged; today Deere has an estimated 55 percent of the North American combine market and 35 percent of the large two-wheel-drive tractor market.

"Ironically, Case during this period has cut prices not to increase share but just to hold share, though the attempt has been unsuccessful. Nevertheless....Deere has had to match those prices, . resulting in substantial margin erosion. However, the combination of a more financially oriented Case management and a healthier farm community should result in better pricing, which, coupled with a superior product line, should move margins and market share higher in the future.. ..

J I Tenneco, which derives about 20 percent of total revenues from Case, has witnessed a steady deterioration in Case's market share in farm machinery....Case's competitive position was vulnerable through the 1970s, despite being profitable, due to its weakened and fragmented dealer network. User surveys indicated that in terms of general reliability, Case's machines ranked among the lowest in the industry. In terms of price, Case's machines were positioned in the most competitive segment of the industry, unlike Deere's and IH's lines, priced at a premium,

"Accordingly, it was a surprise when, following Case's acquisition of the IH line of tractors, it was revealed that the International name, its red paint and logo would be discontinued. Case was attempting the unusual marketing tactic of moving the premium brand product (IH) down to the price-competitive segment of the market (Case). While the decision was reversed later,.. .the die had been cast and International machines had lost some of their premium price image. Coupled with consolidation of the dealer network and dominance throughout the organization of Case people rather than IH personnel, market share losses in tractors resulted.

"At the time of the acquisition, IH had an estimated 20 percent share and Case had 10 percent; today, the combined entity has only about 20 percent....

"A major shift in the strategic direction of J I Case took place with the introduction of the Magnum tractor. Even its competitors admit that this is the first line of Casebranded equipment technically competitive with Deere offerings... .

"Preparing for the new line, Case reduced its excess dealer inventories. Accordingly, Case can no longer severely discount product held by dealers and generate cash at the same time; anything it sells it essentially has to manufacture. The cost of the program was over $100 million in 1987. The magnitude of this loss, start-up problems and disagreements over future strategic direction resulted in the resignation of Jerome Green, Case's president. While it does not necessarily follow that new management will be less price-aggressive, it cannot be more so.

"Perhaps Case really wants to show a decent return on investment compared to its $283 million loss in 1987. The possible change in strategic direction, coupled with greater shareholder pressures on Tenneco to be more return-on-asset oriented, a new, more competitive product line and (lower) inventory should result in a less price-competitive JI Case-a more profitable one in the future."

Ford New Holland"Ford in 1986 closed the $382 million purchase of the New Holland Div. of Sperry Corp. New Holland market trends have been in sharp contrast to Ford, consistently gaining position over the past 20 years, reflecting its leading position in hay equipment. It also benefitted from the rapid growth in foreign markets, where it typically derived about half its sales.

"...The acquisition by Ford rounds out the product line, giving it access to a leadership position in hay equipment and a respectable product serving the combine market.

"Ford's one area of weakness is the high-horsepower, two-wheeldrive market, ironically the segment of the market where price competition is expected to alleviate the quickest, due to the oligopolistic relationship between Deere and Case.

"Integration between Ford, a lowprice tractor producer, and New Holland, a market leader and premium brand, could be difficult. New Holland always had a rich, distinct corporate culture, separate from the rest of Sperry, and very different from the automotive atmosphere which pervades the Ford Tractor Div. . . .

"Overall, while Ford will not participate in the expected revival in pricing in the tractor segment, it does now offer a third, full-line alternative in the industry and should be an increasing force in the future."

Varity: "Varity, formerly Massey-Ferguson, derives about 55 percent of its sales from farm equipment. It has suffered steady deterioration in its relative position since the 1970s, though share is expected to rebound in 1988....Last year, MF sold almost 20 percent of all the tractors and combines in the free world,...but due to the bias in its sales mix toward the very small end of the line, its overall share of industry revenues is only about 8 percent. The company is heavily dependent on U.K. production, with overall manufacturing costs heavily skewed toward strengthening European currencies. This disadvantage has continued to impact margins negatively, resulting in an operating loss last year in farm machinery... .

"Variety's strategy seems to be to operate many small businesses in a global farm equipment environment....Management has been encouraging a more 'entrepreneurial' approach to its market, encouraging local management to supply all of the equipment sold in its territory... .

"It remains to be seen whether this renewed focus on maximizing profitability can offset low market shares in the most profitable market, North America, as well as a low level of R&D and capital spending for the past 10 years. MF's focus on European manufacturing and the European farmer (54 percent of sales are in Europe) makes it unlikely that it will maintain share of market."

Kubota: "Kubota has the lending share of the world market for diesel tractors under 40 hp. The company has an expanded offering up to 90 hp, but has not penetrated markets outside Japan with these models, due in part to lack of a meaningful domestic market to ensure efficient manufacturing and economies of scale.

"Kubota's share should begin to decline in the late '80s and early '90s as exports from Japan are more expensive. Kubota could be impacted by the slowdown in consumer spending in the U.S. and is not in a position to participate fully in any rebound in the midwestern farming markets."

Deutz-"Deutz-Allis has held market share over the past several years, reflecting market share gains in low-horsepower tractors, offset by various start-up problems in combines, where it enjoys its highest market share. KHD acquired the Allis Chalmers farm equipment division in 1985. KHD's historical emphasis has been on engineering innovation and excellence, spending 6 percent of sales on R&D. It is a $2.5 billion company worldwide, though it is saddled with the strong West German currency... .

"Deutz-Allis historically has had only about a 5-6 percent share of the U.S. tractor market....The company's most profitable line in good times was its Gleaner combines, with a market share that ranged from 15-20 percent.... While start-up problems on a number of new lines have hindered share over the past several years, product reputation is still excellent and Gleaner should maintain its position in the industry. Its position in tractors (manufactured in Germany), however, is more tenuous."

Allied Products Corp.: "Allied has gained share of the farm machinery market over the past several years due to its strategy. It has taken advantage of the weak environment to make acquisitions of secondary brand names....This 'Statue of Liberty' strategy ('Give me your tired, your poor...') has been tried before in the capital goods area, though not with much success....

"Allied's original brands included Bush Hog and Kewanee. In 1984, the company acquired New Idea for $16 million, approximately $7.5 million less than its book value, resulting in negative goodwill to be amortized in the future, benefitting earnings but having a neutral effect on cash flow... .In 1985, the company made its riskiest acquisition, White Farm Equipment out of Chapter 11. The company issued $17 million in preferred stock. Total assets exceeded purchase price by over $21 million. Lilliston Co. was acquired for $13 million, though in this case, the price exceeded book value by about $8 million.

"The financial effect of these acquisitions has been high levels of reported net income....but mediocre cash flow. Ultimately, the risk is that these properties were sold at substantial discount to book for a good reason.. ..

"Allied's problem seems to be the competitiveness of its various product lines. The only time the 'Statue of Liberty' strategy works is when an industry is recovering or is above normalized levels. While the farm machinery industry is certainly nowhere near average levels, Allied could be the prime, leveraged beneficiary of a pickup in farm machinery sales."

McGinty likes dealers

At an Ohio State U. conference on "Farm Machinery Distribution Systems for the 21st Century," John McGinty focused on three key trends in this industry:

"They are consolidation, globalization and cost reduction, three ways of saying the same thing, with different implications,

"First, there have been seven major mergers in the last four years (and a few financial accidents) that have reduced industry capacity by 50 percent. We still have three times as much capacity as we need.

"The consolidation in the industry in the next five years is probably going to be as great as what you saw in the last four years. We may be moving to two or three full-line global companies. (Editor's italics.)

"Second is globalization. It is in fact driven by cost reduction, by global sourcing and by scale of manufacturing production. You want facilities in Europe, the U.S., and such places as Japan and the Third World. Ideally, you want four locations to be able to shift your manufacturing back and forth, because currencies are going to fluctuate. You have to have global manufacturing....

"Two points to keep in mind about manufacturers: First, they make their money manufacturing. Second, they manufacture a commodity. There isn't much difference between one make and the next. (The manufacturer is in essence, selling a drive train surrounded by sheet metal. What he cares about is the components because that is where the value-added is.) Ultimately, a tractor is a tractor, a baler is a baler, and at bottom, you are dealing with a commodity.

"The key to success is distribution. What is distribution to the manufacturer? First, it's costly. Nobody likes wholesale receivables, dealer inventory, floor planning-horrible, ugly things that have sent and can send a couple more companies out of business.

"But distribution is what differentiates the product. It's everything to the manufacturer. His goal should be to maximize his distribution, to maximize the health of the distributor. It is the dealer providing the service that explains market shares and changes in market shares over time... .

"The issue is, where does distribution go? Caterpillar has $4 billion in U.S. sales. They do it with 70 distributors, which is down from 100 five years ago. The distributors average a net worth of $20 million. They have about $85 million in sales and they cover 130 percent of their overhead based on parts sales.

"Most importantly, Caterpillar today finances only 35 percent of their dealer inventories....I believe that is the model for the manufacturers- try to grow larger, broader, more cost-effective dealers, dealers who can deal with the changes specific to their territory... ."

"We are going into an up cycle where there are significant opportunities for the kinds of changes that you all want to effect. But remember that it is the dealer that differentiates the product. That is why the manufacturers should be most interested in protecting and building their dealers."