Kubota has built up strong brand leadership in the compact engine and farm machinery industry over the past century. The company’s compact tractors, combine harvesters, and rice transplanting machines have significant if not leading market shares in North America and Asia. As a result, we think the company will continue to benefit from ongoing mechanization in farming.

Kubota is leveraging on an established network to move into the production and sales of Larger farm equipment, which will see it compete more directly with peers such as John Deere and CNH Industrial. This is expected to depress its operating margins and cash flow over the near term as it breaks into this market, adds capacity and also as it is beginning to manage a larger product portfolio. The company has launched a larger tractor series and acquired implement makers. However, we believe that Kubota will be able to tap into part of its existing client and dealer relationships to expedite its entry to this product space. We expect to see the benefits from increased revenue flow through to cash flow within the next five years.

While the long-term growth prospect remains intact, Kubota’s earnings over the past three years has been lackluster, mainly due to the consecutive decline in global Grain Prices, political turmoil in Thailand that impacted sales, and swings in government policies for the agricultural sector. For example, tractor sales in Thailand fell over 30% from the peak in fiscal 2013 after averaging growth of 16% from fiscal 2007 to 2013. However, considering the fact that grain prices hit a six-year low and food consumption continues to rise, we think demand from agricultural machinery is likely to recover.

Analyst: Shanshan Wei, CFA

This insight is part of Smartkarma. For more follow this link.