Capital Goods: A Downturn in Agriculture Markets is Testing the Resilience of Manufacturers and Dealers, Outlook Remains Foggy

In this commentary, Morningstar DBRS reviews the pending contraction in the agriculture segment of the global capital goods industry, and the credit risk implications for Original Equipment Manufacturers (OEMs) and Dealers. Farmers are expected to maintain discipline on capital spending, driven by high interest rates in some markets, uncertainty in government support programs, high operating costs, excess output volumes for some grains and seeds, and a relatively weak commodity price environment. The slowdown is exacerbated by uncertainty in global agriculture exports.

Key takeaways:

-- In addition to weak sales volumes, tight competition, high dealer inventory levels on-hand, and a saturated used equipment market result in OEMs and dealers absorbing major discounts, putting pressure on the gross profit margins.

-- There are structural opportunities that may mitigate the extent of the downturn, including increasing reliance on equipment and machinery to address farm labour shortages, extension of favourable tax write-offs, and regionally focused production to mitigate import tariff impact.

-- That said, the unusual combination of weak agriculture fundamentals, global trade tensions, and uncertain timing in government support could mean the rebound in agriculture equipment sales may be delayed.

"Demand shocks are recurrent feature for most capital goods sub-markets. Morningstar DBRS believes corporate issuers have accumulated sufficient liquidity and leverage cushion to navigate multiquarter performance deterioration," said Azande Ntanzi Ndlovu, Assistant Vice President, Corporate Ratings, Diversified Industries. "In addition, muscle memory from managing variability in demand and changes in supply chains during the COVID-19 pandemic helps issuers respond effectively in such unpredictable times."