Description

CNH Industrial NV (CNHI)   

*Case (not Deere) is the largest global producer of agricultural combines 

Thesis

CNHI (CNH) is a spin-off and simplification investment with secular megatrend tailwinds.  CNH is a $25b conglomerate of industrial machinery companies that emerged from the serial restructuring of Fiat.  CNH is currently an orphaned equity and uninvestable due to their exposure to two separate business cycles and four segments spanning three continents.  Each segment has different capital intensity which distorted FCF, has several messy fincos and intercompany eliminations, and persistently weak investor communication and disclosure.  Analyzing this company for the last 10 years has felt like peering into a black box.  As a result, CNH has traded at a steep discount since its inception in 2013.  We believe the refreshed board and management team are intent on unlocking trapped value.

CNH’s new CEO (former DHR, PII, UTX) has announced his intention to split into two companies in six weeks.  Our checks on the CEO have been very positive.  We believe his plan to separate the businesses will allow industrial/ag investors and passive funds to invest in these businesses for the first time. We believe CNH could re-rate to $29-36 over the next year (60-100% upside).

How the company makes money

CNH contains two businesses.  1. Case New Holland (Case) operates in a global duopoly with Deere (DE) as the second largest producer of Agricultural Equipment and predominantly goes to market via an exclusive dealer channel, 2. Iveco produces trucks and powertrains for the European market.  

Setup

Half of CNH’s analyst coverage is European and does not cover DE.  CNH is perceived by them as the “expensive truck company.”  This is evidenced below by their valuation being roughly inline with Traton (VW’s truck business) at ~5x EBITDA.  Deere, however, trades at 13x EBITDA.  What the market is missing is the fact that 70% of CNH’s EBITDA is derived from the Ag business.  Simply applying a DE multiple to the Ag business results in 80% upside to the combined entity.  We expect a rerating to take place in the next six months due to a very strong catalyst path.

We believe the setup into the spin creates an ideal opportunity to own a strong ag machinery franchise with a new transformation-focused CEO at a massive discount to direct peers.  In addition, inquiry with sell side and IR indicate very little investor interest in this transaction.  From a macro setup, we are in year 1 of a multi-year bull cycle for agriculture.  From a micro perspective, there are numerous advantages to the technical setup.  CNH is dual listed in US/Italy which precludes them from being included in major indexes.  The company has already delayed their spin once and analysts view this as a show-me event.  There has been no disclosure of stand-alone accounting or balance sheets.  Half of the analyst coverage is European and does not cover DE or Ag.  The majority of the liquidity is in Italy, and Daimler is spinning their truck company at the same time as Iveco which has absorbed analyst attention.  

We think the catalyst path to drive this re-rating is very strong.  CNH reported a solid 3Q which was the last quarterly report pre-spin.  We also find the CEO’s $3m open market purchase just ahead of the blackout period as a notable purchase.  This week, the company is hosting an analyst day for the Iveco spinco where balance sheet and pro forma details are likely to be released.  Management is then on another roadshow ahead of the spin-off which the company has said should be effective on January 1.  Finally, Case, the ag company, will host an analyst day in February.  We expect these events to focus investor attention on this opportunity.

As a conglomerate, CNH currently trades at 6x our 2022 EBITDA.  DE trades at 13x, AGCO at 8x and Traton at 5x.  As 70% of their profits are comparable to DE, we would expect Case to re-rate.  Case and Iveco are pursuing the well-worn path in industrials of value creation via transformation previously seen at TFX, IEX, ROP, AME, DHR, FTV and CFX.  We expect Case and Iveco to follow this clear precedent and re-rate towards their best-in-class peers.  We expect them to be worth a combined $29-36 in the next year (60-100% upside) with blue sky upside to $40 in three years (120% upside).

Thesis Points

• Why does this opportunity exist?  

• CNH is covered by industrial analysts on the buy and sell side with a tortured history.  The company has faced many challenges since inception and the market is understandably skeptical.  In fact, over the last eight years, CNH has underperformed DE by almost 300%. The overhangs are the conglomerate discount, lack of management focus, poor analyst coverage and IR, lack of index inclusion due to dual listing, split liquidity, etc.  This has resulted in a lack of fundamental shareholder sponsorship for a $25b equity.  

• Management changes should lead to a reimagining and reinvigoration of the business

• Our calls with former CNHI management indicate a history of weak leadership and execution which we believe has led to a poor reputation in the investment community.  CNHI’s major shareholder, Exor, has a long-term, value-creating track record.  It appears their strategic focus has shifted from RACE to unlocking value at CNHI.  In January, the board hired former Danaher executive, Scott Wine, as CEO after twelve years of exceptional results at PII.  Our checks on Wine indicate he has a disciplined leadership style which has produced a high-performance culture.  For reference, in the five years after he became CEO of PII, shares increased ~600%.  With a reinvigorated leader and industry outsider, we believe Wine will position Case into a more formidable competitor to Deere.  It appears Wine is betting on himself as he acquired $3m in stock in the open market ahead of the 3Q blackout.  This is a compelling signal into a very active catalyst path.

• The current agriculture cycle should be a strong fundamental tailwind

• We believe the current ag machinery cycle is very strong and could surprise to the upside in the next two years.  A combination of crop price inflation, very healthy farmer balance sheets, a strong fleet replacement cycle, extremely high used equipment prices, and exceptionally low inventories at dealers has created a perfect storm.  In addition, the recent labor strike at DE has further exacerbated the shortage of equipment in the market and provides a strong market backdrop for Case.  While supply chain issues are impacting all players, we believe the dynamics above and a broadly inflationary environment create an ideal backdrop for this investment.  link: article 

• Potential for US relisting

• Currently, the majority of trading volume is in Europe.  The dual listing is suboptimal for Case as it precludes inclusion in major indexes like the S&P 500.  We believe the company should pursue a sole listing in the US for the Case remainco.  We think this would focus the market on Case as a clear alternative to Deere for US investors.  This would also allow for a shift in coverage and focus by US analysts as European analysts (who don’t cover DE/AGCO/CAT) would no longer be the logical coverage for this security.  Additionally, this would allow for significantly more liquidity and passive investment from indexes/etfs.  We estimate CNHI has only 6% of their float held by passive indexes/etfs, compared to US peers at 26% on average.  This implies passive investors would need to buy $5b (20% of the float) to be inline with peers upon a US listing.  

• A shift to P/E from EV/EBITDA could lead to meaningful valuation upside 

• DE and Case both have large fincos that provide floor plan financing to dealers and farmers.  Earnings from this flow through to EPS, but have historically been excluded from the segment EBIT reported by CNH.  For Case, we estimate the finco to generate 15-20% of EPS.  If Case can reorient the market towards EPS, they can receive credit for a large amount of earnings that have been inappropriately valued in the current conglomerate structure.  

• Precision agriculture is a megatrend and Raven is a transformational acquisition

• A major challenge CNH has faced in recent years is a lack of a cohesive technology offering in precision planting when compared to Deere.  DE has invested heavily in IOT, autonomy, and technology.  Case has not kept pace and they have been disadvantaged.  The new CEO acquired Raven, one of the market leaders in precision agriculture.  The deal is expected to close by year end, and we believe will be transformational for Case’s technology offering.  Our channel checks indicate that this should allow Case to now compete head-to-head with DE.  The power of the Raven acquisition to transform Case’s market reputation and offering is currently underappreciated.

Catalyst Path

1. Iveco analyst day will detail the value of the trucking company along with pro forma financials (11/18)

2. Non-deal roadshow to discuss companies (2H November) 

3. EGM to approve the spin (December)

4. Iveco is spun off (January 1)

5. Case capital markets day to reveal broader strategy for the remainco (February 2022)

Blue Sky

• The CEO has the opportunity to capture significant share from DE as they integrate Raven’s technology into their offerings.  We don’t assume any meaningful share shift, pricing, or significant margin expansion.  If any of these were to occur, our numbers would increase materially.  CNH’s multiple would also rerate to a premium to DE as they would be perceived as having more future upside potential.  In our bluesky case below we adjust the multiple to DE’s current multiple to account for this potential upside, although it is likely understated.  More diligence is needed to gain conviction in this upside case. 

• Precision ag could begin to be better understood as a megatrend.  Case and DE would solidify their market position and would result in a rerating of these businesses as technology platforms.

Valuation

The foregoing is for informational purposes only and does not constitute an offer to provide advisory services to any person, and does not constitute an offer to sell, or a solicitation of an offer to purchase, any of the investments discussed herein. The description herein of an investment thesis is an opinion and is intended to be a summary and should not be considered an investment recommendation or an exhaustive and complete description of the potential investment strategy.

• I do not hold a position with the issuer such as employment, directorship, or consultancy

• We hold an investment in the issuer’s securities

Catalyst

See above