While strong demand for grain commodities for food and fuel has kept the manufacturers that produce big farm machinery largely insulated from the economic collapse that has pummeled nearly every other industry, one analyst believes the U.S. recession may finally be catching up with ag equipment.

Robert McCarthy, analyst for R.W. Baird, views the growing inventory of big farm equipment, along with the relatively young age of the North American fleet and projected declines in farm cash receipts as signs of a slowing demand that the industry had managed to sidestep during the past 18 months.

"While the North American ag equipment market — particularly large tractors and combines — currently remains relatively strong, we believe downside risks are increasing," McCarthy said in a note to investors.

He notes that combine demand appears relatively stable. And despite this quarter being a seasonally weak period for combine sales, retail sales during the last 3 months have accelerated. Deere, for example, reported that 95% of its combine production, which was recently bolstered by a recent 30% increase in capacity, is currently under order.

"However, both row-crop and 4WD tractor sales comparisons weakened as Deere's second quarter progressed in what is typically one of the busier selling seasons of the year, indicating that demand may have peaked early in the year," McCarthy says.

A Young Fleet

The analyst noted that reliable statistics on the average age of the current North American fleet of large agricultural equipment are meager. "But one common measure indicates that the current fleet is younger than at any time over the past 30 years."

Specifically, he cites the ratio of the last 3 years of large tractor and combine sales to the last 10 years of large tractor and combine sales, which has reached well beyond the prior peak and continues to climb.

"As such, we believe replacement demand is unlikely to support near-term ag equipment sales. It's unlikely to be a primary sales driver over the medium term."

Cash Receipts Drive Sales

U.S. farmer gross cash receipts, what McCarthy calls "perhaps the best predictor of large farm equipment sales," are forecast to decline 9% in 2009 by both the USDA and Deere. This would be the largest year-to-year decline since 1971.

"Annual U.S. gross cash receipts have declined 8 times since 1975 and have been accompanied by declining retail sales of large farm equipment in 6 of the periods. The average large ag equipment decline in the 8 years featuring cash receipt declines was 9%," McCarthy says.

Growing Inventories

McCarthy also cites increasing industry inventories, which he says, implies risk of further production cuts.

"Deere has likely reduced its North American ag equipment production plans for the second half of the year. They now project in fiscal 2009, that U.S. and Canada agricultural and turf production tonnage will be down 14% vs. expectations for a 3% production decline in ag and a 21% decline in C&CE production tonnage for the period previously. Growing industry inventories of row-crop tractors imply further production cuts could become necessary."