During the fourth quarter of 2012, Southeastern Management, a large mutual fund managed by billionaire Mason Hawkins, initiated a position of 1.5 million shares in CNH Global, a $10 billion market cap manufacturer of farm and construction machinery (see more of Southeastern's stock picks). The fund has continued buying stock in CNH, with a recent 13G filing revealing that it now owns 3.7 million shares or a little over 12% of the total shares outstanding.
In the first quarter of 2013, CNH recorded a 21% increase in its earnings versus a year earlier. That is certainly good news, but revenue was up only slightly over the same time frame. It is unlikely that the company will be able to continue growing its net income slowly through improving its margins, and as a result we'd be skeptical about how sustainable this earnings growth will turn out to be unless the top line picks up as well.
Earnings multiples show CNH as quite cheap, with the current valuation placing it at 9 times trailing earnings. Wall Street analysts are projecting that earnings per share will rise modestly over the next several years, implying a forward P/E of only 8 and a five-year PEG ratio of 0.8. A number of other machinery related companies are trading at low multiples in the current environment, which we'd attribute to investor skepticism over macro conditions; demand for construction machinery, for example, is clearly dependent on the overall economy. This is shown by the fact that CNH carries a beta of 2.6.
We are able to see Southeastern's holdings of CNH from the beginning of this year with our database of 13F filings from hundreds of notable investors, including hedge funds. We've also used our database to develop investment strategies; we have found, for example, that the most popular small cap stocks among hedge funds generate an average excess return of 18 percentage points per year (learn more about our small cap strategy). Another major investor in CNH at the end of December was billionaire Mario Gabelli's GAMCO Investors, which reported a position of 2.2 million shares. Polar Capital, Manikay Partners, and Ellington Management are also among CNH shareholders.
CNH's peers include Caterpillar, Joy Global, Deere, and AGCO. Trailing earnings multiples for this peer group are between 8 and 12, showing that CNH isn't that out of the ordinary compared with similar companies and financial markets are expressing skepticism on each company. Caterpillar actually had a quite poor Q1, in which revenue was down 17% compared with a year ago and net income fell 45%. With the sell-side expecting a similar level of earnings growth there, CNH might be a better buy than its larger peer. Joy Global's business has been about flat, and once again- despite what is an anticipated dip in earnings over the next year, we get a PEG ratio of just below 1. Deere and AGCO, which focus more on agricultural machinery as opposed to that for construction or industrial functions, each experienced moderate revenue growth in their most recent quarter compared with the same period in the previous fiscal year. Only Deere, however, was able to convert that improvement to the bottom line as AGCO saw a small decline in earnings. Read another take on how CNH measures up to some of these other companies.
CNH and its peers are certainly cheap, though as we've mentioned this is partly explained by the relationship between construction and macro factors. The company does look a bit cheaper than Caterpillar, and with better recent results as well we'd be interested in learning more about the company. Deere might be an even more promising target for future research, however, given its more broadly based improvement in financials and its potential to be less affected by any poor economic news.