Deere (DE) is a large producer of agricultural machinery, with a strong presence in the North American market. The company gets almost 75% of its revenues from selling tractors, loaders and other equipment to the farming and lawn sector. The rest of the revenues are made up of capital goods, which are sold to the construction and the forestry sector. Like Caterpillar (CAT), Deere also has a financial division which is involved in providing financing for its products. The company has a 175 year old history and is steadily expanding into international markets. Deere is a sound dividend investment, as it maintained its dividend during the Lehman crisis, when many of its peers like GE (GE) were forced to make drastic cuts. With agriculture set to become the focus of global investment due to the dramatic increase in population, we think that Deere is a great long term investment. However, we are a bit concerned about the short term as the stock has spiked along with the rest of the sector in the last one month. We would wait for dips before making a major move into the stock.
Why we would like Deere
- Agricultural Industry - We think that the agricultural industry is going to be one of the best growth industries in the future. The growing population, increasing per capita food consumption, limited land implies that agricultural efficiency will have to improve drastically. Jeremy Grantham has written that he says a major food crisis in the future due to the above mentioned reasons. As a global leader in the agricultural industry, Deere is well set to capitalize on these trends.
- Brand Name - Deere has a legendary brand name in the agricultural market, with farmers having a high degree of trust in the company's tractors and other farm equipment. This forms one of the strongest competitive strengths for the company, as it can charge a premium for its products. The company can use its long history of product quality to expand into international markets as well.
- Valuation is not Expensive - Deere trades more or less at the same industry multiple, with a P/S of 1x and forward P/E of ~10x. However, the company has grown faster than the industry in the last decade and we think it has much better growth prospects. almost 3x times, from 44c in 2003 to $1.79 in 2012 than the rest of the industry in terms of ROE, Operating and Net Margin. The company is all set to tap into new fast growing markets in India and China, where it does not have a big presence.
- Shareholder Friendly - Deere has returned dollops of cash to its shareholders, both through buybacks and dividends. It has managed to keep dividends growing even in the face of one of the worst economic crisis in the last century. The company has a dividend yield of ~2% and has a payout ratio of just ~24%. The company has managed to grow dividends by almost 3x times, from 44c in 2003 to $1.79 in 2012. This is in addition to the substantial buyback programs. The shareholder friendly nature of the company seems to be one of the reasons that Berkshire has taken a big position in the stock.
- Growing Exposure to International Markets - Deere is growing its revenues strongly in foreign markets, with almost ~41% of its sales coming internationally in 2011. The company is building factories and research centers in the BRIC countries. Deere will look to capitalize on its technology, scale and brand to carve out a big market share in these countries.
- High Debt/Equity Ratio - Deere has a substantial net debt on its balance sheet of ~$28 billion, which is almost 80% of its market capitalization of $35 billion. However, the company uses debt to finance the sale of its products through its financial division. While the quality of the debt is quite good in general, but it can become an issue during a big crisis. However since we think that the agricultural industry is on a secular growth trend, we don't consider high leverage as a problem for the stock.
- Cyclical Slowdown - Deere can suffer from a slowing global economy and it was forced to reduce 2013 guidance mainly due to these concerns. European sales are expected to be flat to down 5% in 2013, as the European economies continue to suffer from debt crisis. However, we think that these problems are short term in nature and the company has great prospects over the long term.
Deere is trading just 10% shy of its all time peak of $90, due to a sharp increase in the industrial goods stocks in the last quarter. After a dip in the stock price due to lowered growth expectations, the stocks have surged due to positive economic date emanating from US and China. However, we think that these recovery signs are not sustainable and the global economic growth will slow down over the coming years. This surge in stock price has made us cautious in strongly advocating a buy of Deere stock at this point of time. The stock has outperformed the S&P 500 by 7 percentage points over the last 5 year period. The stock has traded in wide range of $25-$100 in the last decade touching its all time lows in March 2009. This stock fall is the only blemish in its stock performance as it has continued to increase in value over time.
Deere is the biggest supplier of agricultural equipment in the planet and this makes the stock a buy in our book. Investment in the agricultural sector will have to keep on increasing, to extract more food from our limited stock of arable land. The world population will increase by almost 50% in the next 40 years to 10 billion. Feeding this population will mean injecting more capital into the agricultural industry. This makes Deere very favorably positioned to capitalize on this trend. The stock has run up along with the rest of the sector, so you cannot be too aggressive in buying the stock at the current levels. However, we would strongly advocate buying the dips.