The shares of Deere (NYSE:DE) have recently been sold off from its 1-month high at almost $94 following the release of the quarterly results. Since the beginning of 2013, Deere's share price has demonstrated a range trade pattern with a technical ceiling ranging from $92 to $95 and a floor from $85 to $83 (see chart below). I believe the current price level presents a great opportunity to buy in the range trade.
Below are some rationales supporting my view that the stock may find a bottom at around $85:
1. At the current price, Deere shares are priced attractively relative to its comps'. According to the chart shown below, Deere's consensus revenue, EBITDA, and EPS growth estimates are notably below the comps averages. However, the company's profitability margins are above par with only the ROIC metric slightly underperforming. In terms of leverage and liquidity, Deere carries a higher debt load as reflected by the company's above-average debt to capitalization and debt to EBITDA ratios. The firm's free cash flow margin is fairly in line with the peers'. Both Deere's current and quick ratios are markedly above the group averages, reflecting a healthy balance sheet condition.
Deere's current price multiple at 10.2x is 19% below the peer-average P/E multiple. Given the firm's weaker growth estimates, such valuation discount appears to be reasonable. After accounting for the 5-year earnings growth estimate, Deere's 5-year PEG ratio of 1.0x is only in line with the peer average, implying that market has likely not given enough credits for Deere's superior profitability margins and healthy liquidity position relative to its primary peers (see chart above).
2. Deere's forward P/E multiple is now trading at a 33% discount to the same multiple of S&P 500 Index, which stands at 15.2x at present (see chart below).
This relative valuation presents a good buying opportunity as the market discount is modestly exaggerated provided that 1) the market discount averaged at just 26% in the past 12 months; 2) Deere's consensus 5-year earnings growth estimate at 10.0% is notably above the average estimate of 8.2% for the S&P 500 companies; and 3) the stock's dividend yield at 2.3% is fairly in line with the 2.5% average yield for the S&P 500 Index.
3. In a Piper Jaffray research note released on May 15, Michael Cox commented on an interesting pattern (sourced from Thomson One, Equity Research) which supports my view:
"In 8 of the last 9 quarters, DE shares have sold off on the day of earnings, in spite of topping Street estimates in 7 of those quarters. While DE is giving back some of its recent gains, we believe the prospect for upside in 2H13 and greater earnings sustainability in FY14 will serve to lift DE shares."
However, there are also some reasons suggest Deere share are unlikely to surpass the technical ceiling between $92 and $95:
1. Based on the total 20 analyst ratings compiled by Thomson One, the average price target for the stock is at $96.83. Street's price target would usually serve as a psychological price barrier for investors if there have been no significant improvement in the company or macro environment.
2. There remains investors' concern on the inflection point for North American agriculture cycle. As Deere still provides no visibility on how the company will navigate through the issue, I believe the negative sentiment would continue to weigh on any upside on top of the fair value range.
Bottom line, given that Deere's share price is approaching the technical floor range and the valuation becomes somewhat tempting, investors should consider initiating the range trade.
All charts are created by the author and all financial data used in the article and the charts is sourced from S&P Capital IQ unless otherwise specified.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in DE over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.