Deere & Company: Cyclically Low Earnings Make for a Good Entry Point

Deere [NYSE:DE] August 19, 2009: $43.78

52-week range: $24.51 (Mar. 3, 2009) - $71.44 (Sep. 2, 2008)

Dividend = $0.28 quarterly = 2.56% current yield

While nothing ‘runs like a Deere’, earnings in the latest quarter were down from 2008. Consensus views for FY 2009 – 2010 now are centered on $2.55 and $2.65 respectively as the worldwide recession has impacted sales. FYs end Oct. 31st. EPS had surged from 2002 through 2008 rising from $0.67 to $4.70 when times were good.

Investors over-reacted to the good times sending DE shares to an all-time high of $94.90 in early 2008. Paying 24 times trailing earnings at the top of the cycle proved to be a huge error. Buying today at 17 times trough earnings may turn out to be much smarter.

While there is no near-term catalyst there also seems to be little risk of a substantial pullback.

Here are the per share numbers from continuing operations as reported by Value Line:

FY	Sales	C/F	EPS	Div.	B/V
2002	24.49	1.49	0.67	0.44	6.62
2003	27.41	2.02	1.32	0.44	8.22
2004	35.80	3.54	2.74	0.53	12.95
2005	40.95	3.85	2.94	0.61	14.46
2006	43.75	4.09	3.08	0.78	16.48
2007	48.88	5.12	4.00	0.91	16.28
2008	61.10	6.01	4.70	1.06	15.47

Value Line rates Deere’s financial strength as ‘A++’ while noting its ‘price growth persistence’ is better than 90% of the companies in its 1700 stock universe. Morningstar assigns Deere a 4-Star rating (out of 5) and feels ‘Fair Value’ is $56 /share.

Deere has raised its dividend each year since 2004 and now yields a respectable 2.56% on a sustainable payout ratio of about 44%.

How can you play this high-quality issue without much worry?

Consider this buy/write combination out to January of 2011.

	Cash Outlay	Cash Inflow
Buy 1000 DE @ $43.78 /share	$43,780
Sell 10 Jan. 2011 $45 calls @ $8.00 /sh.		$8,000
Sell 10 Jan. 2011 $45 puts @ $10.40 /sh.		$10,400
Net Cash Out-of-Pocket	$25,380

If Deere merely rises to $45 or better (+ 2.8%) by Jan. 19, 2011:

• The $45 calls will be exercised.
• You will sell your shares for $45,000.
• The $45 puts will expire worthless.
• You will likely have collected $1,680 in dividends.
• You will have no further option obligations.
• You will end up with no shares and $46,680 in cash.

That would be a best-case scenario total return of $21,300/$25,380 = 83.9% achieved in about 17 months, on shares that only needed to go up by 2.8% from trade inception.

What’s the risk?

If Deere shares finish below $45 on January 19, 2011:

• The $45 calls will expire worthless.
• The $45 puts will be exercised.
• You will be forced to buy another 1000 DE shares.
• You will need to lay out an additional $45,000 in cash.
• You will likely have collected $1,680 in dividends.
• You will have no further option obligations.
• You will end up with 2000 DE shares and $1,680 in cash.

What’s the break-even on the whole trade?

On the first 1000 shares it’s their $43.78 purchase price less the $8.00 /share call premium = $35.78 /share.

On the ‘put’ shares it’s the $45 strike price less the $10.40 /share put premium = $34.60 /share.

The overall break-even would be $35.19 /share (excluding dividends) and $34.35 /share (including yield).

Deere shares could fall be as much as 21.5% without causing a losson this trade.

Disclosure: Author is long Deere shares and short Deere options.

Comments

[Paul Price:]

A similar take on Deere from another source...

The Only 'Green' Wall Street Doesn't Get
----------------------...

Wall Street just doesn't understand Deere & Co. (NYSE: DE).

No surprise there: There's a Rolls-Royce dealer a few minutes from the stock exchange, but the nearest John Deere dealer is more than 50 miles away, and it mostly sells lawn tractors. The massive heavy-duty agricultural equipment, the large tractors and combines that are Deere's main source of revenue is used in the area of the country that Wall Street tends to fly over.

This goes a long way toward explaining why Wall Street tends to get it wrong when it comes to Deere. It has no frame of reference for the company, which began manufacturing farm equipment in Illinois in 1837.

In the 172 years since, the company has built a unparalleled reputation for quality: Loyal customers have rewarded the company with a 50% market share. My dad still has my great-grandfather's 1941 Model A John Deere in the shop at his farm. Grandpa Ted used it for 30 years, and it still runs perfectly today. That's on par with the aforementioned Rolls-Royce.

So when Deere reported earnings, it came as no surprise to me that Wall Street focused on the wrong things:

* Revenue was down, mostly on a -47% drop in construction sales.

* Deere's outlook for 2009 suggests the worst sales downturn in 50 years.

* Net earnings slipped -27% in the third quarter.

This news caused a predictable result. Shares fell. But that's wrong, wrong, wrong.

What these pin-striped finance geeks need isn't a weekend in the Hamptons, they need to get on their jets and head to Kansas, Indiana or Iowa. A few hours swathing hay or planting wheat would do them a lot of good.

When they've breathed enough fresh air to clear their heads, they'll realize the truth about Deere. They'll learn to focus on the right things when they value the company. When that happens, the shares will be poised to deliver serious gains.

Here are six things to help them get started:

1. Deere has an unconquerable moat.
A farmer would rather keep a older piece of Deere equipment running than to buy from another manufacturer. Deere's "green iron" is not only extremely well made, but the company continually advances agricultural technology. Better technology means more efficiency and greater production, and that puts money in farmer's pockets. These purchases are supported by the best dealer network in the business. Excellent service minimizes downtime during critical harvesting and planting seasons.

2. Deere's Farm Business is Key, Not Construction.
Deere's most critical business segment isn't the construction equipment that hurt it in this quarter -- it's the agricultural equipment that powers its results every other quarter. Agricultural equipment makes up 59.2% of revenue. Ag and credit together make up 79.3% of operating profits.

3. Deere has a strong financial footing.
Assets outweigh debt nearly three to one. It has plenty of cash on hand and no short-term debt. Deere has more than enough resources to take care of the portion of its $13.9 billion in debt that's coming due. No one needed to bail out Deere when times got tough.

4. Deere's performance has exceeded expectations.
And not just by a little. The 17 analysts Bloomberg polled expected Deere to turn in earnings of 56 cents a share. It earned 99 cents a share. As I said, this is a hard company for Wall Street to understand. Deere has exceeded expectations in 13 of the past 18 quarters.

5. Deere has managed well during the downturn.
Let's make sure we're clear: Deere didn't lose any money. The company earned $420 million in its third-quarter. Its net margin was 7.1%, a level of profitability that exceeds 260 out of the 500 companies that make up the S&P. Among the most promising signs: Margins on ag equipment came in at 10.3%, a clear sign that Deere doesn't have to cut prices to move equipment.

6. Deere has a bright, "green" future.
Emerging markets, where Deere's ag sales dropped, will rebound with the global economy. So will the U.S. construction-equipment market. And the biofuel boom will cause greater demand for the crops that can be used for biodiesel and cellulosic ethanol, which could move unproductive acres into production, sparking a demand for more tractors, swathers, balers and planters.

The key to looking at Deere is to take the long view, not to overreact to short-term results. Don't worry about what happened, or even about what's happening. Focus on the future, not on the crop you just cut, but on the one you just planted. Deere has $3 billion in inventory ready to meet the demand that the recovery will bring.

With all that in mind, the inevitable conclusion is that Deere, at current prices, is a steal of a buy for long-term investors who are willing to bet that the world will continue to need the food farmers grow.

Many Happy Returns,

-- Andy Obermueller
Chief Investment Strategist
Government-Driven Investing

Aug 21 08:53 PM

[staples - w...:]

Grandma's gotten run over by a John Deere
'coming home from our house Christmas eve
got a feeling that guy isn't grandpa
cause grandpa ain't h*#g like that we believe'

as heard on "A Filthy XXXMAS".....at filthyxxxmas.com and heard all over radio with a lot of bleeps Not on the original copy though.
(used with permission filthyxxxmas.com. If they can sell Christmas in August for furniture, why not funny parodies you haven't heard anywhere, guaranteed.

watch for the Air Sick Productions IPO one day

I am hardly long on anything, but Deere is one again. for the specifics mentioned. The the further you get into farm country the more Deere is a part of every day life. Watch any movie and when talking to movie or real life farmers, many of them have crusty old bent Deere hat son and proudly. they love their machines like their family. buying a new Deere in like giving birth to anew child, anew member of the family.

we cant think like urbanites. ( new word I guess). Deere will always be a part of American culture and heritage. Why, they make a damn good product. If the people who make a living on them say so, hey thats good enough for me in bull or bear, just the right time to rotate the stocks, not crops!!!

Remember...baseball, hot dogs, apple pie and Chevrolet. Deere is that and more (sniff)


Staples
thedowjokesreport.com

Aug 22 01:29 PM

[Paul Price:]

Deere (DE): FQ4 EPS of $0.23 beats by $0.20. Revenue of $4.73B (-29.8%) vs. $4.44B. Sees sales down just 1% in F2010.

DE closed at $52.22 yesterday - up 19.3% since my August 20th write-up.

Nov 25 08:26 AM