A Fundamentally Bullish Case For Deere & Co.
Deere & Company (DE) is a leading producer of industrial goods, operating in four business segments: agricultural machinery and equipment, commercial and consumer equipment, construction and forestry, and credit. Despite deteriorating Emerging Market (EEM) conditions, and a pullback in demand for industrial machinery in the BRIC economies (BKF), the company has increased total revenue by 9.042% and increased DPS by 10.87% in the last five quarters (Q2 '12 - Q2 '13). Deere & Co. has outstanding fundamentals that set the company apart from the competition, namely Caterpillar (CAT).
Growth is Deere & Co.'s Valuation Trump Card
Deere & Co. has a major valuation edge on Caterpillar in EPS growth rate, and sales growth rate. The company has an EPS growth rate of 12.70; Caterpillar has an EPS growth rate of -6.2. The percentage difference in EPS growth rate between Deere & Co. and Caterpillar is 148.819%. But wait, there's more! DE has a sales growth rate of 11.70; CAT has a sales growth rate of -0.1%. The sales growth rate of Deere & Co. is 100.855% that of Caterpillar. With a P/E ratio of 10.34x, compared to Caterpillar's 11.58x, and an ROE of 41.02%, compared to Caterpillar's 29.93%, Deere & Co. is a screaming buy with significant growth opportunity, at tremendous value, looking forward.
The company has stellar fundamentals which have been outlined in the table below; the highlights and homeruns are indicated in yellow.
Fundamental superiority is set to break Deere out of a 5-year lockstep with Caterpillar, shown on the chart below.
Annual Growth Highlights: Balance Sheet, Income Statement, and Cash Flow
Deere & Co.'s balance sheet, income statement, and cash flow statement reflect solid, continuing growth. In five years (10/31/08 to 10/31/12), the company has increased total revenue by 27.143%, increased DPS by 68.868%, increased diluted EPS (GAAP earnings) by 61.996%, and increased net income by 49.562%. The table below shows an annual breakdown of fundamental, growth highlights.
Quarterly Growth Highlights: Balance Sheet, Income Statement, and Cash Flow
In the last five quarters (Q2 '12 - Q2 '13), Deere & Co. has become more profitable, increased spending on R&D, grown cash reserves, and increased total revenue by 9.042%. The share price was up 8.426% at the end of Q2 '13, when DE closed at $89.30, up from the Q2 '12 close of $82.36. The company yields 2.47% and has increased the dividend by 10.87% over the last five quarters, and 68.868% over the last five years. Priced at a certain discount to fair value, DE last traded at $82.59; this entry point offers a long position strong profit potential. The table below shows how the company unlocked value for investors, despite choppy demand in the deteriorating BRIC economies, and in spite of macro headwinds due to the highly cyclical nature of agricultural machinery demand.
Sources of Future Growth
Deere & Company has a fundamental advantage over Caterpillar with regards to growth, and profitability. This advantage makes the company the most attractive investment in the construction & agricultural machinery sector, a sector in which inventory turnover rate is critical. The highly cyclical and volatile nature of global agricultural machinery demand necessitates effective inventory management so as to control costs associated with inventory retention. Trailing twelve months, the company generated an inventory turnover ratio of 4.25, indicating that the company is turning inventory into sales 31.059% more profitably than their chief competitor in the construction & agricultural machinery sector, Caterpillar, who posted an inventory turnover rate of 2.93.
Demand for agricultural machinery is gaining positive momentum on the back of global stimulus programs. In Brazil, tractor sales increased 6,023 units, 27% YoY; tractor production was up 6,605 units, 32% YoY. Deere and Co. accounts for 38% of total combine sales in Brazil; June combine sales grew 99% YoY. If demand continues to gain momentum, as is the current trend, shares of Deere and Company will reach my 12-month price target of $110, a return of 34.409%.
Deere and Company's shares have yet to recover from the economic downturn in 2008, and 2009, and this has left the company undervalued. Demand is strengthening, balance sheets have solid cash reserves, and the company boasts best-in-sector fundamentals.
Generating Alpha: 15% Discount To S&P Ahead of Earnings
A 12-month price target of $96.50, 15% growth YoY, is absolutely attainable if demand remains in line with the last five quarters. However, shares of Deere and Co. have risen 11.47% in the last year, while the S&P 500 (SPY) has gained 25.98% in the same amount of time. As seen in the chart below, shares of Deere are currently trading at a 15% discount to the S&P 500.
The current 15% price disparity between shares of Deere, and the S&P 500 is significant. Deere traditionally tracks the S&P with a 1.6 beta, as is shown in the chart below.
Earnings and Emerging Markets
Earnings reports will likely come in stronger than expectations due to improving tractor and combine sales in economies such as Brazil, as previously discussed. Looking at a comparison between shares of Deere, and the BRIC economies, it becomes apparent that the share price of Deere jumps at the slightest sign of strength out of the BRIC economies. I believe that emerging market deterioration has found a relative bottom in Brazil, Russia, India, and China. As these markets start to show signs of life, Deere stock will react positively. The chart below shows the correlation between whispers of BRIC economy strength, and positive DE price action.
Deere & Company is a valuation play, a dividend play, and an emerging markets play ahead of earnings. Fundamental superiority in the agricultural machinery and equipment sector, along with quality trailing and forward growth, make Deere an excellent long opportunity.