Shares of Deere (DE) saw a modest correction after the company reported a very strong set of third quarter results. The cautious guidance for the remainder of the year makes the investment community wonder whether the best is over for the company.
Third Quarter Results
Deere generated third quarter revenues of $10.01 billion, up 4% on the year, thereby comfortably beating consensus estimates of $9.1 billion.
Net income rose by 26% to $997 million, just shy of a billion. Earnings per share came rose even quicker, and were up by 29% coming in at $2.56 per share. Analyst consensus stood at $2.17 per share. Chairman and CEO Samuel R. Allen commented on the third quarter developments:
John Deere is well on the road to another year of impressive performance after reporting record third-quarter results. Deere's success is a reflection of considerable strength in the farm sector, especially in North and South America. We also are making further progress executing our wide-ranging operating and marketing plans, which call for expanding our global market presence while keeping a close watch on costs and assets.
Looking Deeper into The Results..
Sales of equipment rose by 4% compared to a year earlier, on the back of a 3% increase in prices. Deere faced some slight headwinds from adverse currency movements which shaved off 1% of total revenues. Agriculture & Turf revenues, the biggest division of Deere, were up by 8% to $7.85 billion. Operating income rose by 32% to $1.33 billion on strong pricing and volume growth, as well as operational excellence.
Construction and forestry revenues fell by 11% to $1.47 billion, mainly on lower volumes. Operating income fell by just 5% to $107 million on stronger prices and strict cost control. The financial service unit reported net earnings of $150 million compared to $110.4 million last year, aided by growth in the credit portfolio and better crop insurance margins.
..And The Remainder Of The Fiscal Year
Equipment sales for the fourth quarter are expected to fall by 5% compared to a year earlier, marking full year growth of 5%. Full year earnings are seen around $3.45 billion, up from a previous guided $3.3 billion. Deere is suffering from tough comparables for the final quarter of the fiscal year of 2013. Deere stresses that the guidance for the final quarter is still quite strong and marks the third consecutive year of record results.
Deere ended its third quarter with $4.8 billion in cash, equivalents and marketable securities. The company operates with $33.7 billion in total debt for a sizable debt position, although most debt is related to Deere's financing division.
Revenues for the first nine months of the year rose by 8% to $28.34 billion. Net income rose by 15% to $2.73 billion, or $6.97 per share. At this pace full year revenues could come in about $36 billion while earnings could come in around $3.45 billion, or around $8.75 per share.
Factoring in losses of about 2%, the market values Deere at $82 per share, or the company at some $32 billion. This values the company's assets at around 0.9 times annual revenues and 9-10 times annual earnings.
Deere pays a quarterly dividend of $0.51 per share, for an annual dividend yield of 2.5%.
Some Historical Perspective
The commodity boom, even in soft commodities, has created a lot of value for long term shareholders in Deere. Shares tripled between 2004 and 2008 from $30 to $90 per share. Amidst the financial crisis, and concerns about its debt position as well as commodity prices, shares fell back to lows of $25 in 2009.
Shares have been trading in a $80-$100 bandwidth in recent times amidst a strong recovery and historically high commodity prices in corn last year, which boosted demand for Deere's products.
Between 2009 and 2012, Deere has increased its annual revenues by a cumulative 60% towards $34 billion. Net income almost quadrupled to $3.1 billion over the past year.
Despite a very strong set of third quarter results and a $150 million increase in the full year earnings target, investors and analysts are a bit cautious. The guidance for a 5% drop in equipment sales in the fourth quarter is quite severe, especially compared to a 4% growth rate in the past quarter.
A large portion of this growth slowdown is being attributed to $350 million of sales being shifted from last year's third quarter into the final quarter of that year. Adjusted for this, the sequential slowdown in revenues is much less severe.
Despite this legitimate explanation, some analysts are wondering if party time for Deere is over. The current softness in soft commodity prices could be the new normal after corn prices went through the roof last summer.
While plunging sales prices are hurting some farmers, relative solid meat prices and milk prices help other farmers as feed costs are falling which should keep farmers' overall income steady. Deere has furthermore done a great job in operational excellence to keep cost and assets under control.
The long term prospects remain good as the world population continues to grow and crave for food. The current valuation, at 9-10 times earnings is appealing as well, although 2013 might be a peak earnings year.
There is only big concern which I have, and that is the financing activities of Deere. Just like other giant industrialist companies like Caterpillar (CAT) and General Electric (GE), the financing unit and its large debt position create a risk if tough times come around, while they boost results in the good years. The fact that current credit losses run at just 0.03% of the loan book make me hesitant towards a worst case scenario.
I remain on the sidelines, despite the appealing current valuation, attractive dividend rate and share repurchases. The implicit leverage, in case the agricultural sector deteriorates, makes me hesitant to invest.