Thesis: Deere & Company (NYSE:DE) can be a core holding for almost any type of portfolio.
Introduction: The largest maker of farm equipment in the world has numerous superlatives that one might not expect.
For example, it was named by Information Week "as the second most-innovative of business technology among U.S. companies for its remote diagnostics software." (Source: John Deere Annual Report, page 7.)
Its financing division has essentially zero loan losses (Investor presentation, page 42.)
It has moved into related fields from agricultural machinery. These include general construction equipment, turf and utility equipment, and a high quality financial division.
Background: Last year, Deere celebrated its 175th birthday. It refers to itself as John Deere, the man who founded the company in 1837. The company provides a summary of, and additional links to, its history on a web page. I urge anyone considering investing in this stock to review its history. The history of DE and the small number of companies that have grown over the decades by sticking to their knitting to become A++ companies informs me that it is a relative gift from the investing gods when such companies can be purchased at approximately half the P/E of other high quality companies.
For the next 145 years, either John Deere or a direct descendant either ran the company or was chairman of the board. Deere is one of the few major U.S. companies that has grown since the 19th century under essentially the same name and with the same non-diversified business plan.
From its formation as a company that made a superior plow designed for sticky Illinois soil, Deere has survived numerous depressions to become the global leader in manufacturing agricultural machinery, especially vehicles. It's important in my view to note that this was done with no bankruptcies or extraordinary support such as certain financial and automotive companies recently received. Along the way, countless competitors folded. Meanwhile, I look at food production as the single most important industry in the world and think, how can this stock be so relatively cheap (granted, the market as a whole is expensive)?
Deere also competes effectively in construction machinery and in home and garden equipment. The majority of its sales are in the U.S., but increasingly it is expanding into South America, Russia, Western Europe, and China. Local crops, field conditions, farmers' preferences, and other factors differ from region to region. Deere has been setting up manufacturing facilities in numerous ex-U.S. countries to compete most effectively by aligning its products to meet local requirements. My expectation is that as years pass, Deere will become a growing force ex-U.S. I therefore look at it as possessing strong, secular growth characteristics. So does the company:
Macro-economic tailwinds are at our backs. By 2050, the world's population is expected to expand to 9 billion people. We're at more than 7 billion today. That growth will come mostly from emerging economies, such as China and India, where incomes are increasing, and diets improving. An increased demand for food, fuel, and fiber will require an approximate doubling of agricultural output in that timeframe.
Also expected to continue is the migration from rural areas to cities. In 2010, for the first time in history, over 50% of the world's population lived in cities. By 2050 that number is expected to reach 70%. A smaller labor pool in rural areas creates the need for more mechanized farming, as manual labor is replaced by more productive equipment solutions. Increasing urban populations also creates the need for housing, roads, bridges, and other infrastructure investments.
The stock chart reveals that the company has been a superior performer for some time, especially considering that the 1980s was a time of tremendous stress for farm equipment manufacturers (Yahoo! Finance):
DE has outperformed the S&P 500 by about 150 basis points yearly since January 1982 on price, though I cannot accurately estimate DE's dividend yield over the years. Given how strong a decade the 1970s were for agriculture and how difficult the 1980s and parts of the 1990s were, my (? wild) guess is that this comparison understates DE's relative performance over yet longer periods.
Operations: The company is doing a great job in my view. Its Aug.-Sept. online presentation demonstrates that since it focused on shareholder value added, returns have surged, providing higher and more consistent net cash flows (see slides 7-8). Since 2003, dividends have risen from $0.11 to $0.51 quarterly. It has done this by spending about $10 B since Q3 2004, repurchasing about 170 million shares and retiring a net of about 100 million shares (slide 15 plus Value Line data).
DE is on an Oct. fiscal year. Q3 results beat the Street. As the company put it in its earnings press release:
Deere Announces Third-Quarter Record Earnings of $997 Million- Income jumps 26% on 4% gain in net sales and revenues.
- Performance driven by strong profits in farm machinery and financial services.
- Extensive growth investments remain on track, helping expand company's global footprint.
- Full-year income forecast raised to $3.45 billion.
Not bad given drought conditions in the Midwest and elsewhere.
Now, anyone interested in DE has either read, or can easily read, this release and various analyses. I want to focus on a small, overlooked point, namely the following brief statement in the press release:
Also affecting third-quarter results was an impairment charge for long-lived assets related to John Deere Water operations.
I have previously criticized other investment icons IBM and Caterpillar (NYSE:CAT) for putting lipstick on pigs of a quarter by unnecessarily running away from GAAP accounting, and instead defining "operating earnings" whatever way management wanted. What Deere did is different and characteristic. It is what ultra-high quality companies do. (Apple (NASDAQ:AAPL) is in this category.) An impairment charge either is, or is not, an "operating" expense depending on one's point of view. Under generally accepted accounting principles in the United States, it is a cost. Deere accepts GAAP and does not bother to try to argue that this impairment should be removed from EPS to make EPS look better. It does not even matter to me what that charge amounts to. I give the company credit for ignoring the lure of higher "as reported" EPS and simply telling its story. We can figure it out.
Following this latest quarterly "beat", investors increased EPS estimates for FY 2013 to $8.82. However, they have been lowering them steadily for next year. Currently Deere is tipped to earn $8.01/share on a mild sales decline to $34 B for FY 2014. At a price around $83, cyclical trough earnings far below $8 are embedded in the share price.
Valuation considerations: S&P's Capital IQ division estimates DE to be amongst the most undervalued stocks it follows, estimating fair value around $94. (Note: that this is not very undervalued suggests the S&P agrees with me that the stock market is richly valued.)
Value Line is looking past the earnings valley to EPS in the 2016-18 time frame of about $10. It also estimates a mid-cycle P/E on those possible earnings of 14X, providing the potential for annual total returns of 12-20%. Over decades of following Value Line (initially for performance ratings, now much more for its data), I have come to respect its forward estimates for large, strong companies.
Deere has risks. It must earn its way to success every day. It competes with CNH Global NV (NYSE:CNH), AGCO (NYSE:AGCO), Kubota, other multinationals, and many local companies in its core ag division. In heavy construction, of course Caterpillar is #1 globally. Deere also competes in other fields, with no shortage of competitors.
I take a long-term view of Deere's cycles. In the late '90s, DE joined a number of "Old Economy" stocks in peaking operationally around 1998. These stocks did not take part in the late 1998-early 2000 bubble action. (Many of them bottomed in March 2000 just as the bubble stocks peaked.) DE peaked in early 1998 around $30, then dropped under $15. It did leave $20 behind until late 2005. It then soared to around $90 and briefly went under $30 again in 2009. In the 1998-2002 period, the stock was supported even with very low or nominal earnings. It is now forming a similar base in my view to that which it formed in the 1998-2005 period. Because of this pattern and the cyclical nature of its main industries, the analytic community attempts to come up with a mid-cycle EPS and guess at a proper P/E on those suspected EPS.
My approach is slightly different. It is more the approach of a true believer. I look at DE this way: It trades around 1X sales per share and well above book value. Neither is cheap. However, when you are 176 years old and now the #1 global player in perhaps the single most important industry, your intangible value is, well, priceless. With a market cap of only around $31.6 B and international growth opportunities that are in theory limited only by Deere's capability to manage growth, I do not care about rain in the plains, or lack of such.
DE is trading at a price it first hit in November 2008. The dividend yield is 2.5% and is likely to grow at an acceptable rate. One of these days, completely unpredictably, my expectation is that the stock will move through its March 2011 high around $99 and establish a new trading range in triple digits.
Is DE vulnerable to a market sell-off? Yes.
Is it vulnerable to a continued decline in earnings estimates? Yes.
Is it cheap as an asset play? No.
Is there any special technical reason to suspect that the all-time bottom is in on this stock? No.
In fact, do conventional moving averages suggest that now is a poor entry point? Yes, and I respect that particular point, and I have merely reinitiated a small position in IRAs for now for that reason rather than have "too much" in cash.
Is around $80-81 a critical lateral support level for the stock (as it is for CAT)? Yes, I believe so. I expect that traders are watching for a break of $80, especially if that occurs as part of a period of underperformance of DE versus the averages.
Conclusion: DE is a faith-based buy here for me as a total return purchase. Having been trading it for a few years in the $80-90 range with success, I'm tired of watching the tech and perhaps housing bubbles recrudesce. I'm accepting that so many "billionaires" have been created in the past decade, and especially in the past 5 years, that the asset inflation cannot easily be reversed. Thus I want to be in high quality stocks with relatively cheap valuations which I assume will move on up to new high within 5 years or at least within 10 years.
In the 1990s, a younger DoctoRx did great with growth stocks. The Doc has now seen the riskiness of what he did then and does very little of that sort of gambling anymore. While those of us with new money looking for buys would like a cheaper market overall so that DE traded farther below 1X sales per share and closer to book value, increasingly I look at DE and a number of stellar long-term outperformers that are now at reasonable valuations and say: this is where new money should go.
Patient investors looking for a flow of rising dividends with eventual and probably lumpy price appreciation may wish to consider the concept that in marketing its product and in the field of investing, nothing rides like a DEere.
Additional disclosure: Not investment advice. I am not an investment adviser.