Agriculture Machine Makers: Layoffs and the Equity CDS Ratio

Heading off the farm this morning but still staying out where you can count the number of traffic lights in town on one hand; driving along in ‘ole MacDonald’s brand spanking new John Deere (DE) and with climate control, GPS and an eight speaker sound system, there is nothing that “runs like a Deere”. The company recently announced they were bringing back 452 of the workers it laid off at its Ottumwa, Iowa factory which makes the equipment used by livestock producers. This also gives a little support to all the pig press from Monday.

Back to work is good but it should also be noted that the Deere facility in question employed 980 people before the full on freeze in the global economy hit so over half the original workforce is still walking, not running.

Where we’re headed is the local quarry where Caterpillar (CAT) bulldozers and bucket loaders are hard at it and where most of the electricity for the conveyors, augur lifts and beltways is supplied by one of the bigger Cummins (CMI) diesel power plants.

CAT also announced it was bringing back furloughed workers but the 550 that are supposed to rejoin by the end of next year are just about 1/5th of the 2,500 the company said it will permanently trim from its payrolls during the same period and a drop in the bucket when compared to the 30,000 folks the company has been forced to cut over the past two years.

CMI recently announced better than expected 3Q09 earnings but warned of a difficult 2010. The bright spots for CMI are Brazil India and China as CMI’s CEO, Tim Solso stated: “There’s no question that developing markets will help us next year.” But even there the effects of the global slowdown are evident as TS remarked, “We’re down $1.5BN in exports, and we’re not seeing any uptick in that whatsoever.”

After comparing the boom-time export number of $3.5BN with a 2009 export estimate of $2BN, the CEO commented, “I expect that we’ll see an uptick in exports, but not to the level we had before – it’ll be relatively moderate.”

One of the factors dampening CMI’s export outlook is that the company has spent most of the last decade building factories in its high demand foreign markets. While a good decision at the time, the lack of exports during a time of dollar weakness and slow growth in its domestic market are not allowing CMI to reap all of those benefits.

Building satellite facilities was a strategy made popular by “Neutron” Jack Welch during his time at the helm of General Electric (GE). The company created a distribution network that operated in both directions. GE would sell its products in various far flung locations but would also be purchasing something from those locations as well, whether that was raw materials or a certain part of the manufacturing process. As those local economies prospered it created even more demand for GE’s products.

The effect of this was cited by James Paulsen of Well’s Capital Management earlier this year when he described the results of the actions of companies like GE and CMI over the last generation as an “exporting of the middle class” which would now turn into a growth engine for demand of consumer products.

DE closed last night at $47.21, just off the high of the year set on 10/22 at $48.38. The stock has hit the mid-$40s a few times this year falling back slightly each time and in general moving sideways. It will take some time to see if the recent new high will be enough to use old resistance as new support. The CDS for DE peaked in March (195bps), hits its nadir on 8/7 (51bps) and closed last night at 60bps.

CAT has actually had a smoother run than DE although the 30,000 ex-employees might not agree. From a March low of $22.61 to a recent high of $59.61 (10/20), there hasn’t been a lot of variation between interim highs and lows. The CDS dropped from March (427bps – 3/5) to 130bps on 5/7; rose to 241bps on 7/17 and has been trading close to last night closing level (87bps) since August as the stock continued higher.

The movement of CMI's CDS/equity relationship has been consistent with empirical theory as the negative correlation has remained intact but the pair has spent most of the second half of the year in a very choppy sideways pattern. The latest move in the CDS however has been to levels not seen since late July on the upside so this could be something to watch as the recent low of $43.06 in the stock was back down close to the $42.54 price seen on 10/2.

Disclosure: None