A rising global population is playing a key role in carving out the future of many industries. Agricultural production, in particular, has become a core emphasis among the emerging economies, which means a big business for companies like Deere & Company (DE), Monsanto (MON) and Mosaic (MOS). I am interested in studying Deere & Company as it has a strong dealer network to support its products. The company has to assign more resources to R&D in order to sustain its leadership. I am aiming to study the impact of demand for its products on the profitability of the company. Moreover, let's have a glance over the future prospects of the company in order to figure out the investment opportunity.
The company has consistently outperformed its peers. Operating margin of the company was 14% relative to the industry average of 11.7% over the trailing twelve months. Deere has a net margin of 9.0%, which is quite higher than the industry average of 6.9% over the last twelve months. Assets turnover of the stock was 0.68, which is slightly better than the industry average of 0.66. However, stock has a higher leverage than the industry. Leverage ratio of the company is 6.79, which is quite higher than the industry average of 5.39 times which indicates that the company has more financial risk than the industry. Stock has higher ROE than the industry average. Higher ROE is primarily attributable to a higher net margin and financial leverage.
The outlook for the major sources of revenue
Deere is mainly operating with three business segments that are Agriculture & Turf, Construction & Forestry and Financial services. The company manufactures and distributes agriculture & turf equipment, construction and forestry equipment. Financial services segment finances sales of and leases these equipments.
Agriculture & Turf is the largest contributor in the total net sales of the company. As shown in the following chart, it contributed approximately 78% to the total net sales of the company the first nine months of the fiscal year 2013.
SOURCE: Company's Financials
The worldwide sale of the agriculture and turf equipment is expected to increase over the long-run. The population of the world is expected to exceed 9 billion by 2050, up from approximately 7 billion today. The most of the population growth will be in Asia and Africa. Therefore, to feed this population, the rate of productivity must accelerate from the current levels and the agriculture output must be doubled by 2050.
In order to capitalize on the high demand for agriculture equipment, Deere has recently announced to acquire Bauer (OTC:BRAGF). Deere expects that the deal will stimulate its planter business worldwide. In my opinion, acquisition will not only help the company to grow its business but will also help Deere to boost its earnings in the short run.
Total global growth for agriculture segment will be $520 billion from 2009 to 2018. Agriculture segment will grow at a CAGR of 3.4% until 2018 in the G20 countries. G20 accounts for 73% of the global agriculture segment. Therefore, I can conclude that the strong growth in the agriculture segment in the G20 countries will positively affect the earnings of the company in the years to come. As shown in the following graph, significant agriculture growth will be seen in Brazil, Russia, India and China (BRIC) by 2018.
(click to enlarge)SOURCE: Strategy Presentation
As the company is aiming to enhance its presence in the developing economies, therefore I believe that the company will be in a better position to post higher margins because of an increasing market share in the developing economies.
Developed economies witnessed a higher growth rate than the developing economies from 1970 to 2008. However, the growth rate of the developed economies is expected to be slower than the developing economies going forward. Developing economies will grow at a CAGR of 4.9% while the developed economies will grow at a CAGR of 1.9% during 2008 to 2039. Thus, I can conclude that much of the growth will be sourced from the developing economies as the company is focusing on growing its market share in the developing markets. Therefore, I believe that the company will be able to post higher margins in the long run owing to high growth in the developing economies.
(click to enlarge)SOURCE: Strategy Presentation
Other segments scrutinized
Construction & Forestry is the second largest contributor in the total revenues of the company, generating approximately 15% of the total net revenues in the first 9 months of the fiscal year 2013.
Given the cautious outlook of the U.S economic growth, global sales for the construction equipment may fall in the near future. However, global forestry sales are expected to be higher because of an improved demand for forestry equipment in the US.
However, according to a report, the global construction equipment market is expected to exceed $190 billion by 2017 from $143.6 billion in 2012. It is expected to grow at a CAGR of 6% from 2012 to 2017. China accounts for the majority of the global construction equipment consumption. Therefore, I believe that Deere will be able to increase its revenues from this segment due to the strong global demand for construction equipments.
Moreover, I believe that the massive urbanization will also create a high demand for the construction equipments. Migration from rural areas creates a need for infrastructural development, which drives the demand for construction equipments. More than 50% of the global population lives in urban areas and this figure is expected to be more than 70% by the end of 2050.
The global GDP is expected to grow at a CAGR of 3% till 2039. Moreover, much of the growth will come from the developing economies as these economies will witness a higher growth in their GDP relative to the growth rate of developed economies. Therefore, I believe that the higher GDP growth will eventually drive the demand for the products of the companies like Deere.
The demand for the agriculture equipment is expected to increase in the long term owing to an increase in population and a large middle class in China, India, Latin America and the developing economies.
Moreover, due to massive urbanization, demand for construction equipment is also expected to rise. The trend of living in urban areas is increasing; therefore I believe that the migration from rural areas towards urban areas will create the demand for infrastructural developments. Thus, increasing trend will drive the demand for construction equipment which will eventually help the company to boost its revenues in the future.