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Executive summary:

  • Deere beats estimates and should earn $8.80-$9.05 in fiscal 2014.
  • Despite near term headwinds, farm profitability is still strong, and agriculture's long term outlook is strong.
  • An improving economy will push construction sales up 10% this year.
  • Deere is returning more cash to shareholders, which will accelerate EPS growth.
  • With strong long term fundamentals, shares should trade at least 12x earnings or $107-$110.


Shares of Deere & Company (DE) popped nearly 2% Wednesday morning after the company reported fantastic earnings (press release available here). Shares are flat over the past year even as the market has rallied dramatically because some investors are concerned that the multi-year agriculture super-cycle is coming to a close. Fortunately for Deere, farm profitability remains strong, and a growing middle class around the world will power higher agriculture demand over the next five to ten years. After this quarter, it is clear the Deere bull thesis is still intact, and long-term investors should continue to own the stock.

In the company's fiscal first quarter, the company earned $1.81, which handily bested estimates of $1.53. Revenue of $7.65 billion beat by roughly $1 billion. Thanks to the company's aggressive buyback policy, EPS growth was a robust 10%. Net income was up 4.8% year over year while revenue was up 3.1%. For the full year, it expects to earn $3.3 billion compared to analyst consensus of $3.13 billion. Depending on the pace of the buyback, this means Deere should be able to earn $8.80-$9.05 this year, so shares continue to trade slightly below 10x earnings while other equipment companies like Caterpillar (CAT) trade at 16x numbers.

The company reported solid numbers in both of its segments thanks to cost cutting and solid demand. In its agriculture and turf unit (that unit mostly serves farmers), sales were up 2% while operating profit was up 4%. This increase came despite currency headwinds and a cheaper product mix. Over the full year, it expects sales to drop about 6% with the U.S. and Canada down 5-10% and Europe down 5%. As you can see in the following chart, Deere is expecting farmer profitability to decline somewhat in 2014 though it does remain historically robust.

(click to enlarge)

With farmers making more than $350 billion, we should continue to see strong machinery purchases, which is a positive for Deere. Farm land remains the ultimate commodity, and as the emerging markets continue to develop, we will see incremental demand outstripping additional supply in 2015 and beyond, which is why I expect strong profits for farmers beyond 2014. A strong farming industry means strong orders for Deere equipment. Issues like the California drought and some unfavorable price trends will pressure 2014 results, which is why sales will be lower than the fantastic 2013 numbers. Still, farms remain financially robust, and with strong long term demand, Deere continues to be well positioned.

Deere's construction and forestry unit saw revenue increase 4% in the quarter, and it is looking for acceleration in 2014 to the 10% level. With the U.S. and European economies performing better, we are seeing increased construction activity, mostly on the residential side. The strengthening economy will push construction sales higher and help to offset the immediate term weakness in agriculture.

In addition to its strong operating performance, Deere has become increasingly shareholder friendly, and over the past decade it has returned about 58% of net cash to shareholders. Deere has also been accelerating its capital returns with an 82% increase in the dividend since 2010. Coming into this year, the company added $8 billion to the buyback for a total authorization of $9 billion. Management will likely execute on this plan over 4-5 years.

As a consequence, I would expect the company to repurchase about $2 billion in shares every year, or 6% of its current market capitalization. This plan will provide support for the share price and hasten the pace of EPS growth appreciably. Even if you assumed an average purchase price 25% above current levels, Deere will be repurchasing over 21% of outstanding shares over the next 4-5 years, which will provide tremendous value for existing shareholders. With a solid 2.3% dividend yield and accelerating share buybacks, Deere is an excellent buy on capital returns alone.

Overall, Deere reported solid numbers with its agriculture and construction units performing well. While a drought and slightly lower farmer profitability will pressure near term earnings, long term trends in agriculture remain strong as the emerging markets continue to develop. A stronger economy will also benefit the construction unit and offset near term weakness. With about $8.90 in earnings power, a solid dividend, and fantastic buyback, shares should trade at least 12x earnings or $107-$110. Below $90, Deere makes a lot of sense as a long term investment.

Source: Deere Delivers, Is A Top Pick