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Summary

  • Deere's agriculture business is expected to remain under pressure, but there are certain positive signs in the end-market that shouldn't be ignored.
  • Economic stabilization and strong performance in certain markets can lead to an improved performance from Deere going forward.
  • Deere's valuation is also quite attractive, and along with a solid dividend yield, this is a stock that investors shouldn't sell just yet.

Agriculture and construction equipment company Deere (NYSE:DE) is having a tough time this year. The company's problems were compounded when it released its second-quarter results recently. Although Deere posted better-than-expected earnings, it slashed its sales guidance for the full year. Deere's sales have been declining and as such, a weak outlook didn't go down well with investors. But is there any hope for Deere going forward, or should investors stay on the sidelines? Let's try to find out.

Agriculture weakness proving to be a pain

Deere's revenue decreased 9% year over year to $9.95 billion in the second quarter. In addition, its earnings fell to $980.7 million from $1.08 billion in the same period last year. The company is seeing weakness in the agriculture segment, which was down 12% from a year ago. Since Deere is grappling with a number of issues, it is unlikely that it would come out of its slump any time soon for a few simple reasons.

First, as reported by management, "Although the agricultural economy remains in a relatively healthy condition, farm income is forecast to be lower than last year. The decline is putting pressure on demand for farm equipment, especially for larger models." Moreover, as Deere is trying to meet stringent emission standards, it is having to undergo a product transition that's hurting sales.

As reported by Bloomberg --

Costs were hurt by a transition at production lines to make tractors and harvesters that meet more stringent emission standards, Tony Huegel, Deere's director of investor relations, said on a conference call today.

"That could cause delays when you ship to the dealer as you change your production lines," Matt Arnold, a St. Louis-based analyst for Edward Jones & Co. who recommends buying the shares, said by phone.

Since sales of agricultural equipment account for almost 80% of Deere's revenue, according to Bloomberg, the signs aren't looking positive. Moreover, political tensions in Ukraine are also affecting Deere's business. As reported by Investor's Business Daily --

Market conditions in the former Soviet Union have weakened in light of the ongoing political crisis between Ukraine and Russia and industry sales there are expected to decline to that significantly, the company said.

Positives to consider

Hence, there seems to be no respite for Deere going forward, at least in the short-term, as its primary business of selling agricultural equipment is under pressure. However, there are certain positives that investors shouldn't ignore. Deere is trying its best to mitigate the weakness that it is seeing in the business by controlling costs.

It has kept costs and assets well under control while successfully managing major new-product transitions associated with more stringent emission standards. As a result, Deere was able to trump earnings forecast in the previous quarter. In addition, its construction and forestry and financial services operations delivered improved results, reflecting the power of its broad-based business portfolio.

Also, the company has observed that planting is well underway in North America where farmers appear to be shifting some acreage from corn to soybeans in response to relative prices. Moreover, global grain and oil seed demand remains strong.

Better economic conditions can make Deere better

There are signs of economic stabilization and cyclical recovery, with a modest forecast increase in GDP growth and rising business and consumer confidence. Margins remain supportive for livestock and dairy farmers with easing feed costs, strong beef prices, and near record milk prices. Although grain prices and farm income are expected to decrease in 2014, there's improving demand in the U.K. and Spain.

Prospects of the agro business in Brazil are also looking up. The 2014 value of agriculture production is expected to increase about 5% over the 2013 levels. This year, Brazil soybeans production is expected to increase again with yields of historically high prices and margins. Deere is also targeting the South American market aggressively, introducing over 60 new products in the region, including 5E Series tractors with cab, self-propelled sprayers for sugarcane, and planters.

Construction is getting better

There are some robust indicators of an improving economy. Housing starts are slowly ramping up, home inventories are low, and prices are improving. Landscaping activity is picking up and financing for land developers is slowly recovering.

As a result, Deere's construction and forestry sales are forecasted to be up about 10% for the year. The increase reflects higher shipments following the low levels of 2013, as well as industry growth in response to an improving U.S. economy and increased international sales.

The global forestry market is expected to increase about 10% in 2014, according to management. Following double-digit growth in 2013, the North American forestry markets are expected up about 10%, while Europe and Russia are expected to improve from the depressed levels of 2013.

Conclusion

Hence, there are a few positive takeaways that investors can focus on. However, with the agriculture business in decline, at least in the short-term, Deere shares might remain under pressure. But considering the fact that Deere's valuation is quite attractive, and it carries a solid dividend yield of 2.20%, existing investors shouldn't sell the stock. Deere trades at less than 10 times trailing earnings. In comparison, the industry average is 18. As such, investors should consider waiting patiently for Deere's turnaround as the company is cheap and also pays a solid dividend.

Source: Don't Sell Deere Just Yet