Deere - Strong Operational And Financial Performance Will Drive Future Returns

May.26.14 | About: Deere & (DE)

Summary

Deere remains "committed to those linked to the land".

The company has aggressive revenue targets of $50 billion for 2018.

As investors "receive" excess cash flows through dividend hikes and share repurchases.

Deere (NYSE:DE) continues to report solid results, even as both earnings and revenues are under pressure compared to a very strong 2013. The agricultural equipment producer has a relentless focus on efficient operations while excessive cash flows are used to please investors.

Despite these favorable trends, investors in Deere have seen their holdings underperform over the past year, making shares quite appealing at the moment.

Recent Investor Update

John Deere remains committed to ¨those linked to the land¨ according to a recent investor presentation. The company remains committed to agricultural equipment and construction equipment and services supplied across the world.

Continued growth in global food production should result in Deere being able to report $50 billion in sales by the mid-cycle of 2018. Currently reported operating margins of 12% are seen as normalized margins throughout the cycle.

The company remains committed to productivity, which rose by 6% per annum over the past three decades, as annual sales have risen to more than $550k per employee. The company remains very focused on reducing inventory and accounts receivables, cutting its working capital significantly, after adopting the shareholder value added model in 2001.

A Global Superpower

Deere reported sales of $35 billion over the past year with $29.1 billion in sales being tied to its agricultural business and the remainder to construction and forestry equipment sales.

Despite having operations throughout the world, Deere is still very much focused on the US and Canada where it recorded sales of $21.8 billion last year. Sales in Western Europe came in at $4.4 billion while Central and Southern American operations totaled $4.3 billion in revenues. Deere's presence in Asia, Africa and Australia is rather limited with total sales of $4.5 billion.

Financial Business

On top of the huge equipment business, John Deere has a large financial business, which runs a $36.8 billion owned portfolio. Loans are largely focused to the agricultural side of the business with three quarters of outstanding credit being loaned in the US.

The unit reported net earnings $469 million over the past year driven by write-downs totaling just 0.03% per annum. Net income during the financially difficult 2009 fell to $149 million as write-offs increased to 70 basis points of the total portfolio.

Returning Cash To Investors

At the moment, Deere still has $7.9 billion worth being authorized to spend on share repurchases after already repurchasing $1.1 billion worth of shares so far this year. In comparison, Deere spent $1.5 billion on repurchasing its own shares in the entire year of 2013.

Sizable share repurchases have been accompanied by a solid dividend, which has been hiked aggressively in recent years. The quarterly dividend of $0.51 per share provides investors with a 2.3% yield.

At $90 per share, Deere commands a valuation of $33.3 billion, which values equity in the business at little less than 0.9 times annual revenues which came in at $37.8 billion over the past year. Reported earnings of $3.5 billion implies a valuation at 9-10 times annual earnings based on 2013's results.

2014 To Become A Softer Year

Following 2013's strong momentum, 2014's results are set to come in a bit lower. Two weeks ago, Deere reported a 9% drop in second quarter revenues while earnings fell to just below the billion mark.

Based on the performance in the first half of the year, Deere foresees revenues to drop by 4% for the entire year while earnings are anticipated to come in around $3.3 billion. Despite the modest drop in both anticipated revenues and earnings, the compelling valuation remains.

Future Outlook

Despite having global operations, Deere's fortune is still very much tied to the US agricultural industry where total farmers cash receipts are anticipated to remain at high levels. Note that government payments continue to be under pressure. Farm equity has ballooned in recent years thanks to a strong recent performance and elevated land prices.

Continued growth, notably in international markets should allow Deere to meet its annual revenue target of $50 billion in four years time. New technologies like Deere's Farmsight, which integrates technology, equipment, farmers and dealers, should bolster productivity to farmers as well, increasing the value added by Deere's equipment.

Takeaway For Investors

Investors are disappointed with the anticipated fall in both revenues and earnings in 2014, but they should note that this year's and 2013's results in particular were historically strong.

This resulted in a low price-earnings ratio, although strong farm fundamentals and signs of global food inflation continue to provide tailwinds to Deere's business. The $50 billion annual revenue target is comforting as well, calling for significant future revenue growth.

This current status quo has left shares tied up in the $80-$95 trading range over the past year amidst poor short-term prospects while long-term prospects remain good.

I do expect shares to approach the $100 mark provided that markets remain at favorable levels later this year, creating compelling upside.

Disclosure: I am long DE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.