Deere & Company's Hidden Source Of Value

Jun. 3.14 | About: Deere & (DE)


Deere & Company trades at a discount relative to its peers.

It is a Dividend Contender, having increased its dividend for eleven consecutive years at a CAGR of 16%.

Its massive share repurchase program is boosting EPS.

This article is part of an ongoing series that highlights specific companies that are on sale. It helps me to document my thought processes when I add to my holdings or initiate new positions. Please provide your feedback in the comments section below.

Deere & Company (NYSE:DE) is currently offering investors an opportunity to buy portions of the company at about $90/share. The stock had been steadily rising for most of 2014, but has recently pulled back since reaching its 52-week high and may now provide a good entry point. Right now, DE is about five percent off the 52-week high hit a few weeks ago at almost $95 per ownership interest. This few week pullback provides long-term investors with a good opportunity to initiate a position.

Deere & Company has a business model that is simple and sustainable. It makes and distributes equipment for the agriculture, turf, construction, and forestry industries worldwide. In its 2013 annual report, it mentioned that revenue actually grew 5% from 2012 to 2013. Net income grew 15% to a new high. Remarkably, it was Deere's third consecutive year of record earnings. EPS was also up 19%, augmented by its share repurchase plan, which will be discussed below. Deere & Company is able to increase its revenue at a rate that keeps up with inflation, passing along the devastating effects of inflation on to the consumer, not the owners.

Despite the growth, I believe that Deere & Company trades at a discount to its true valuation. DE currently trades at under 10 times TTM earnings and under 12 times projected next year earnings. EPS is expected to grow 8% annually for the next five years. DE appears to be heading in the right direction as a company, and I am content to accumulate shares at this perceived discount.

Also, DE has been buying back its own stock at a pace that affects the bottom line. Just one year ago, four short quarters, there were over 393 million shares outstanding of DE. Today, there are under 370 million diluted shares. In one year, Deere & Company has retired six percent of its outstanding share volume. The company has indicated on many occasions that returning cash to shareholders via share buybacks is an important goal for management. It is using its free cash flow to buy out other shareholders, which further adds to the gains of the remaining shareholders.

Let's take a look at Deere & Company's earnings. Analysts are expecting a consensus EPS of $2.24 for the next quarterly earnings release, with the lowest estimate coming in at $1.97. For reference, DE reported EPS of $2.56 for the same quarter last year. It doesn't appear that analysts are expecting much, if anything, from Deere & Company. DE is buying back shares in a way that moves the EPS needle in a mighty way. Due to this, DE wouldn't have to make more in total earnings to affect the bottom-line EPS. Even if profits stagnate, EPS will increase due to the share buyback. Even if EPS remains flat, you're still only paying ten times earnings. That's half of the P/E of many of its competitors. I believe that Deere & Company will have a positive surprise, and this is the catalyst that will cause DE to reverse its recent downward trend and close substantially higher at the end of 2014.

Let's take a quick look at a few of DE's competitors: Caterpillar (NYSE:CAT), Joy Global (NYSE:JOY), & CNH Industrial (NYSE:CNHI). These three firms are the largest of DE's competitors. DE has the lowest earnings valuation with a P/E of 9.9, compared to CAT's 18, JOY's 14, and CNHI's 14. Additionally, DE has the highest ROE and highest gross margins, potentially indicating an enduring economic moat. Compared to its competitors, DE seems to be undervalued at the present time. Deere & Company is the type of company that I want to own for the long haul, and this appears to be an opportune time to add to my position.

Turning to yield, Deere & Company also has a solid yield. You literally get paid to wait. DE has a current yield of over 2.6%. Deere & Company is a Dividend Contender, having raised its dividend for eleven consecutive years. Its 10-year dividend growth rate is over 16%. Is this sustainable? Absolutely. Its payout ratio is only 22%, giving it ample room to increase its dividend. Additionally, DE is sitting on $8.50 of cash per share. That's over four years' worth of dividend payments. Its most recent dividend increase was 18%. With these dividend growth rates, your yield-on-cost will be very high after a few years, especially if you are reinvesting your dividends. Its dividend growth rate of 16% is a much faster pace than inflation. That means that if you are relying upon dividend income to sustain you, you would not lose purchasing power over time. In fact, it would grow. DE is a dividend king.

Despite its future growth and massive share buyback activity, the real attractive quality here is to buy a profitable company at under ten times earnings. Even if profits were to stagnate or regress from here, it's still trading at ten times cash on hand. This is a profitable company with solid free cash flow, high margins, and its industry is unloved at the moment. Baron Rothschild said to buy when blood is in the streets, and these past couple of years have been rough for the agricultural industry. Despite these challenges, DE is a very healthy company. I welcome the opportunity to add to this position.

As always, this article represents my opinions at the time of writing. You should do your own due diligence before making any decisions. However, I believe that Deere & Company represents a quality company that is trading hands at a discount.

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.