- Shares are down over 5% since May due to a guidance statement.
- Management has a history of being very conservative with guidance, leading to earnings being beaten in 5 out of the last 6 quarters.
- No problems Deere faces are long term, and with a strong and rising dividend and healthy buybacks, present share prices are attractive.
Deere & Company (NYSE:DE) operates in 3 segments:
- Agriculture & Turf
- Construction & Forestry
- Financial Services
Over the past year, the geographic breakdown of the sales is as follows:
- U.S. & Canada $21.8 billion
- Asia/Africa/Australia $4.5 billion
- Western Europe $4.4 billion
- Central/South America $.4.3 billion
Of the $35 billion is sales, $29.1 billion of it was related to Agriculture. The remainder was from Construction and Forestry.
While Agriculture produces most of Deere's operating profits and has the highest CAGR out of all the segments, it also happens to generally be quite a bit less volatile than the other segments. It was thanks to Agriculture that during the worst year of the recession, 2009, Deere still managed $2.3 billion in operating profits. Construction and Forestry's operating profits dipped slightly negative, while Financial Services still managed $150 million in operating profits.
Recently however, falling agricultural commodity prices have been hurting farm incomes. As a result the amount of spending on Deere's agricultural products should be falling a bit. A May announcement by Deere stated that sales forecasts are going to be cut by 3-4% for the year. This led to the presently available discount in Deere shares, as their price sits at just above $89, down about $6 from its high in May.
There are two important things to keep in mind with this announcement. First, Deere has a history of very conservative forecasts, which there is then very often an easy time of beating. Second, 2013 was such a strong year for Deere that it makes YOY forecasts very tough. The recovering housing market should also be able to pick up some of the slack, as it will benefit growth in the Forestry and Construction segment.
Deere has a business model which is not complex, and has some excellent sustainability built into it. Like all businesses, it has risks, but there are no hurdles it faces that aren't also faced by its competition. In fact, if risks such as price wars among competitors or governments cutting some farm subsidies took place, Deere would suffer much less, and probably gain market share over its competitors, thanks to its size advantage.
Agricultural mechanization is still fairly low in many countries around the world, particularly when dealing with the kind of large equipment Deere offers. In the United States, full mechanization on farms has for all intents and purposes been achieved. Still, replacing old machines with new ones is an activity which must continue. Due to equipment replacements being put off during the economic downturn of recent years, the more advanced age of equipment fleets ensures there should be healthy replacement levels in upcoming years.
Deere does have more debt than many of its competitors, a concern voiced by a few individuals. A deeper look at it reveals that most of this debt is tied into Financial Services, which is very well managed. The Financial Services segment earns profits on the interest spread of borrowing money at low rates to finance retail equipment sales. With an impressive $36.8 billion portfolio, loans given by Deere are generally to the Agriculture portion of business and centered in the U.S. With net earnings of $469 million for the past year, write downs were a miniscule 0.03%. As mentioned previously, positive earnings were still generated by this segment during the awful year of 2009.
Deere has been buying back stock aggressively, as outstanding share volume has been reduced by 6% over the past year. Deere has also increased dividend payments for 11 consecutive years. The dividend increases have been healthy ones, as they have averaged over 15% during this period.
Compared to other farm and equipment manufacturers, to the market as a whole, and to itself historically, Deere appears cheap, with a P/E below 10. With hiccups anticipated and announced by management, there might be a wait before Deere picks up momentum, but with a 2.66% yield, long-term investors who DRIP have a solid entry point.