Why Deere & Company Should Interest Long-Term Investors

Aug. 4.14 | About: Deere & (DE)

Summary

Deere should benefit from favorable long-term economics of the agriculture industry.

Deere's cheap valuation presents a compelling entry point.

Deere also provides a solid dividend yield plus great dividend growth.

Farm machinery equipment maker Deere & Company (NYSE:DE) has some very strong long-term tailwinds that should provide years of solid growth. Primarily, it should benefit from rising global populations and the immense strain that is having on global food production. As populations across the world continue to go up, particularly in the emerging markets where populations are soaring, the amount of land available for food production has stayed the same.

That is placing enormous stress on the global agriculture industry, and makes it critically important for farmers to increase crop yields and farm productivity. That's where Deere comes in.

And yet, this year has not been kind to Deere. The poor harvest season is having a negative effect on Deere's sales and profits. As a result, the stock holds a discounted valuation to both the broader market and peer Caterpillar Inc. (NYSE:CAT).

But the end result is that Deere's short-term struggles are presenting an opportunity for long-term gains.

A disappointing 2014
Crop nutrient supplier The Mosaic Company (NYSE:MOS) stated in its most recent annual report that the world's population recently eclipsed 7 billion, and is poised to reach 9 billion by 2050. That means the world will add approximately 75 million people every year. And, as you'd expect, those people need to eat to survive.

With that as a backdrop, you'd think Deere would have no trouble posting stellar results. After all, its namesake farm equipment and services should see plenty of demand. But that's not what's happened so far this year.

In fact, Deere's revenue and net income are down 5% and 4%, respectively, over the first two quarters of the fiscal year.

Surprisingly, the primary culprit has been the agriculture and turf division, which generates the vast majority of the company's profits. Sales of agriculture equipment are down 7% so far this year, due to lower crop prices and farm incomes around the world. That's having a negative effect on demand for tractors, combines, and other farming equipment.

Still, Deere management has high hopes for the future, based on the strong fundamental economics of the agriculture industry.

How Deere stacks up against Caterpillar
In the near-term, Deere's operating struggles are presenting potential investors with a good opportunity. Here's how Deere stacks up against Caterpillar across a few key metrics:

TTM P/E

Dividend Yield

5-Year Dividend CAGR

Deere

9

2.8%

16%

Caterpillar

17

2.6%

10%

Click to enlarge

Deere's measurable discount to Caterpillar is confusing, because Caterpillar focuses on a different industry than Deere that doesn't offer the same positive outlook. Caterpillar's machines are utilized primarily for mining, which is stuck in a cyclical downturn. Precious metals prices have declined significantly from their peaks of a few years ago, and that's having an effect on demand for Caterpillar's mining equipment.

Complicating matters is that Caterpillar management doesn't expect the mining industry to recover for a while, and can't predict when a turnaround will materialize. That's why it's surprising to see Caterpillar trade at a higher valuation.

Deere's pain can be your gain
Admittedly, Deere is struggling right now. It's seeing lower demand from international markets, because of a poor harvest season that has reduced farm incomes. But the long-term future of agriculture is very strong, which management stressed in its most recent earnings presentation.

In the United States, Deere is projecting farm cash receipts to hit a record this year.

In the emerging markets, booming populations mean the downturn in farming activity is likely temporary. While South America is expected to remain weak this year, Deere states that continued government focus on productivity and farmer incomes in China and India will support future demand.

Deere offers a higher yield than Caterpillar, greater dividend growth over the past five years, and the potential for out-performance going forward. While Caterpillar's core business faces significant headwinds now that the global mining cycle appears to be turning downward, Deere's future is much brighter.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.