Deere - Executing In A Tough Environment, Through The Cycle Appeal Remains

| About: Deere & (DE)

Summary

Deere reports falling sales and earnings as expected.

As the lowered full year guidance could imply an ugly fourth quarter.

Easy comparables could stabilize the business, with shares trading at just 10 times earnings.

Investors in Deere (NYSE:DE) have largely been anticipating a weaker guidance for 2014 as low commodity prices for key agricultural products have materialized after good summer weather.

Deere managed to report reasonably healthy third quarter results given these circumstances as the cut in the full year outlook implies that the final quarter will be very though.

Main Third Quarter Highlights

Deere posted third quarter sales of $9.50 billion, a 5.1% fall compared to the same period last year. Equipment sales of $8.72 billion were in line with consensus estimates.

The fall in topline sales hurt the bottom line quite a bit which should be no real surprise. Reported earnings dropped by 14.6% to $850.7 million.

Thanks to rather sizable share repurchases, after the company repurchased over 6% of its outstanding share base over the past year, the fall in earnings per share was limited to 9%. Reported earnings per diluted share came in at $2.33 per share, topping consensus estimates by thirteen cents.

Construction A Bright Spot, Agriculture Takes An Expected Hit

The overall year of 2013 was a particular strong year, while 2014 is turning up to become an especially weak year driven by low prices for agricultural commodities resulting farmers to cut back on their investment in farming equipment.

Sales of agricultural and turf business fell by 11.2% to $6.97 billion on lower volumes as well as the divestiture of John Deere's Water and Landscape business. Higher production costs, lower sales and unfavorable currency rates outweighed price increases of 2% resulting a plunge in operating earnings. Operating earnings fell by 29.6% to $941 million, for still very healthy operating margins of 13.5% of sales.

Besides weakness induced from poor soft commodity prices "at home", Deere also was hurt from increasing interest rates and inflation in important agricultural countries like Brazil and Argentina. The unrest in the so important grain producing country Ukraine was of course not helpful either.

Construction and forestry sales rose by 19.4% to $1.75 billion for the quarter thanks to the general recovery in the economy and the housing sector in particular. The growth in topline sales resulted in very nice operating leverage, with earnings being up by 81.3% to $194 million. Operating margins of 11.1% still trail those in the agriculture business however.

Financial service revenues were up by 11.8% to $656 million with operating earnings improving by just 6.4% to $249 million for a very healthy margins. Credit growth was partially offset by higher operations expenses and higher provisions for bad loans.

A Weak Ending Projected For The Year

For the current fourth quarter, which is the final quarter of the year, Deere is quite cautious. Equipment sales are seen down by 8% for the final quarter, and down by 6% for the full year.

Included in this sales guidance is a currency headwind of 1%, as earnings are now seen at $3.1 billion for the full year, slightly less than the previous forecast for earnings of $3.3 billion. The guidance implies that fourth quarter earnings are seen around $600 million which compares to $807 million as reported in the comparable period last year. As such reported earnings could take a plunge, as the fall in earnings per share will be partially mitigated by share repurchases.

To accommodate the lower than anticipated demand, the company is cutting back on production at the moment as the company remains very confident in the business for the long run.

Valuation

By the end of the quarter, Deere held some $4.5 billion in cash and equivalents while it has a very sizable debt position of some $36.7 billion. This results in a net debt position of about $32.2 billion, yet it should be noted that most of this relates to the financing business of the company. The company has some $31.4 billion in normal and securitized financing receivables outstanding, explaining the large "leverage" position incurred by the financing business.

With some 365 million shares outstanding in the latest filing, and shares exchanging hands at $86 per share, equity in the business is valued at little over $31 billion. On a trailing basis the company has posted sales of $36.5 billion on which it reported trailing earnings of $3.3 billion. As mentioned before, the company guided for annual earnings of $3.1 billion.

This values equity of the business at roughly 0.85 times ales and 10 times projected earnings including a weak fourth quarter.

History Of Growth As Comparables Become Easier

Over the past decade, Deere nearly managed to double its business. After reporting sales of $20 billion in 2004, revenues have increased to $36-$37 billion, a region in which sales have stagnated over the past three years.

The company managed to improve earnings quite a bit, increasing from $1.5 billion in 2004 to a peak of $3.5 billion in 2013. Earnings are currently expected to fall to $3.1 billion this year, with perhaps a bit more downside in 2015. Earnings per share have benefited from sizable share repurchases as the company has retired some 25-30% of its outstanding share base over the past decade.

A word of caution, the relative importance of the financing business has increased with receivables now being equivalent to the market capitalization, and steadily approaching the annual sales mark, as more sales go on credit.

Final Takeaway

Deere continues to return cash to investors even in this difficult operating environment. Deere's $0.60 per share quarterly dividend provides investors with a near 3% dividend yield, accompanied by appealing share repurchases.

While sales have been difficult this year don't forget that the company is being hit by very low prices in key commodities this year, a reversal from historically high prices in recent years.

I like the historical growth, strong positioning and guidance for long term growth. The adoption of the economic value added concept has really aided investors over the past decade, as the relative importance of the financing business has increased some risks. While loan loss provisions of the business came in at just 10 basis points for the past quarter, and have been below 1% over the past decade, the total amount of receivables in quite sizable.

While softness is anticipated in the final quarter of this year, comparables should become easier coming in to the first quarter of next year. This is to say that the cutbacks in production could result in a rather ugly earnings picture for the final quarter. Reported dollar earnings could potentially fall by a quarter.

Prospects for stabilization in 2015 could be very appealing in such a scenario with shares trading at 10 times earnings for this year, even as they are anticipated to fall some 10-15%. Even as 2015 might continue to be a rough year, the valuation provides a lot of comfort in my eyes.

I continue to hold on to my long position.

Disclosure: The author is long DE. 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.