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Summary

  • Maturity in the agriculture sector has hurt Deere, but the company's diversification can help it stay strong.
  • An improvement in the economy and secular agriculture growth can lead to an improvement in Deere's performance.
  • Deere's valuation is eye-catching, along with impressive cash flow and a solid dividend, making it a stock worth considering.

Deere (NYSE:DE), the agriculture and construction equipment giant, has been under pressure due to sow farming growth that is taking a toll on its financials. This is evident from its latest set of results. When Deere reported its third quarter, its revenue dropped 5% year over year. The company's bottom line also took at hit. Deere announced net income of $850.7 million, or $2.33 per share, down from $996.5 million, or $2.56 per share, in the year-ago period.

Investors, however, should not ignore the fact that Deere is pretty cheap and carries an impressive dividend. It trades at less than 10 times last year's earnings, and yields a robust 2.60% in dividend. In addition, the company has got strong operating cash flow, generating $3.35 billion over the past year. Considering that its payout ratio is low at just 22%, it will be a good idea to hold this stock for the dividend.

Trying to stay strong

Deere is trying hard to rescue the situation. The company has announced that it will be laying off more than 600 workers at four plants in the U.S. as it tries to escape the end-market weakness. According to a Reuters report:

Deere & Co, the world's largest maker of farm equipment, said it would indefinitely lay off more than 600 employees at plants in Illinois, Iowa and Kansas as falling grain prices hurt demand for tractors, harvesters and other agricultural machinery.

This looks like a good move considering the constrained environment in which the company is operating. The decline in Deere & Company's performance is due to the farm sector reaching a maturity level globally, which in turn has resulted in a decline in farm machinery demand. This has led to feeble sales and profits for its turf and agriculture business. But, the company's other division, financial services and construction and forestry, is picking up. Hence, the fact that Deere is running a diversified operation can work to its advantage.

Can better times be expected?

But, the question is, can Deere turn around its agriculture business, which fell 11% as a result of a decline in shipment volumes last quarter. Probably yes. According to management, soybean and grain production levels are forecasted to rise in 2014. Moreover, livestock is estimated to be at peak levels.

In addition, supplies are expected to be sufficient, with solid demand for oil seed and global grain. The poor growing conditions around any primary growing region in the world, in addition to unfamiliar outcomes for geopolitical issues, might reduce production, lower the stock to use ratio, and lead to rapidly increasing prices. Hence, better grain prices can lead to an increase in demand for Deere's equipment.

Also, Deere is seeing signs of a cyclical recovery and economic stabilization, with a slight expansion in GDP growth. This will lead to an increase in confidence for businesses, consumers, and exports.

The moderation of feed costs, rising beef prices, and peak milk prices are also supporting dairy farmers and livestock. Moreover, some crucial markets like the U.K. and Spain are seeing an uptick in demand. Moreover, rainfall in India is forecasted as normal. However, the late arrival of the monsoon season and least precipitation in important agricultural regions might negatively affect production.

But on an overall basis, agricultural production level during 2014 is expected to expand by nearly 5% against the 2013 level. Despite the recent drop in prices, agriculture fundamentals for grain are expected to remain strong, supported by robust market conditions and a better financing environment. The expansion of the livestock sector will fuel sales of small and mid-size tractors.

So, there is cautious optimism about the end-market prospects. Deere, however, is not getting carried away. Going forward, the company will scale back production, and thus match agricultural product demand in order to avoid oversupply and low prices for its equipment. Further, it plans to expand its market presence all over the world. Moreover, secular growth due to the world's expanding need for shelter, food, and infrastructure in the future is another tailwind that investors shouldn't discount.

The company is also making smart moves to move inventory. It calls the John Deere Certified Pre-Owned Program as a "game-changer" that is expected to assist dealers in reducing inventories of used equipment. Deere believes that this program will allow farmers to improve their purchases owing to feeble crop prices.

Conclusion

All in all, Deere is no doubt seeing some weakness, but the company is trying its best to overcome it by expanding its global presence and scaling back its production. Moreover, the world's population is growing by the day, so demand for agriculture will continue rising, and this will lead to higher demand for Deere's equipment. As such, the company will ride a secular growth trend going forward, and this is the reason why investors should continue holding the stock in their portfolios.

Source: Deere's Fundamentals And Expected End-Market Improvements Make It A Good Investment