By Mark Bern, CPA CFA
When most people think of combines, they think of Deere (DE). Deere is the world's largest manufacturer of farm equipment but also makes a broad range of industrial equipment for construction and forestry, as well as consumer products for lawn and gardens. As 2012 gets rolling, a look back at 2011 makes one wonder if a better year could possibly be in the making after a record year for sales and earnings. With prices of many crops having increased in 2011, the demand for new farm equipment in the U.S. market was strong. The picture I see for the U.S. market in 2012 is less exciting, with growth slowing some. But the picture of international sales looks much brighter as demand for farm equipment looks like it will remain strong. I also expect crop prices to continue to climb at a moderate pace while demand for better quality machinery in emerging countries continues to strengthen.
On the other hand, Deere stock has had a great rally over the past 4 ½ months of about 40%. Granted, the stock was a screaming buy at just under $60 in early October, but how much of the expected 2012 earnings gains are baked into the current price? The stock closed at $83.87 last Friday, February 20, 2012. The dividend is $1.64, yielding 2.0%, but was increased by 31% in 2011. I look for a more moderate increase in 2012 of about 12-14%. And I also expect earnings to increase by about 10% in 2012 over 2011. I also believe that the longer-term future for Deere will be even better than 2012 with a 5-year earnings growth rate closer to 12-14%. That would seem to warrant a 12-month trailing P/E ratio of at least 14 in my estimation. Yet the P/E is currently at 12.4. The price of the stock just tumbled in the days before 1st quarter earnings that increased only 4% year over year. The 1st quarter is historically the slowest quarter of the year for Deere, so I don't read too much dour news from these results. The big quarter is the 2nd quarter of each year which ends April 30th.
Let's look at my report card for Deere.
Ave. Annual 5-Yr. Earnings Growth
Net Profit Margin
Debt to Total Capital
Return on Total Capital
The debt to capital ratio is the only area where the company does not have a better ratio than the industry average, yet Deere's debt ratio is in line with the industry and very manageable. From a valuation stand point, Deere is priced at a discount to the industry. I think that the market was worried that earnings would be flat or down. Since the stock price rose by more than triple what the broader market did on Friday after the announcement, I would say that the results were well received.
The market seems to be taking a much-needed breather since the beginning of February and could continue to show weakness if the promise of resolution to the Greek debt crisis is not announced this week. By contrast, quality companies like Deere could spike higher if an acceptable resolution is announced. In any event, I think that the downside risk for Deere is less than the upside potential. I'd like to get the stock below $80 if I could and will be watching it this week for a drop below that level.
Alternatively, I am considering selling put options for March expiration with a strike price of $80 for $0.96 a share, collect the premium and hope that the stock will be below my strike price on the expiration (March 16th) and give me a cost basis of $79.04 a share. If not, I'll still have the premium of $96 for a return of 1.1% on my cash while I wait for less than a month. I can keep selling puts on this great stock until I get it and earn about 12-13% on my money while I wait. The way I like to think of this strategy is that I am just getting paid to place limit orders. If I get a fill, I'm happy. If I don't get the stock, I'm still happy because I earned money for trying. But I must warn investors to use this strategy on stocks that they really, really want to own. Happy Investing!
Additional disclosure: I may sell puts on DE stock this week if the premiums hold up.