When last I wrote about Deere (DE), I worried that aggressive growth assumptions might be setting investors up for a correction. Since then, the stock has dropped about 10% - helped, I'm sure, by the growing worries about seemingly every economic region outside of North America.
I still have my worries about whether North American farm demand is peaking and whether emerging markets like Brazil, Russia, India, and China can take up the slack. Although these shares are looking increasingly attractive from a cash flow perspective, sentiment and fears of further economic sluggishness are risk factors well worth considering.
Growth Increasingly Carried By North America
Deere did pretty well this quarter relative to sell-side expectations, as total revenue rose 12% and equipment revenue rose about 13%. Agriculture and turf saw sales growth of nearly 11%, while construction and forestry grew almost 26%. Sales within North America jumped another 18%, but ex-NA sales rose just 6% - a significant slowdown from the last quarter.
Once again Deere did deliver the goods with its margins. Equipment gross margin improved more than half a point, while segment operating profit rose 20%. Ag/turf equipment margins were especially strong, improving 150 basis points from last year.
On a relative basis Deere did alright as well. CNH (CNH) and AGCO (AGCO) did deliver better top-line results, with AGCO in particular seeming to benefit from a large increase in sales outside of core tractor and combine categories. On the construction side, Deere's growth did trail CNH as well, but outperformed Caterpillar (CAT) - suggesting to me that there's more strength today in the smaller/lower-power construction equipment categories.
It's also well worth noting one other detail - although Deere's growth may have lagged its biggest ag comparables, its margins are well ahead of these rivals.
Guidance Not Too Surprising, And Very Deere-Like
For better or worse, Deere's management has always taken a relatively conservative stance with its guidance. I happen to appreciate that, but then my investment instincts tend to be more on the value side of the spectrum. In any case, while some growth-oriented investors may be concerned that Deere's upward revision was smaller in magnitude than AGCO's, I'm not bothered by it.
What does concern me a bit is the mix. North American demand seems to be steadily improving, given the trend in management's guidance over the past few quarters. At the same time, the South American market is getting worse (due in part to a drought), and everybody seems more skittish about Europe, even if the core underlying agricultural trends there are solid. What this all means to me, then, is that more and more eggs are riding in the North American basket.
At the same time, components companies are sounding more than a little skittish. It's impossible to draw straight lines between Eaton (ETN), Parker Hannifin (PH), Cummins (CMI) and Deere, but it seems like more and more companies with vested interests in the construction and ag markets are pulling their cards a little closer to their vests.
The Bottom Line
Investors already expect a lot from Deere in terms of free cash flow growth. On the plus side, there's little sign in either the commodity markets or in the guidance from ag input companies like Potash (POT) and DuPont (DD) that ag activity is approaching the edge of a cliff. What's more, countries like Brazil, India, China, and Russia need more and better equipment.
Against that is the reality that the North American ag market has been pretty strong for a while now, and despite what some investors always think during cyclical upswings it's not actually different this time. Moreover, while the potential demand is there in the emerging markets, the road from potential sales to reported sales can be longer and bumpier than optimists care to believe.
Even with that backdrop, I'm a great deal more interested in these shares today than I was a quarter ago. I do worry that margins may be peaking (and sales too, for that matter), but there's no such thing as a worry-free stock. Right now, Deere looks cheaper than Caterpillar or Cummins and while I'd wait for this current downward trend to work itself out, these shares are most definitely on my watchlist now.