Last time I wrote an article on Deere & Company, it was August 3rd and I was exploring the idea as to whether the stock would be a good investment. This is what I concluded in my last article:
"We have made the case that it is positioned well having most of its business here in the U.S. and is set up for international growth also once things turn around. The only question is: Will the economy turn around sooner than later? Invest now and be prepared to wait or invest now and expect a quick turn around."
Well, it appears that with hindsight, the former would be the right decision if one was investing in the stock. The U.S. economy has not yet turned around, and Deere (DE) will not be performing as well as it originally forecasted. Net income in the year ending Oct. 31 will be $250 million less than an estimate in May. Even though the stock may be struggling with the economy, other types of investors are flocking to the company that are interested in buying debt. Company's like Deere are considered a safe long term debt investment with higher yields than government bonds so investors come. Jeffrey Cannon, an analyst at Chicago-based Morningstar Inc.
"You have slower growth but you still have growth, and so from a credit metric perspective the company still looks solid, "It's a great time to issue debt because rates are low and spreads are tight."
The company may be considered a good long term debt investment, but I do not believe the stock will perform well in the near future. Not only is the net income for the company projected to be $250 million less than forecasted last May, but the company's last quarter was far from stellar. If you have been keeping up you will know that by its numbers in August. If you haven't read about the company, here is a quick summary:
- Projected net income of $3.1 billion for the year compared to $3.3 billion analysts were anticipating
- An 11 percent increase in net income to $788 million or $1.98 a share in the third quarter did nothing to impress analysts who were expecting much higher at $2.32 a share.
Regional events and economic conditions are just not favorable for Deere right now. We have the drought in the U.S.; another one in Argentina; there are visible signs of softening sales in both India and China as the economy slows. The company was looking for a more global balance as it became more aggressive in international growth but its projections are going to have to change as the company's international sales for the entire industry are expected to drop 5 to 10 percent for the full year.
It appears the stock has been moving in a fairly wide neutral trading channel since mid May. The range goes from 73 up to about 83 and there have been a couple mid range high and lows in between. There is neutral support for this trading pattern in both the RSI and the MACD. Both indicators have been moving between their neutral positions as the stock has reached highs and lows. Presently it is trading against the high point of its channel. Will it turn and go down, or will it break through its channel?
The Options Play
The company is presently trading at 82.29, at the top end of its trading zone. Because of the retracting forecast and economic conditions, I am taking the position that the stock will remain in the zone for the short term and move back down now.
- Buy the December 2012 puts with a strike of '82.50' (priced at $4.10)
- Sell the December 2012 puts with a strike of '80.00' (priced at $2.92)
- Net debit to Start: $1.18
- Maximum Profit: $1.32
- Maximum Risk: net debit
- Maximum Length of Trade: 3 months
Reasoning behind the Trade
- Future net income projections much lower than expected earlier this year
- Contracting global economy hinders sales
- No present catalyst to push it out of its trade zone in the short term
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.