Deere & Co: Top Line Is Expected To Fall

| About: Deere & (DE)

Deutsche Bank reportedly gave Deere & Co. (NYSE:DE) a buy rating and a $110 price target though the stock is currently trading at $84.80. The investment firm indicated that improving fundamentals in international agriculture and construction markets would bring growth prospects for the company.

On the contrary, the company forecasts its global sales of agriculture and turf equipment segment would decline by about 6% for FY 2014. This outlook accounts for the sale of a majority interest in the John Deere Landscapes operations. This is an internal factor that will be impacting the financial performance of the company's agriculture and turf segment. Therefore, I will determine the outlook of some external factors that will influence the revenue performance of the company's agriculture and turf segment.

The company's FY 2014 guidance for its construction and forestry segment is in line with Deutsche Bank's view. The company has projected its worldwide sales of construction and forestry equipment to increase by about 10% in FY 2014. The forecast is built upon expectations of further economic recovery and higher housing starts in the U.S., as well as sales escalation outside the U.S. and Canada. The company expects its global forestry sales for FY 2014 will also improve due to general economic growth and higher sales in European markets.

Hence, I will analyze the outlook for both of these operating segments considering the projections made by Deutsche Bank and the company.

First of all, let us determine which segment among these two is more influential over the company's overall top line results. This will aid in forecasting the overall outlook for the company's top line.

Which Segment is More Influential?

Deere & Co. operates through its three business segments: agriculture and turf, construction and forestry and financial services. The company generated 77.08% of its total revenue in FY 2013 from its agriculture and turf equipment sales, as shown in the table below. This make the segment's performance more influential over the company's overall results. The segment has also been the growth driver for the company, as it recorded a 7.41% increase in its net sales in FY 2013 compared to the previous year.

Source: DE 10K and 8K

On the other hand, the construction and forestry segment contributed 15.52% to the company's total revenue. The segment recorded an 8.03% decline in its revenue for FY 2013. Since the company and Deutsche Bank are expecting a recovery in this segment of the company, I will determine the external factors that are likely to impact the segment's performance in the coming period.

First, let us analyze the outlook of the agriculture and turf equipment market.

Agriculture and Turf Equipment Market Outlook

The company's sales of agricultural equipment are impacted by total farm cash receipts that reflect levels of farm commodity prices, acreage planted, crop yields and government policies, considering the amount and timing of government payments.

A majority (62.35%) of revenue earned by the total equipment sales, that include both agriculture and construction equipment, made by the company in FY 2013 came from the U.S. and Canada, as shown in the table below. Therefore, I will discuss the forecast for U.S. farm cash receipts for FY 2014.

Source: DE 10K and 8K

Decline in Farm Incomes and Cash Receipts in the U.S. and Canada Are An Adverse Factor

Source: DE First Quarter 2014 Earnings Conference Call

You can see from the chart above that a fall in U.S. farm cash receipts is expected for FY 2014. The U.S. net farm income is also projected to decline till the year 2015, as shown in the chart below.

Source: OCE

In Canada, crop receipts are forecast to total $29.1 billion in the year 2014, 3% below the projection for 2013.

All of these forecasts indicate an adverse impact on the company's revenue it earns from the sale of agriculture equipment. The major reason behind this fall will be declining commodity prices, as discussed below.

Commodity Prices will not be Supportive of Growth

The volatile agricultural commodity prices directly impact the sales of agricultural equipment made by the company. Higher commodity prices generally benefit Deere & Co.'s crop-producing agricultural equipment customers, who are then more willing and able to purchase crop equipment. As a result, I will determine the forecast of commodity prices for the coming years.

According to Rabobank International, the world is entering a phase of "more balanced" supply and demand fundamentals for agricultural commodities after a span of mounting volatility that drove prices for many farm goods to records. Global inventory levels for agricultural commodities accumulated throughout 2013, but the rapid demand growth of recent seasons has slowed. The bank expects agricultural commodity prices to continue to decline for most markets in the grain and oilseeds complex in 2014. The forecasted decline in commodity indices is depicted in the chart below.

Source: Financial Times

This will result in less income for the farm producers, which will adversely impact the purchase of farm equipment by the farmers. This will ultimately serve as an external factor to decrease the sales of Deere & Co.'s agriculture and turf segment. Overall, both internal and external factors indicate a fall in the revenue the company generates from the sales of agriculture equipment for FY 2014.

Now, let us discuss the prospects of the company's sales recovery and growth from selling to the construction and forestry industry.

Construction and Forestry Industry

The prevalent levels of residential, commercial and public construction and the state of forestry products industry influences the retail sales of Deere & Co.'s construction, earthmoving, material handling and forestry equipment. General economic conditions, the availability and cost of credit and certain commodity prices, such as pulp, paper and saw logs prices impact the sales the company makes to the construction and forestry industry.

Global Construction and Equipment Industry Outlook

Source: Alix Partners

You can see from the chart above that a recovery in global construction equipment and sales is forecasted for FY 2014. The sales of global construction equipment recorded a decline in FY 2013. The recovery in global sales of construction equipment is projected as economies are expected to increase their spending on infrastructure to support economic recovery. The global construction equipment market is forecasted to reach $192.3 billion by the year 2017, up from $143.6 billion in 2012. China will record the highest demand and consumption of construction equipment, followed by Europe. Moreover, in the U.S., home prices are forecasted to continue to rise above the inflation rate, at least by the end of the year 2014. U.S. Housing starts will also reflect construction and housing sector improvement by supporting 1.2 million starts in 2014 and about 1.6 million units in 2015 and 2016. So, overall, these forecasts are in line with the company's and Deutsche Bank's forecasts.

Global Forest Products and Equipment Outlook

As a result of the increased number of housing starts in U.S., the demand and prices of lumber are forecasted to surge in the year 2014. China will import more and more logs and lumber from North America to fulfill its wood deficit that will also contribute to its augmenting demand for logs. The global demand for wood fiber for pulp manufacturing is forecasted to rise in 2014, also receiving support from the rise in global demand for packaging materials. This increasing demand for forest products and the rise in prices of forest products in the coming years will drive growth in the demand for forest machinery and contribute to the growth of Deere & Co.'s construction and forestry equipment segment.


The company's guidance for the revenue growth of its agriculture and turf equipment segment for FY 2014 contradicts Deutsche Bank's forecast. Upon analyzing the internal and external factors, it became evident that the company's agriculture and turf segment's outlook is gloomy for the coming year. This is because the company disposed of its landscape operations and depressed agriculture commodity outlook. Lower commodity prices will lower farm income and cash receipts for the company's U.S. farm customers that generate a majority of the company's revenue. For the company's construction and forestry segment, the growth forecast by both the company and Deutsche Bank is in line with the industry outlook, and the company will recover the revenue performance of this segment. Since the agriculture and turf equipment segment is the largest contributor to the company's top line, the decline in this segment will impact the company more than what will be partially offset by the growth in the company's construction and forestry segment. As a result, I expect the company's revenue from equipment sales, that generated 92.60% of the company's total revenue in FY 2013, to fall in FY 2014. Therefore, I recommend selling this stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by a Blackstone Equity Research research analyst. Blackstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Blackstone Equity Research has no business relationship with any company whose stock is mentioned in this article

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