A Caterpillar Vs. A Deere In A Battle For Agricultural Cash

Includes: CAT, DE
by: Jerry R. Carter

This is a worldwide economy and investments need worldwide views. Nowhere is this more evident than in production agriculture. Production agriculture, as we know it here in the Midwestern part of the United States, has been on nearly a 10-year bull market run. Farmland values continue to set new records month over month. December 8, 2011, saw a new record for farmland sales in Iowa. A farm in Northwest Iowa in Sioux County sold for $20,000 per acre. The tract was 74 acres and was purchased by a neighboring farmer. The previous record was a 120-acre farm that sold for $16,500 in the same county in October.

Margins have been reduced for crop production as this agriculture bull market move seems to at least be slowing heading into the winter on the production side. Corn futures on the CBOT have dipped below $6.00 per bushel, down from a high of well over $7 earlier in the year. Every farming operation is different but production costs per bushel are more than likely in the $4-$5 per bushel range. There is little to compare to for this stage in agriculture. Much of the country has been faced with recessionary problems while the Midwest has seen some of the fastest personal wealth growth in history.

These tremendous price appreciation moves in farmland values seem eerily reminiscent, myself a child of the farm crisis of the early 1980s. My family survived the 1980s crisis and is still actively engaged in farming today. Although a questionable reference fact, it has been mentioned that 80%-90% of current farmland purchases recently are said to be paid in cash, debt-free. There is cash on the sidelines in much of agriculture and investments for a typical farming operation (CD’s and land) are either are in short supply, or have paltry rates of return at this time. Is buying a farm machinery manufacturer a way of playing this market as a stock investor?

John Deere (NYSE:DE) and Caterpillar (NYSE:CAT) both have sizable worldwide participation in the farm machinery markets. John Deere has for many years been known as strong agriculture name. Deere agriculture is definitely worldwide and its products support the farmers that produce crops of every shape and size. Caterpillar has been known for larger commercial construction equipment and being at the forefront of industrial growth. CAT is growing in the agriculture markets with partnerships in countries around the world producing track and wheeled equipment that have taken away some of Deere's, and their other competitor's, market share.

There are two sides to this comparison. The first is to consider the battle of agriculture versus industrial and infrastructure growth. Since Deere in more entrenched in agriculture, and CAT in construction, this is where the lines are drawn. The bull market view has been stated earlier with increasing producer's equity driving the move in agriculture. The second viewpoint comparison is the construction cycle. The construction industry here in the United States seems to have at least stabilized near a bottom. Worldwide the countries of China and India have continued to grow, albeit at a slower pace. CAT will have the largest benefit of other companies as its equipment “moves” the building blocks of other countries. Seldom does an industry that led to a recession lead everyone out of a recession.

Deere or Caterpillar are two ways to play the agricultural move. Other companies like CNH Global (CNH) and Agco Corp. (AGCO) are large conglomerate producers of agricultural machinery and have been left out of this comparision. In order to compare DE and CAT from a stock investment viewpoint, the preference is to use TTM’s, or Trailing Twelve Month, financial data. These figures are calculated on CAT’s 3rd Qtr results ending 9/30/11 and Deere’s 3rd Qtr results ending 7/31/11.

CAT is a $47B industrial giant, under basic market capitalization figures. This trumps the market capitalization of Deere, at nearly $33B, by $14 billion. These figures have earnings per share on their respectable final quarter at $6.78 for CAT and $6.15 for Deere. The forward earnings show Deere trading at a higher expectancy of nearly 13 times earnings versus CAT trading at 11 times.

Profitability of the both companies are near 8% in net profits. Net Working Capital for Deere is over $13B and CAT has over $11B of cash to work with. Debt-to-Equity of the companies is nearly identical with CAT (2.14) and DE (2.11).

Both stocks at this time are not the greatest dividend plays in the market. CAT pays slightly over a 2% yield, while Deere is slightly under 2%. It may be better than CDs or money market accounts, but only marginally once you include the investment risk of stock ownership. These are growth stocks that will pay upon greater-than-expected earnings and promising outlooks in construction and agriculture by stock value appreciation.

Since these companies are so closely matched, which of the two investment catalysts should an investor believe in? The first catalyst is the worldwide industrial and infrastructure spending and development. Will this be the next large move? If so, being long CAT is the favorable move as it has higher exposure in this area. The second catalyst is the continuing bull market in agriculture with strong agricultural exports and ethanol demand for corn. If this is an investor's thesis, DE should continue appreciating as producers look for ways to offset taxable net profits with new machinery purchases for years to come.

These companies both have compelling stories when it comes to agricultural sales. With low “pay to wait” dividends, neither company should be purchased on dividend yield, there simply are better options available. Right now the larger potential investment profit looks to be CAT for a long-term hold. CAT's advantage is that it has already been through a downturn that drives a majority of its earnings. The increasingly stale bull market in agriculture can be viewed as higher risk and lower future earnings for DE. Deere can still be played short term as agricultural markets continue to spout higher-than-average proftis, but investors must keep an eye on headline news in agriculture concerning world exports, ethanol and input costs.

Disclosure: I am long DE, CAT.

Disclosure: Unless listed, DavidsCreek, LLC or Jerry R. Carter, does not have a financial interest in any equities, equity options, futures, or futures options recommended or described herein. All employees and agents will not initiate positions until 24 hours after publication before acting on recommendations. Copyright 2011 all rights reserved. All data and statements are reasonably believed to be reliable and accurate; however DavidsCreek, LLC or Jerry R. Carter, does not guarantee its accuracy or completeness. Opinions expressed are subject to change without notice. There is a risk of loss trading equities, equities options, futures and futures options. Past performance is not a guarantee of future results.