Deere: Recent Acquisition Helps Solve A Huge Problem

Summary

• Deere is a great company that stacks up well against competitors.
• The Bear Flag Robotics acquisition aims to reduce the gap between supply and demand in the farming industry.
• However, now might not be the best time to buy the stock.

esemelwe/iStock Unreleased via Getty Images

Deere & Company (NYSE:DE), is a great company that has performed exceptionally well in the past year. It has a reputation of being innovative and its recent acquisition of Bear Flag Robotics demonstrates why. Despite this, now might not be the best time to buy.

Industry Snapshot

Deere & Company operates in four industries:

• Farming Equipment
• Forestry
• Construction
• Financial Services

The farming equipment, forestry, construction, and financial services industries are expected to grow at CAGRs of 6.2%, 4.75%, 7%, and 9.9%, respectively. All four industries are very cyclical in nature making Deere sensitive to business cycles.

Taking a quick look at some of its peers, Deere seems to stack up well against its competition:

Source: Finbox

An important metric that immediately stands out is Deere's cash conversion cycle. The cash conversion cycle is a metric that measures the number of days it takes for a company to convert its investments in inventory and other resources into cash flows from sales. The shorter the time, the better because it means the company has more liquidity.

In addition, Deere has enjoyed a strong average return on equity over the past 10 years at 29.5%. The average EBIT margin is also on the higher side as well compared to its competitors at 12.1%. The Toro Company (TTC) is the only one out of this sample that has higher scores on these metrics.

Furthermore, each company is currently trading at book values higher than their historical averages. This does not necessarily mean that each company is overvalued since we are in a low-interest-rate environment. However, it is interesting to note nonetheless.

Bear Flag Robotics

Recently, Deere announced the acquisition of Bear Flag Robotics which we believe is a great purchase. Currently, farmers in the US face a huge labor shortage. It's getting bad to the point where the US might have to start importing its food. The issue is compounded by the fact that wages for farmworkers have been increasing fast enough to make it harder for farmers to be competitive. For instance, in 2018 the agriculture industry experienced a 7 percent decline in hired help and a 5 percent increase in labor wages.

The average age of principal operators is 59.4. As more operators reach retirement age, there are fewer young farmers coming in to fill their shoes. Farmers under the age of 35 account for only 9 percent of the total population. This declining trend in agricultural interest is mostly due to:

• High real estate and land prices;
• Steep initial investment cost of machinery and agrotechnology;
• Volatile commodity pricing;
• Unpredictable weather;
• Unequal work-life balance; and
• The physical demand of the industry.

Bear Flag Robotics boasts that it will be able to reduce the gap between labor supply and demand with the use of autonomous machinery. What's interesting about Bear Flag is the fact that farmers aren't required to purchase any new machinery. Instead, existing ones can be retrofitted with the technology.

The technology greatly increases production because it gives one person the ability to control multiple tractors at once. This allows highly skilled workers - who are very hard to come by - to be freed up from performing mundane tasks. Instead, they will be able to pay more attention to the quality of the crops or have more time to perform complex tasks. In addition, Bear Flag claims that the autonomous vehicles have the ability to run all night unsupervised.

We believe autonomous vehicles will likely have more success in agriculture as opposed to cars for 2 reasons:

1. Farmers are business people, and businesses are much more willing to pay extra for something that improves their returns on investments.
2. There is no traffic on farms which means the chances of an accident are much smaller.

We believe the second reason is very important. In order for everyday cars to become fully autonomous, engineers will need to overcome the technical challenges of sharing roads with other cars and cyclists at varying speeds. In addition, the cars will require the ability to reacts to street lights, stop signs, and make right turns without running over pedestrians. This is definitely not an easy feat.

However, machinery that's on an open field with nothing but crops can be commercialized sooner because it doesn't need to be as perfect. Tractors, for example, are slow which gives the system more time to react. It also gives anyone that could be in potential danger more time to react. Therefore, it will be more successful because it has fewer variables to deal with.

The acquisition should also help the company eventually become less cyclical as it will help it generate more high-margin software revenue. However, as great as this technology sounds, it will likely be a while before the acquisition makes a material impact on Deere's top and bottom lines.

Valuation

Let's take a look at Deere's historical p/e ratio:

Data by YCharts

As you can see, the stock's p/e ratio has seen some wild swings in the past 17 years. It has been as low as roughly 3x in 2008/2009 and as high as approximately 39x only a few years ago. What's interesting about this pattern is that when the p/e ratio reaches the current level on the way down, it continues to fall to around 10x.

Now, this doesn't necessarily mean that the stock will crash 50% soon. It could be that the company will grow into a lower multiple. Nonetheless, it would appear that the multiple is on its way down.

Risks

The main risk we would like to touch on is the valuation. Since the p/e ratio is on its way down, the company could be heading for a further multiple contractions if the historical pattern holds. Rising bond yields could definitely add pressure to the downside if they rise too quickly.

Final Thoughts

Deere & Company is without a doubt a great company. The acquisition of Bear Flag Robotics appears to be promising and could definitely be a great solution to the labor shortage being experienced in the agriculture industry. Although the stock may continue to perform well, we will sit on the sideline for now as we believe there are better opportunities elsewhere.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.