Deere: Interesting Long-Term Buy
Summary
- Deere saw revenue increases in all business segments due to a favorable volume/mix and partially due to price increases. These were partially offset by higher production and SG&A costs.
- The outlook for 2023 looks good with revenue growth and operating margin improvement.
- Over the past 4 years, more cash has been paid out than has been generated in free cash flow, so net debt has increased considerably.
- Growth in sales and earnings, improved profit margins, attractive growing dividend and stock valuation make Deere an interesting long-term buy.
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Introduction
Deere (NYSE:DE) has become a major player in the field of agricultural machinery. Both sales and profit margin have grown significantly in recent years. Investors are enthusiastic and the share price has risen sharply as a result; especially since the corona crisis. Is the share still interesting after this strong rise? Certainly it is, because the prospects are excellent and the forward valuation also looks fine.
Strong Growth and Good Outlook
Deere is a reliable and well-known brand of farm vehicles and equipment in the agricultural industry. Farmers highly appreciate Deere's reliability and good quality, which is why the company has many fans.
Deere has a broken fiscal year ending in October. Earnings for the first quarter of 2023 came in strong with 32% sales growth, 117% growth in net income and 124% growth in earnings per share.
The Production Ag business segment is the biggest revenue driver with 41% of total revenue, followed by Small AG with 19%. The Production and Precision Ag segment grew significantly with 55% revenue growth to $5.2 billion. In addition to strong sales growth, operating income increased significantly due to favorable volume/mix and price increases, partially offset by higher production costs and selling and general administrative expenses. Sales in the Small Ag and Turf segment increased 14% year-on-year to $3 billion, and here again we saw the same comparison of operating income as in the Production and Precision Ag segment. Finally, Construction and Forestry sales increased approximately 26% year-on-year to $3.2 billion, and also here we saw an improvement in volume/mix and price increases that led to higher operating margins.
Net sales and revenues by major product lines (Deere 1Q23 investor presentation)
For fiscal year 2023, Deere expects sales growth of about 20% in the Production and Precision Ag segment and an improvement in operating margin to 24% by midpoint. For the Small Ag and Turf segment, sales are expected to remain flat with an increase of up to 5%. Operating margin is expected to improve to 15% by midpoint. For the Construction and Forestry segment, sales are expected to increase about 13% at the midpoint and the operating margin to improve to 18%. Consolidated, Deere expects $9 billion in net revenue and $9.5 billion in net operating cash flow. Long-term, Deere is well positioned with a total market opportunity of more than $150 billion.
Deere's $150 billion market opportunity (Deere's FY2022 investor presentation)
Dividends and Share Repurchases
Especially in recent years, Deere's dividend has risen sharply. We see an average annual increase of 21.8% since 2020. For next year, several analysts expect more moderate dividend growth of 4.8%. The dividend is $5 per share and represents a dividend yield of 1.3%.
Dividend growth history (DE ticker page on Seeking Alpha)
Deere's dividend payments have increased significantly each year, and the company also repurchases its shares. In total, this represents 63% of net income over the past 4 years. We see that more than twice as much cash was distributed to shareholders than was generated in FCF. And as a result, its net-debt has risen strongly from $37.8 billion in 2018 to $49 billion today. Interest coverage is still comfortable at 8.8x times but rising interest rates and maturing debt will eventually lead to higher interest expenses. In the long run, the shareholder return program is not sustainable and I expect Deere to scale back its share repurchase program soon.
Deere's cash flow highlights (Annual Reports and analyst' own calculations)
Valuation
Deere has become more profitable in recent years. It still generated an operating margin of 14% in 2018, which has currently improved to 23.5%. With this increased efficiency, it makes no sense to value Deere based on the price to sales ratio.
This makes the PE ratio an appropriate choice to chart the current valuation and also to examine whether the current price offers value for the near future. The GAAP PE ratio is currently around 14.3 and is below the 3-year average of 19.8. Now I do think the average PE ratio is very high in this interest rate environment. After all, we see fluctuating cash flows at Deere. I think a PE ratio of 14.4 (earnings yield = 6.9%) provides adequate coverage for any recession risk.
Analysts predict a bright future with earnings per share up about 26% for this fiscal year. Sales are expected to grow by mid-teens annually in the coming years. The strong increase in earnings per share makes for a very attractive stock valuation with an expected PE ratio of 11.9 by 2025.
Deere's earnings estimates (DE ticker page on Seeking Alpha)
Conclusion
Deere saw revenue increases in all business segments due to a favorable volume/mix and partially due to price increases. These were partially offset by higher production and SG&A costs. The outlook for 2023 looks good with revenue growth and operating margin improvement. Deere has always been shareholder-friendly by paying a growing dividend in conjunction with share repurchases. These share repurchases further increase the dividend per share and provide a tax-efficient way to return cash to shareholders. Over the past 4 years, more cash has been paid out than has been generated in free cash flow, so net debt has increased considerably. However, this is not yet a problem because of the high interest coverage. But this does mean that their share buyback program is not sustainable in the long run. Taking a closer look at equity valuations, we see a favorable picture both historically and in the near future. The projected PE ratio for 2023 is only 12.8, making it an attractive investment at this price level, provided growth is delivered. However, the Federal Reserve expects a recession at the end of this year, and we see in analyst forecasts that earnings growth for Deere beyond 2023 is moderate. All in all, the stock remains attractively valued. Growth in sales and earnings, improved profit margins, attractive growing dividend and stock valuation make Deere an interesting long-term buy.
This article was written by
Analyst’s 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.
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