Deere & Co. (DE) has a legendary place in the history of U.S. agriculture. From its humble beginnings in the early 1800s as a business dedicated to “blacksmithing, plowmaking and all things thereto”, it has developed into the world’s largest manufacturer of farm equipment, with more than $33.5 billion in sales during fiscal 2012 (all years end on October 31st). While most of the company’s revenues and profits still come from the U.S. and Canada, the biggest catalyst going forward is likely to be growing overseas demand for agricultural output in relatively new markets.
The company divides its business into three main segments. The agriculture and turf unit, which accounts for the vast majority of the company’s operating profits, manufactures and distributes agricultural equipment such as tractors, loaders, combines, corn pickers, and cotton and sugarcane harvesters. It also makes turf equipment, such as riding lawn equipment and walk-behind mowers, golf course, commercial mowing, and irrigation equipment. The construction and forestry division manufactures and distributes machines and service parts used in construction, earthmoving, materials handling, and timber harvesting. Meanwhile the financial services business finances equipment sales and leases by John Deere dealers.
Deere’s fortunes have traditionally been closely linked to those of the U.S. farm sector, and by that measure, recent years have been plentiful. Cash receipts at U.S. farms are at all-time highs, having nearly doubled over the past 10 years, as agricultural commodity prices have experienced a long rally. U.S. farm balance sheets are in strong shape as well, and with farm-equity booming in recent years, debt-to-equity ratios are set to reach the lowest levels in decades in 2013. This has left farmers in a stronger position to make large equipment purchases than at any time in recent years.
As a result of the strengthening agriculture sector, Deere has posted impressive growth numbers over the past 10 years. Earnings rose at a 25% annualized clip over this extended period, while cash flow rose at an 18% yearly rate. The company has a long history of putting this cash flow to investors’ benefit, as the dividend has increased at a 13% compound annual growth rate over the past decade, while the share count has declined steadily due to an aggressive share buyback program.
Further, the balance sheet is strong. At the end of fiscal 2012, the company had over $5 billion in cash assets on hand. While it carries a sizeable debt load, including $5.4 billion of long-term debt, the burden can be easily sustained, due to low interest rates and strong earnings.
Deere has adopted a strategy to capitalize on these trends. The company has set ambitious sales goals (including a target of $50 billion in revenue by 2018), which will require substantial capital investment. To this end, over the past two years Deere has announced plans to build seven factories in developing markets. For example, it is building facilities for the production of construction equipment, engines and large farm machinery in China. Another two construction-equipment factories are being built in Brazil, a farm tractor manufacturing site is being developed in India, and finally, a facility is being constructed in Russia for seeding, tillage, and application equipment. With most of these sites set to begin production in fiscal 2013 or 2014, the company’s presence in emerging-markets is set to bloom. The farm equipment maker company has set up new parts centers and finance operations around the world in the past year, as well.
The outlook for fiscal 2013 indicates moderate growth for the agriculture and turf segment. Relatively high commodity prices and strong farm income are expected to continue supporting demand for farm machinery. Demand also should be pushed by global expansion. However, while sales in South America are forecast to rise due to favorable commodity prices and aggressive planting intentions, momentum in Asia is set to slow as India and China face more challenging economic conditions than some had previously expected. Construction and forestry, on the other hand, is expected to be a strong contributor to growth, with sales forecast to rise significantly due to the slow improvement in U.S. economic conditions. The financial services segment is expected to get a boost from an expanding credit portfolio and lower crop insurance claims (which have been elevated in recent years due to drought conditions).
The stock’s rise from $24.50 a share at their trough during the last boom market in 2008 and 2009, to almost $90 now, raises concerns that the shares may be getting more richly capitalized. However, on a P/E ratio basis, the valuation seems reasonable as they carry a forward P/E of about 11, which is significantly below the Value Line median. However, this measure is based on peak earnings, which have skyrocketed in recent years. Thus, the shares may be vulnerable to short-term reversals in fortunes in agricultural commodities prices.
It is widely estimated that by 2050, global agricultural output will need to approximately double to meet demand, largely because of increased demand in emerging markets. With the top brand name in farming equipment, the company is well positioned reap the benefits. Further, migration from rural regions to cities, which is continuing across the developing world, will drive demand for more mechanized farming methods, as manual labor becomes scarce and productivity growth becomes vital to the farming sector.
Urbanization and economic development will likely lead to greater infrastructure spending as well, which could bolster the company’s construction and forestry segment going forward. However, in that area, Caterpillar (CAT - Free Caterpillar Stock Report) poses stiff competition, and Deere’s biggest gains should come in agriculture, where the John Deere brand name still rules the roost.
Overall, Deere & Co. presents an opportunity for investors to take ownership of one of the world’s strongest brand names, and a competitive advantage in its core business of agricultural equipment. Global trends look set to reward such qualities in the long term. However, we don’t foresee the company increasing its sales and earnings at the same staggering rates as in the last 10 years, and we see this equity as more of a steady, long-term growth opportunity.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.