Deere & Company (DE, Financial), which manufactures and distributes agriculture and turf, and construction and forestry equipment worldwide, is a long-term value creator in my opinion. This article will discuss the key growth drivers for Deere & Company, which also pays a dividend of $2.4 per share on an annual basis.
In the last few articles, I have discussed companies like Walmart (WMT) and Caterpillar (CAT) with a view that these companies are not high growth, but dividend investments. I hold the same view for Deere & Company, and I consider the stock as a dividend stock even when the company’s growth can be strong in emerging markets. In current market conditions, Deere & Company has witnessed sharp decline in revenue, but I consider this phase as temporary and a buying opportunity for long-term investors.
My view that Deere & Company is a quality dividend stock is backed by the fact that the company has increased quarterly dividends from $0.3 per share in 2011 to $0.6 per share currently. In addition, Deere & Company has repurchased shares worth $7.9 billion in the five year period from 2010-14. For YTD15, the company has already repurchased shares worth $1.2 billion. However, to maintain or increase dividends and to accelerate share repurchase, Deere & Company needs to generate strong cash flows and this article will discuss the revenue and cash flow drivers for the coming years.
One of the key growth strategies for the company is to increase revenue share from outside US and Canada, and I believe that this is important for company’s revenue and cash flow growth. By 2018, Deere & Company targets 50% revenue outside US and Canada.
I see China and India as the key growth market for Deere & Company in the next five years. In China, the agriculture sector makes up for 9% of the GDP as compared to just 2% of GDP in EU28. With the Chinese government providing 108 billion remnibi in equipment subsidy in 2014 and a total of 169 billion remnibi in agriculture subsidy for the same year, there is a big market for Deere & Company in China.
Similarly, the agriculture sector in India constitutes 18% of the GDP and there is a big need for development in this sector. India’s agriculture yield is still half of that in China and Deere & Company can provide much needed technology and equipments to boost yields. The Indian government has also provided 1,830 billion rupee in agriculture subsidy in 2014 and this indicates the big market potential for Deere & Company in the next 5 years.
Besides China and India, I am also bullish on Brazil where the agriculture sector constitutes 6% of the GDP and the Brazilian government also provides significant support for the agriculture sector. With these high growth markets, Deere & Company can sustain strong cash flows and dividends.
It is also important to realize that the global population is trending higher and is expected to touch 9 billion by 2050 from 7 billion currently. This will result in continued demand for agricultural commodities and the sector will continue to grow at a decent pace in the coming decades. While the sector has witnessed near-term setback, I see long-term prospects for the agriculture sector as bright. Even for the United States, the farm balance sheet is strong with high farm equity and this will allow the sector to leverage and grow at a robust pace to meet the demands. In addition, US corn is being used as ethanol fuel and that increases the demand further.
Another point that I like about Deere & Company is that research and development related investment has been strong. As of 2014, R&D as a percentage of net sales was nearly 4.5%, and this is translating into new products and technology to overcome the challenges faced by the agriculture industry.
From a valuation perspective, Deere & Company is trading at FY16 PE of 17.9. Valuations are not expensive, but I would like to see some strength in global sales in the coming quarters. However, even with the current sales trend, Deere & Company can be considered for stable dividends and value creation through share repurchase. The company has significant debt, but I don’t see that as a concern as the company’s senior long-term rating with S&P and Moody’s is A and A2 respectively.
