Deere & Co's (DE, Financial) stock is vastly underappreciated at the moment, in my opinion. I believe that large shifts in near and short-term agricultural activity could send Deere into a new paradigm. Sure, supply chain congestion is a concern, as is eroding consumer spending power. The stock is also pricey compared to its historical valuation metrics and GF Value. Nonetheless, Deere has all the makings of an attractive investment opportunity; here's why I think so.
Deere's strategy
Deere is well-placed in the market because the company possesses a stronghold in the farming equipment industry, which is ever-changing. It's forecasted that global food demand will surge by 50% between now and 2050 due to the growing population and growing wealth of emerging markets, leaving farmers responsible for meeting the demand. Thus, companies such as Deere will benefit significantly in the next few decades.
Furthermore, precision farming is entering the fray, equating to smaller land with higher yields than usual, since old industrial farming practices could never hope to meet future demand without destroying the land. This provides Deere with an opportunity to focus on autonomy and connectivity. For instance, the company launched its fully autonomous 8R Tractor this year, which allows farmers to yield excess crops at a lower cost.
Lastly, Deere will probably experience strong sales in North America, Europe and Sub-Saharan Africa in the near term. This is because of the recent spike in commodity prices that has proliferated farmers' balance sheets, in turn providing them with much purchasing power. The war in Ukraine and an ex-Russia trade infrastructure could also cause farmers of western nations to have an opportunity to fill a critical gap by expanding operations, thus increasing the demand for Deere's equipment.
Economic challenges
There's no denying that economic challenges are becoming a problem for most companies. Factors such as the war in Ukraine and China's continued attempts to fight the Covid-19 pandemic are disrupting the globe's accessibility to primary materials, work-in-progress goods and manufactured goods.
Furthermore, manufacturers are struggling with rising wage demands. For example, the United States currently has 1.9 open jobs per unemployed person. However, many aren't returning to the labor force as their wage demands aren't being met. A company being unable to raise wages in line with inflation is a bad sign, since it means its business model is unsustainable in the long-term.
Source: Bloomberg
All of the above is challenging Deere's internal operations, as can be seen by its first quarter's year-over-year net income falling by 26% and its diluted EPS by 25%.
Source: Deere & Co
Although these economic issues are present, Deere's top-line revenue is still growing. The company reported quarterly year-over-year net sales growth of 6% in February, suggesting that it's showing much resilience in a trying economy.
The economic headwinds are more related to variable cost, which I think shall pass in time, thus providing an excellent opportunity for investors to capitalize before matters take a turn for the better.
Shareholder value
Deere's cash policy suggests that it values its shareholders. The company pays between 25% to 35% in dividends on its mid-cycle earnings. This means that it looks at its average five-year earnings to base its dividend payout on as a means of accounting for industry cyclicality. Furthermore, Deere uses most of its cash to sustain an "A-Rated" balance sheet, investments in growth opportunities and share repurchases after dividends payments have been satisfied.
Source: Deere & Co
The bottom line
Deere could benefit from a powerful cash positions among primary producers as well as farmers' need to meet greater demand. Furthermore, investors need to look beyond short-term troubles as they're likely to be transitory issues. Deere is a very shareholder-driven company as well, prompting me to be bullish on its stock.
