Deere & Co.'s (DE, Financial) more than 11% year-over-year return is admirable, considering the security endured a substantial bear market. Moreover, Deere outperformed most industrial stocks in the past year, indicating its resilience throughout the economic cycle.
Although Deere has already realized substantial index-relative returns in the past year, key variables indicate the stock could soon reach new heights.
Morgan Stanley's bullish call on machinery
Starting with a top-down analysis, Morgan Stanley recently upgraded its outlook on the machinery industry.
Morgan Stanley claims its fundamental analysis guides it toward a bullish outlook for machinery. However, the investment bank urges investors not to throw caution to the wind as it remains wary of a recession.
The bank's research team published a note over the Christmas holiday, which said: "While our fundamental work implies a more bullish backdrop for the bulk of our coverage, we are not ignoring the potential risk of a recession and still see pockets of excess with our end market exposures."
Even though Morgan Stanley's argument yields substance, investors need to pay attention to a critical variable, which the bank failed to mention, namely income statement depletion within the primary sector. A relative number of construction, forestry and farming companies' retained earnings are compressed after last year's inflationary pressure. Therefore, various asset-heavy enterprises are unlikely to enter a renewed investment cycle for the time being.
Agricultural equipment sales increased in December
An additional industry-specific component to consider is product sales momentum.
According to the Association of Equipment Manufacturers, North American sales of large agricultural equipment rose by 4% in December. Even though demand for row crop tractors waned during the month, products such as four-wheel drive tractors and self-propelled combines remain in peak demand.
Due to its substantial cross-segment market share, Deere's product range could benefit from sustained systemic support.
Strong fourth-quarter earnings report
Despite various macroeconomic headwinds, Deere's fourth-quarter earnings report asserted dominance with a revenue beat worth $891.84 million. In addition, the machinery giant posted earnings per share of $7.75, topping estimates by 64 cents.
The company's fourth-quarter net sales grew by an astonishing 35% year over year. Equipment accounted for approximately 93.5% of the top line for the three-month period, while concurrently contributing an 18.5% net margin for the full year.
As for Deere's per-segment results, the production and precision agricultural business recorded illustrious growth of 59% year over year. Critically, the segment was supported by higher production rates, inventory clear-outs and higher sales prices.
Further, the company's small agriculture and turf segment experienced 26% net sales growth. The primary drivers behind the unit's success were improved price realization and higher shipping volumes. Although the segment's retrospective results are robust, there is room for improvement as non-core items such as higher currency impacts phased out much of the segment's fourth-quarter success, which is unlikely to reoccur.
Finally, Deere's construction and forestry segment also posted substantial numbers, with a 20% increase in net sales. As with the company's other segments, the business received support from higher prices and smoother shipping. However, the division's margins were impacted by Russian inventory obsolescence.
Collectively, Deere's revenue mix remains in great shape, and its 10% recurring revenue target is not out of the question. The company expects another robust year, stating that it "is looking forward to another strong year in 2023 based on positive farm fundamentals and fleet dynamics as well as an increased investment in infrastructure."
Total return prospects
At face value, Deere's stock is deemed overvalued with a price-book ratio of 6.81 and a price-earnings multiple of 18.04. However, its elevated multiples are not a reason for concern as most low-beta, low-volatility stocks exhibit higher-than-average price ratios. Moreover, its price-earnings ratio is accommodated by a PEG ratio of 0.93, which indicats the company's earnings per share growth is intact, thus justifying a higher price-earnings ratio.
Deere's stock does not present a clear value gap. Instead, the security provides potential for sustained price returns in line with gross domestic product growth.
In terms of carry returns, Deere's forward dividend yield of 1.15% supplies investors with additional incentive as it adds a welcoming layer to the stock's potential price returns. Moreover, the three-year average share buyback ratio of 1.6 suggests the company rewards its investors with best-in-class stock-based compensation.
Guru trades
Although gurus have yet to partake in 2023, GuruFocus data indicates several Wall Street whales turned bullish on Deere's stock toward the back end of last year. Notably, 13F filings show legendary investor Ray Dalio (Trades, Portfolio)'s Bridgewater Associates added 19,350 shares to its position during the third quarter.
Investors should be aware 13F filings do not give a complete picture of a firm’s holdings as the reports only include its positions in U.S. stocks and American depository receipts, but they can still provide valuable information. Further, the reports only reflect trades and holdings as of the most-recent portfolio filing date, which may or may not be held by the reporting firm today or even when this article was published.
Concluding thoughts
Deere's stock is in great condition. The company's fourth-quarter earnings report displayed operational prowess, which led to robust year-over-year growth. Furthermore, the stock has promising total return prospects, backed by some of Wall Street's finest investors.
