A few weeks ago, I wrote an article on how John Deere's (DE, Financial) stock was a buy. Since then, we have learned new information and changed our opinion.
It's no secret that low grain prices have been hurting the agricultural community. Many of us have been waiting for a year of inclement weather to drive grain prices higher. The great weather that we've experienced over the last few years has provided bumper crops for farmers. Bumper crops equal lower grain prices.
Farm equipment is not cheap. To get into row crop farming, you probably need to spend $1 million to $1.5 million if you want new equipment. Or you can buy used if you are mechanically inclined or want to pay the dealer for service.
Ag equipment is not like automobiles. Farmers are looking for hours of usage, not miles. A 10-year-old tractor with only a few hundred hours is worth comparatively more than a 10-year-old car with only a few thousand miles. This is because the farmer does not care about the looks of the tractor, only the functionality.
So the tractor must be able to pull the implement, and its power take off (PTO) must work. This is a spinning device on the back of the tractor that powers most implements. The PTO powers a shaft that turns the blades on a mower. On a combine, there are also usually two different grain heads. One is for corn and the other for soybeans and wheat. The heads must be purchased separately. Of course modern tractors and combines have sophisticated computers that show where to plant and harvest and can even drive the machinery.
My simplistic way of comparing hours on a tractor to miles on a car goes something like this: 1,000 hours on a tractor is about like 20,000 miles on a car. So 10,000 hours on a tractor is like 200,000 miles on a car. At that point, both the car and tractor will need major maintenance.
Upon looking at a recent heavy equipment auction at Ritchie Brothers in Kansas City, two 2013 John Deere model S680 combines with only 916 and 942 hours sold for $160,000 and $177,500. According to John Deere's website, this combine retails for $468,203. So if you are a farmer, it makes no sense to buy new. Furthermore, if you owe well over $400,000 on a $160,000 combine, you may be incentivized to allow John Deere Finance to repo your equipment. Then, go back to the auction and buy it for 40 cents on the dollar.
A second look at the same auction shows two 2014 model 829SR John Deeres with 707 hours and 742 hours that sold for $145,000 and $140,000. This is a top-of-the-line tractor with dual tires in the rear and smaller dual tires in the front. It retails for $275,576. So it's the equivalent of buying a 2-year-old car with 14,000 miles for half off.
The problem with Deere is that its balance sheet holds about $4.6 billion in cash and $34 billion in accounts receivable. Much of that accounts receivable is equipment financing. This is to $7.2 billion in accounts payable, $13.2 billion in short-term debt and $24.6 billion in long-term debt. So if you marked those receivables to market, the value would be much less than $34 billion.
This problem does not seem as if it has shown up just yet. Perhaps things will work out. Deere has already begun to cut production and shrink its inventory. Still, with the stock trading in the high $70s, it seems that it could go down much further. This is why we sold our shares. Just a week ago, I wrote about how John Deere was for the patient investor. With this new information, I've changed my outlook.
Disclosure: We do not own shares.
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