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Ishan Majumdar
Ishan Majumdar
Articles (62) 

Deere & Co. Might Not Be Worth Your Money

Despite a weakened outlook, the agricultural equipment manufacturer’s stock continues to be pricey

December 05, 2019 | About:

The year 2019 has been fairly kind to investors of the agricultural U.S. machinery sector. While the U.S.-China trade war had an adverse impact on the demand for U.S. agricultural commodities in the Chinese market, there was little impact on the stock prices of most of the equipment manufacturers supplying to these very U.S. farms. Most companies have a positive year-to-date performance, including Deere & Co. (NYSE:DE), one of the oldest players in this space since 1837. The Illinois-based manufacturer was recently in the news when its stock price witnessed a slump after the management projected a weak outlook. At its current price level, it is interesting to analyze whether Deere has any steam left for investors.

Strong results, but a weak outlook caused by the agricultural slowdown

Deere delivered solid results in terms of revenues as well as earnings, beating analyst estimates on both counts. The company reported a top-line of $8.7 billion, which was well above the analyst consensus estimate of $8.47 billion and was largely driven by its Construction & Forestry division. The division generated sales of $2.9 billion and grew 8% compared to the previous year. Agriculture and Turf equipment, Deere’s core business which has largely been struggling due to the trade war as well as weather issues, managed a 3% growth resulting from retail sales. In terms of the bottom-line, the company reported earnings per share of $2.14, marginally above the analyst estimates of $2.13, but its operating margin has definitely been hit as a result of the trade war.

In light of political uncertainty, Deere’s management adopted a highly prudent approach while delivering its future outlook. They forecasted their net income for the coming year to be around $3.1 billion, lower than their 2019 number. This guidance shocked the analyst community, which was expecting a level of $3.46 billion. Ironically, the $3.1 billion of net income will also be achieved after continuing cost-cutting efforts and the implementation of the company’s voluntary separation program for some employees, which should result in annual cost savings of about $150 million. Clearly the management is not very optimistic about the market situation.

Slowdown in the agriculture and turf equipment division

The biggest problem that Deere is facing today is with respect to its Agriculture and Turf equipment division, which is gradually slowing down. This is a problem because the division accounts for more than half of its top-line. While the division did manage to show a 3% year-on-year growth in the recent result, the economic slowdown resulting from the trade war has undoubtedly had an adverse impact on the demand for Deere’s products, incluidng  tractors, sugarcane harvesters and loaders. The rising production costs and the declining margins of this division are a direct result of the trade war.

After the recent trade deal, China has agreed to purchase a limited number of agricultural products from the U.S., which is a ray of hope for Deere. The biggest hope for the company would probably arise from Trump providing incentives to the agricultural sector as an impetus to deal with the aftermath of the trade war, but that is probably wishful thinking. This is the reason why CEO John May has provided for highly conservative guidance.

Deere is expensive and probably not worth it

Even after its recent slump, Deere is not a cheap stock today. While the stock price may have doubled over 5 years, it is currently trading above the Peter Lynch fair value. The stock trades at an enterprise value-to-revenue multiple of 2.35 and a price-earnings ratio of 16.29, which is certainly on the higher side for a capital goods manufacturing company. One may attribute this high valuation to the financial strength of Deere manifested by its operating margin of 10.41% and its strong Piotroski F-score of 7. However, the high debt levels and the huge amount of gearing must be taken into account while analyzing the inherent risk associated with investing in Deere.

Today, in order to generate its huge return on equity of 27.95%, the management has piled up a large amount of debt. Deere’s Debt-to-EBITDA ratio of 7.42 is very high, and it its Altman Z-score of 1.62 puts it in the distress zone. High capital gearing, a slowing agricultural sector and a generally overvalued stock imply that there are a fair amount of risks associated with the Deere.

Key takeaways

Deere has a number of factors going against it. The company is highly leveraged, overvalued and slowing down in its core Agriculture and Turf segment. Moreover, gurus like Joel Greenblatt (Trades, Portfolio) have already sold off their stake in the company earlier this year, whereas other gurus, including Mario Gabelli (Trades, Portfolio), have also been consistently reducing exposure to the company. Analysts at the Bank of America Merrill Lynch have downgraded the stock twice in the past three weeks from “Buy” to “Neutral” to an “Underperform” rating. Given all these considerations, it seems best for prudent investors to avoid this stock, at least until there is some form of recovery in its core business and some correction in its value.

Disclosure: No positions.

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About the author:

Ishan Majumdar
I am a qualified chartered accountant with a masters in management (Grande Ecole) from HEC Paris. I run a proprietary boutique financial advisory firm called Baptista Research specializing in research and valuation of listed companies.

I have over six years' experience spread across investment banks, financial advisory firms, investment funds and other corporates in many different geographies, such as France, Spain, India and others. I was a part of the LBO Financing team at BNP Paribas where I worked on deals with a combined enterprise value of over $1 billion. I have also worked in mergers and acquisitions with Credit Agricole CIB and corporate strategy with Groupe Danone SA. Over the years, I have developed a strong specialization in corporate valuations, strategy and financial analysis.

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