Story URL: http://news.medill.northwestern.edu/chicago/news.aspx?id=221107
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Jordan Monroe Schultz/MEDILL/Data from University of Illinois (corn) and Yahoo Finance (stock price)

Deere's stock price performs in line with the rise and fall of corn prices.


Deere's profit will grow, but for how long?

by Jordan Monroe Schultz
May 7, 2013


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Jordan M. Schultz/MEDILL

Deere's net income has popped nearly 64 percent since 2010.

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Jordan M. Schultz/MEDILL

Deere's sales have increased 54 percent since 2009.

Deere & Co. and its analysts agree that the farm equipment giant will post big earnings for the year ending in October. However, the analysts worry that the rise in commodity prices that's fueling those earnings will peak this year, ending Deere's ascent. 

The world's leading maker of farm implements has performed particularly well in the past few years. Sales have soared 54 percent since 2009, to $33.5 billion in fiscal year 2012 from $20.8 billion. In the same period net income has grown an astronomical 251 percent to $3.1 billion, or $7.63 per diluted share, from $874 million, or $2.06 per diluted share.

Shares have popped 159 percent, zooming to $85.03 in April from $32.87 in 2009. The dividend is $2.04 per share.

Due to strong first-quarter performance, the East Moline manufacturer boosted its fiscal 2013 profit guidance 6 percent to $3.3 billion from $3.1 billion. Analysts are estimating $8.54 per diluted share for the year, up 91 cents from the firm’s actual fiscal 2012 earnings.

Despite this success, analysts such as Andrew Casey of Wells Fargo, who has an underperform rating on Deere, are growing increasingly bearish on the company and other agro-manufacturers. Casey said he fears that commodity prices have already peaked and will begin to decline.

For instance, corn futures were $7.13 per bushel in March compared with a year-ago $6.35.

“Our view is that commodity prices likely decline from current levels due to a return to more normal growing conditions and moderating corn-based ethanol consumption growth in the U.S.,” Casey explained in a report.

These factors will put downward pressure on farm equipment demand in 2014 and 2015, Casey said. “Looking past 2013, we now expect U.S. large farm equipment to decrease on average 15-20 percent in 2014 and 20-25 percent in 2015 due to anticipated declines in farmer cash flows.”

Casey expects a share valuation between $72 and $75 in the next 12-18 months, down from his previously expected range of $90 to $93. Historically, “DE’s stock price tends to be influenced by corn prices, which we expect will decline in an anticipated mean reversion crop and an exit from a once-every-30-year price spike,” he said.

Casey said he's also concerned that increasingly-stringent emissions regulations will reduce profitability.

Despite Casey’s forecast, Deere anticipates revenue growth primarily in South America due to continued commodity price strength and higher planting intentions. The company expects North American sales to flatten due to concerns about United States livestock and dairy sectors. Sales in Asia are expected to remain consistent with 2012 levels due to softening economies in China and India. Still, North American markets still make up 62 percent of total sales.

European prospects are grim in this sector. Deere predicts a 0 to 5 percent revenue reduction due to an overall weakening of the regional economy and a poor harvest in the United Kingdom.

In the construction and forestry sector, Deere expects that an accelerating American economy will drive an 8 percent sales increase despite flatlining global sales resulting from European weakness.

Finally, the company expects to earn $500 million in net income from its financial services sectors in light of a growing credit portfolio and a reduction in crop insurance claims.

While Casey is the only analyst who has a sell rating on Deere, others, such as Lawrence De Maria of William Blair & Co., have doubts, too. 

De Maria, while rating the stock market-perform, is still concerned about global economic conditions.

Although De Maria said commodity prices have yet to peak, he said it's likely that 2013 will mark the top of North America’s farm equipment cycle. But he believes Deere’s reputation should allow the Moline manufacturer to push past any possible market pitfalls, he said in a report.

Unlike Casey, De Maria says any market downturn in the farm equipment sector, which makes up 89 percent of Deere's operating profits, will not exhibit the same “peak-to-trough” moves seen in other slipping markets such as mining, trucking and construction--industries that are much smaller components of Deere’s business.

While an uncertain trajectory in agro-manufacturing is concerning, “volumes may continue at high levels,” DeMaria said. “Food demand isn’t going anywhere.”

William Blair & Co. applauds Deere’s combine sales. Industry-wide, combine sales grew 67 percent in March compared with a year ago, according to Deere. The firm’s combine sales rose more than 100 percent. Industry inventories remain strong and, given resilient crop prices, equipment sales should not wane, De Maria explained.

Additionally, the analyst said he believes that Brazil remains a bullish agro-equipment market. Brazilian farmers continue to pick up slack from lagging U.S. production associated with last year’s drought. With successes in South America, Deere raised its 2013 farm machinery sales outlook to between 10 and 15 percent, up from 10 percent in a previous guidance, in the region.

“Given Deere’s leading market position, prominent brand name, industry-best margins, shareholder friendly capital allocation and high return-on-invested-capital, we believe a premium multiple is warranted,” Blair stated in a report.

Blair awarded Deere an 11 times earnings multiple on its fiscal year 2013 $8.50 per share estimate, which equates to $95 per share. De Maria believes the company will perform similarly in 2014.

The current price-to-earnings ratio is 11.46, a surprisingly low figure for a steady company. “Since grain prices are probably at peak levels this year,” De Maria explained in an interview, “cyclicals like this one exhibit lower multiples at the top of the peak.”

During a record-breaking fiscal 2012, while earning $3.1 billion, Deere announced factory expansions in China, India and Brazil. In the U.S., the company announced capacity expansion for products such as sprayers and cylinders, and a $70 million investment to increase its Waterloo, Iowa plant’s production of tractors by 10 percent.

With these new initiatives, the company remains positive: “We’re confident our investment in new products and additional capacity will help Deere fully capitalize on the world’s growing need for food, shelter and infrastructure in the years ahead,” CEO Samuel R. Allen said in a conference call.

At the same time, Deere isn't obvlivious to market challenges: “The near-term outlook is being tempered by uncertainties over fiscal, economic and trade issues that are undermining business confidence and restraining growth,” Allen said.

Despite analyst concerns, Deere expects commodity prices and, in turn, farm incomes to remain strong throughout 2013. As such, the agro-manufacturer expects its agriculture and turf sector to increase 4 percent globally.

With expected growth, Deere is looking forward to a prosperous fiscal year 2013: “We are proud of the company’s performance in 2012 and look forward to building on these gains in 2013 and beyond,” Allen said. “Despite fragile economic conditions in many regions, we have great confidence in the company’s prospects and in our ability to deliver value to investors and other stakeholders in the future.”