Despite setbacks, Deere will recover

In Investment ideas on September 23, 2016 at 1:11 pm


They say nothing runs like a Deere. Established in 1837, John Deere (NYSE: DE) is the market leader in agricultural equipment. Due to a challenging environment for farm incomes over the last few years, Deere’s sales and earnings are down. As a result, Deere shares are cheap. The Company has seen its sales trail downwards from a peak of $36.1B in 2012 to $28.8B in 2015. Due to low crop prices, farmers don’t have the money to buy new tractors and gear.

Deere generates 69% of its revenue from the sale of agricultural and turf equipment. More than half of that is in North American market. It has a dealer network that is unmatched in North America with around 1500 dealerships. This is a big competitive advantage because it means that customers who need equipment serviced can do so quickly and conveniently. I experienced this firsthand purchasing a ride-on lawnmower for a commercial property I managed in rural Nova Scotia, Canada. We chose Deere because of the local dealership’s proximity for service repair in addition to the brand’s reputation for quality. Another big competitive advantage for Deere is its large in-house financing department.

Deere enjoys high returns on equity with ROE averaging 20%+ over a 20 year period. Over the same period (1996-2015) the company never reported an operating loss in any year. The company is also remarkably shareholder friendly, returning more than 100% of owner income (CFO-capex) to shareholders in the form of dividends and share buybacks over the same 20 year period. Due to buybacks over that period, share count was reduced by 36%.

Management (CEO / CFO) have long tenure with the company as do other senor executives. And all senior managers (dozens of key people) are required to maintain large personal shareholdings in the Company, which is unusual.

Crop prices will rebound at some point in keeping with the agricultural cycle. In addition, tractors and other equipment wear out and will need to be replaced at regular intervals; thus most sales can be delayed but not entirely foregone. Also interesting, new technological advances (self-driving tractors) could mean a greater demand for next generation products.

Berkshire Hathaway bought some Deere stock ($1.7B) around $80 per share in 2015. At $84 per share, Deere has a market capitalization of $26B and around a 3% dividend yield. This price represents a 11x multiple on 5 year average EPS. Deere’s sales are expected to recover in 2020 to about $45B. At this time, EPS could be about $11/share. At 12x P/E ratio, this will result in a share price of $132. Total returns – share price appreciation plus dividends – could be 44-96% for an approximately 5-year holding period.


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