Deere and Co (DE)

[Enterprising Investor]

Deere Should Reap Harvest in Due Time (2/19/15)

Forward Earnings Expectations Could Be Too Pessimistic

On the American farm, the boom is a distant memory. For Deere & Co., the duration of the bust is what matters now.

The U.S. Department of Agriculture on Tuesday said net farm income is expected to fall by 32% in 2015 to $73.5 billion. That would mark the second consecutive year of double-digit declines. Plunging receipts from corn, hogs, and dairy products are to blame.

Since farm incomes correlate strongly with Deere’s bottom line, that is potentially bad news for shareholders. In fiscal 2014, more than 80% of the equipment maker’s revenue came from its agriculture-and-turf division.

In November, the company forecast equipment sales would fall by 15% in fiscal 2015 versus the prior year, and by 21% in its first fiscal quarter ended January. Additionally, management slowed production by as much as 55% in some large equipment factories in the fourth quarter, compressing margins. And the stronger dollar will take a toll. Analysts surveyed by FactSet expect Deere on Friday to report fiscal first-quarter earnings per share of 83 cents versus $1.81 a year ago.

More worrisome is the consensus view that sales and earnings will keep falling into fiscal 2016. That could leave Deere in an already deep rut: over the past three years the stock has lagged behind the S&P 500 by 44 percentage points.

But when it comes to Deere’s future, history may provide comfort. Since 1980, net farm income has fallen by 20% or more on six occasions, by an average of 31.7%. In the year immediately following those declines, income snapped back by an average of 51.25%. What’s more, net farm incomes haven’t fallen for three consecutive years since the 1970s. So there is some hope 2016 could see an improvement.

In that case, forward earnings expectations could prove too pessimistic, and Deere’s multiple at nearly 17 times wouldn’t prove as rich as it would otherwise seem. Indeed, the idea a turn may be coming was reinforced by the disclosure this week that Berkshire Hathaway has purchased a 4.9% stake in the company.

With cyclical companies like Deere, the trick is to get in when the seeds of a rebound are being planted, not to wait until it is harvest time.

http://www.wsj.com/articles/deere-should-reap-harvest-in-due-time-ahead-of-the-tape-1424370310