The Rising Influence of Rising Affluence

[DewDiligence]

Barron’s Is Bullish on Deere

[See #msg-61382266 and #msg-60344244 for related info.]

http://online.barrons.com/article/SB50001424053111904646704577293782368622246.html

›‘Big Green’ Finds Fertile Fields Abroad - Deere, maker of heavy equipment for agriculture, forestry and construction, has put up seven straight quarters of record earnings. Underwhelmed investors need to rethink…

MARCH 24, 2012
By ROBIN GOLDWYN BLUMENTHAL

Deere, the storied agriculture-equipment company, would seem to have it all—even a country-music song, called "John Deere Green," that refers to the company's brightly colored tractors and combines.

The world's largest maker of farm machinery, with fast-growing construction and forestry units, Deere has put up seven straight quarters of record earnings, and has substantial growth on the horizon. It trades at a price/earnings ratio 25% below the broad market's, and has been increasing its dividend at a 14% annual rate for five years. The company (ticker: DE) is expanding in all the right global markets, both in agriculture and construction, while maintaining its dominant share in U.S. farm equipment. And its single-A credit rating makes it easy for Deere to fund its financing arm, which accounts for about 7% of revenue. Perhaps the one thing it lacks is recognition from Wall Street.

Deere is "the Rodney Dangerfield of the Big Board," says Scott Black, portfolio manager at Delphi and a Barron's Roundtable member who recommended the stock earlier this year. Although U.S. farm income, a key driver of equipment purchases, appears to have peaked, it's still elevated compared with the 10-year average. Corn and soybean prices are trading well above farmers' break-even levels, and Deere's own estimates of these commodity prices are "significantly understated," according to T. Jerry Harris, chief investment strategist at Sterne Agee Asset Management of Birmingham, Ala. He likes the stock around its recent level in the low 80s: "People underestimate the stable part of the business—North American farm equipment, where Deere holds a nearly 50% share—and fail to focus enough on the emerging-market growth." He notes that the huge profit margins farmers have been experiencing "give them lots and lots of room to buy farm equipment from John Deere."

Management is upbeat. "Our business remains very strong, especially in large agriculture equipment products tied to corn and soybeans," Samuel Allen, chairman and CEO, recently told Barron's. He notes that when farmers are making healthy returns, they tend to flip their fleets more frequently and buy extended warranties and the like. Another indicator of strong demand: used-equipment prices continue to rise.

As a cyclical company, Deere is targeting midcycle growth in both agricultural and turf (lawn-equipment) sales, which represent about 75% of revenue, and construction and forestry, which contribute 17%, at a compound annual rate of 9.2%. That's up from the historical 7% midcycle growth. In the fiscal year ended Oct. 31, it posted a 52% increase in earnings per share, to $6.63, on revenue of $32 billion, up 23% from the previous year. Sales were driven by a 21% jump in agriculture and turf and a blistering 45% in construction and forestry. In February, after it reported record results for its fiscal first quarter, Deere raised its forecast for construction and forestry sales growth this year by two percentage points, to 18%, while maintaining its agriculture and turf sales forecast at 15%, despite a bigger bite from unfavorable currency translations. It also raised its forecast for net income by $75 million, to $3.275 billion.

Allen, who took the helm in 2009 after 34 years at the company, sees significant growth opportunities in agriculture and construction in South America, particularly Brazil, as well as in Central Europe and Russia, which holds 9% of the world's arable land and thus is "very conducive" to Deere's large tractors and combines. China, a highly fragmented market where Delphi's Black says no one holds more than a 3% share, will be important for both agriculture and construction equipment, as will India, where Deere already has a construction-equipment joint venture. In the past year, Deere has unveiled plans to build seven plants around the world [#msg-70823464, #msg-63527907, #msg-63258547, #msg-60841789].

That isn't to say that North America, which accounted for 60% of Deere's revenue and 75% of its profit in 2011, and other developed markets won't remain key drivers. Allen says there's plenty of room for expansion in Europe, where Deere hasn't achieved the dominance it has in the U.S. Happily, the market for Deere's large-scale equipment is in Europe's stronger economies, like Germany, France and Britain. Black says that although U.S.-made cars are rarely in evidence in Europe, he's spotted "plenty of Deere equipment" with the familiar green and yellow colors on a trek through France's farm country.

Because of its cyclicality, Deere's multiple of 9.4 times next year's earnings estimates of $8.52 a share is depressed during peak earnings years. But Black notes that even assigning a lower-than-market multiple of 12 to Deere, its shares could rise more than 20% to $100 in 12 months. And the big manufacturer has a 2.3% dividend yield; competitors AGCO (AGCO) and CNH Global (CNH) don't have payouts. Black notes that Deere has almost finished converting its engines to mandated tighter emissions standards [so-called Tier 4]. Thus, it will be able to reclaim some margin losses attributable to the upgrades. The company also has been steadily buying back shares, and still has $3.7 billion to spend on repurchases from a 2008 authorization.

Agricultural output will have to double by 2050 to feed the world and to satisfy increasing demands for grain-fed animals. CEO Allen, who is seeking midcycle sales of $50 billion by 2018 [#msg-60344244], believes pressures for greater farm productivity will be a key driver of growth. Deere has already developed its own system for transmitting real-time data from working tractors to its engineers and to its vast network of dealers, who can monitor servicing needs. Indeed, Deere is trying to duplicate in both Europe and Brazil its North American network of nearly 500 independent dealers.

Deere is comfortingly conservative about its estimates. In the latest quarter, losses on its credit portfolio totaled a breathtakingly low 2/100ths of a percentage point. Allen says that farmers—who "can't go away" and can't afford to see their equipment repossessed—are "some of the best credit risks in the world."

That could apply to Deere, too. Investors who take a chance on it are likely to become familiar with all sorts of green.‹