Looking to Agricultural Equipment for Further Growth
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As sentiment on the global financial markets seems to be improving, investors are returning to cyclical stocks after a long period of risk-off behavior. In the world of cyclical, high-beta stocks, there are a number of interesting choices at the moment. An industry that I generally find promising is that of agricultural equipment, as the need to produce crops and foodstuffs is growing explosively along with our world population. Deere and Co. (NYSE: DE) is the world’s largest producer of agricultural equipment, and is currently trading at a discount to the broader market and its industry.
According to CNBC Deere trades at only 11x earnings, compared to the industry average of 16.34x. The price to book is a little high at just shy of 4, but is still lower than the industry average of 5.3. Kubota (NYSE: KUB), an important Japanese competitor, is priced at over 16x earnings, but has a more attractive price to book of 1.57. Deere and Co. has a lot of debt with a LT Debt to Equity ratio nearing 250, but has an excellent return on equity of 42.3% and a healthy 16.1% operating margin. To compare, Kubota has a return on equity of 10.1% and an operating margin of 10%. At the moment, Deere offers a 2.2% dividend yield which has been growing steadily in the last few years.
Roughly two thirds of Deere’s revenue is generated in the North American market, which is comforting for those eschewing European stocks at the moment due to turmoil in the region. The firm is seeing strong demand in its home market, as well as in South America, where the booming agro-industry requires ever more equipment to expand. The company recently announced the construction of several new factories worldwide, which should allow it to keep up with growing demand in various parts of the global economy.
Deere and Co. earnings had somehow beaten the street for a staggering 13 consecutive quarters, before a bit of a letdown in Q3, and the company has an EPS growth rate which outpaces the industry. CNH Global (NYSE: CNH), an American competitor, lags behind both Deere and the S&P in terms of EPS growth. However, looking at P/E and price to book, CNH is a little cheaper than Deere at the moment. The outlook for Deere has been adjusted downward, to a revenue growth of 13% down from 15% for Q4 2012. Still, due to its size and the advantages in efficiency resulting from cost cutting, Deere & Co should be able to stay ahead of the competition especially in the American market.
There are a number of risks for the company moving into Q4 of 2012. If the global economy continues to show signs of improvement, material costs will rise, putting pressure on the firm’s margins. Conversely, if the world economy slows down once again, the firm will have to deal with lower agricultural prices and lower demand, which will also affect profits. Also, Deere’s focus on North America does not make for a well-diversified geographical spread, which would help protect the company against slowing demand in the US.
All in all, it appears to me that Deere and Co is an interesting choice for investors who are banking on worldwide recovery and the return to cyclical stocks in the face of improved risk sentiment. The company has fairly strong earnings and is priced at a reasonable valuation at the moment. Offering a 2.22% dividend yield, the stock might be interesting in terms of income as well. Although the company faces a number of risks, and has a beta of just over 1.5, it seems well positioned to stay ahead of the competition in the near-term.
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