Deere Ploughs in the Dough
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Deere & Company (NYSE: DE), despite the release of its rather positive quarterly report, trades down nearly 2% this morning on high volume. The corporation posted a year-over-year 12% and 23% jump, respectively, in quarterly revenues and net profits, with meaningful gains across all of its divisions. Agriculture and Turf equipment sales (75+% of total) enjoyed a 10.5% revenue increase, and Construction and Forestry equipment sales (15+% of total) a 25.7% increase as compared to the same quarter in 2011. The gains follow a continuously strong performance improvement from mid-recession lows:
The huge improvement in year-over-year sales growth in 2010 quarters makes the continued double-digit growth even more impressive, and the corporation’s increase of estimates of year-end 2012 results shows that the growth is not expected to fall off anytime soon. With the continued performance improvement and the relative market inaction has created a unique value proposition on Deere stock. Although the corporation does not appear to stand out as a glaring bargain – especially when compared to other peers in the industry – its more consistent performance and higher long-term growth potential makes it a more attractive pick.
- 5 Year Sales Growth CAGR
- 5 Year EBIT Margin Average
- Deere: 14.3%
- Caterpillar: 10.8%
- Kubota: 9.7%
- CNH Global: 6.7%
- 5 Year EPS Growth CAGR
- Deere: 13.5%
- CNH Global: 13.5%
- Caterpillar: 8.3%
- Kubota: -34.4%
Several key factors will lead to continued Deere growth in both top line and overall profitability over the remainder of the 2010s.
- Worldwide Food Demand
One of the primary drivers behind the massive surge in equipment sales is the explosion in worldwide food demand and farmers’ replacement and expansion of machinery bases during the boom era. With the worldwide population expected to grow nearly 30% by 2050 to 9 billion people, gross food output needs to grow at an estimated rate of nearly 3.4% over the next ten years, at least. This compares to the past ten-year average annual growth rate in food output of 2.4% (source: Deere estimates and USDA). U.S. farmers last year, for instance, enjoyed the largest corn crop since 1937, and farmer income jumped to a record of nearly $100 billion. Although income levels are expected to dwindle slightly over the next several years, the continued elevated crop prices will continue to drive marginal spending on new equipment.
- Continued Urbanization
Alongside the increased population will come continued urbanization. More than half of the world lived in cities in 2010, the first time in history that the rate gained a majority share, and the figure will continue to gravitate towards 70+% as the population reaches 9 billion by 2050. This mass exodus to urban centers will require continued investment in construction and infrastructure, and although Deere’s division does represent a minority share of total annual revenues, it is the corporation’s fastest growing revenue stream. Construction/Forestry contribution levels to total revenues have jumped more than 625 basis points over the past ten quarters (17.7% in most recent twelve month period), and operating margins have simultaneously expanded by more than 1000 basis points. Increased infrastructure spending, especially in emerging markets, will continue to add higher margin dollars to Deere’s top line. Total international revenues (non-U.S. and Canadian-based) hit a record high of $12.75 billion in the most recent twelve-month period – which is up from $7.7 billion in 2009 – and Deere expects to hit $25 billion in international sales by 2018.
- Increased Efficiency
An investment in Deere is not a simple play on the growth in worldwide populations, however. The corporation has also showed a significant improvement in a behind-the-scenes clean up of its operations. A strategic build-up of personnel in the fastest growing machinery markets has led to growth in sales per employee of 77% between 2001 and 2011 (total worldwide employees grew 36% over same period).
Likewise, Deere has made meaningful improvements in asset efficiency – more specifically, the reduced reliance on working capital to generate marginal sales. Inventory and receivable requirements per unit of sales, as depicted, have decreased from around 34% in 2001 to 24% in the most recent fiscal year.
At the same time, the corporation’s total return on core operating assets (described in footnote) has expanded to all time highs near 12%. The corporation estimates that it has saved more than $5.5 billion in working capital investments alone between 2007 and 2011 through the restructuring of internal operations and processes, and such funds can be (and have been) put to use in higher-returning projects. Growth in international infrastructure, as opposed to idle inventory, for instance, will continue to lead to higher levels of Deere profitability.
Deere might not be the most exciting corporation in the fastest-growing of sectors, but it is set up to generate meaningful returns for investors over the long run. Programmed growth in necessary international markets – not consumer electronics, for instance, but food and infrastructure – will continue to drive the corporation’s top line, and the investment that Deere has made back into the corporation to improve efficiency will ensure that an increasing percentage of top line dollars will flow through towards the bottom of its income statements. Sometimes such less exciting, albeit consistent growth is the most attractive route towards long-term investment gains. This holds especially true when the corporation is, like Deere, cheap.
Footnote
Core Operating Assets = (Total Assets - Financial Asssets) - (Total Liabilities - Financial Liabilities). Return on Core Operating Assets = (Post Tax Operating Income / Average Core Operating Assets)
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