The Temporary Lull in John Deere Stock

John is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

There is no doubt that John Deere (NYSE: DE) is a strong global company that is doing well and will continue to do well long term. But it has not done so well since mid February when it peaked around 88 and presently trades around 80. We expect the company will be a good long term buy but in the short term we do not expect the downward trend to stop just yet. It is possible to see the stock touch bottom between (73-76) before it moves up again. The reason for this may be higher production.

Samuel Allen, Deere's chairman and CEO, said:

"Our business remains very strong, especially in large agriculture equipment products tied to corn and soybeans."

Another company in the same boat is Argo (NASDAQ: ARII). They were on a roll in 2011 with farmer's incomes hitting record highs. Yes presently they are in a downward trend just like John Deere. The company beat its fourth quarter estimates by 8.3% Sales rose 16.1% in the fourth quarter to $2.5 billion from $2.2 billion a year ago. Sales for the full year, excluding favorable currency translation of 5%, rose 22.2%, a new record. Those are impressive numbers. So why is the stock down 20% from its highs in February?

There are a couple factors in play right now that may have influenced both stock prices, even temporarily.

While prices for soybean and corn may have meant higher profits for farmers and investment in new equipment, 2012 is not looking the same. Let’s take corn as an example.

We had a warm and fairly dry winter season this year and this usually pans out to an early planting season and better yields. Corn planting is early so equipment is bought early. But—crop product was down in 2011 so we saw record highs. As we return to a more normal crop production, that means lower prices for corn. So there may be an increase in production, but the lower prices means no real increase in crop revenue for the year.

Not only will production pick up to create a lower priced crop, but production costs are expected to increase possibly as high as (15%-20%) between fertilizer, fuel, and cash rents. What does this mean? Net returns or profits from farm lands will also drop. Even a decline from record high levels means a decline. 

And this is how Wall street looks at it. Even though relative incomes are as strong as they have been over the last decade, a decline is a decline. And that means less equipment will be bought. Not only that, but it appears U.S. farm income, a key driver of equipment purchases, may have have peaked.

One would think that higher production means buying more equipment.  This is partly true. It also means reduced crop costs even though production costs are increasing. And since farmer’s income has peaked already, that would mean buying equipment would also begin to slow down. Even if this is cyclical, it still means a slow down. This could be the reason for a temporary lull in John Deere stock. 

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