Is This Company Still a Good Buy Despite the Recent Drought?
Lior is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The recent drought that afflicted crops in the U.S and in other countries may have some adverse effect on related industries. Deere & Company (NYSE: DE), one of the leading companies in providing products and services for agriculture and forestry industries could also be affected by the recent drought. Let’s examine the recent developments in the market that could affect the company’s growth in 2012.
According to the company's financial reports for the third quarter (for the fiscal year) the company has performed well: the company's sales rose by 15% compared to the parallel quarter of 2011 and the operating profit rose by 12.6%. On the other hand, the company's profitability hasn't improved from the parallel quarter of 2011.
One of the prime factors that adversely affected the company's sales was unfavorable changes in currencies; this includes the depreciation of the US dollar against major currencies. The recent developments in Europe, including the ECB bond purchase plan that is likely to further restore confidence in the Euro, and the recent announcement of the FOMC to issue QE3, in which it will buy mortgage backed securities at $40 billion per month, are likely to further depreciate the USD in the months to follow. This could suggest that, assuming all things equal, this stimulus plan may continue to adversely affect the revenues of the company.
When comparing the performance of Deere with other similar companies such as Kubota Corporation (NYSE: KUB) and Caterpillar Inc. (NYSE: CAT), it's evident that Deere led the pack in the previous quarter in terms of operating profitability but not in the third quarter of 2012. During the third quarter, the operating profitability of the Caterpillar was slightly higher than Deere and Cummins's operating profitability. Caterpillar's profitability also rose from the second to the third quarter. The chart below shows the development in the operating profitability of all three companies in the year. This means that Deere has performed well in recent quarters in terms of profitability compared to related companies. Did this steady profitability reflect in the company's stock?
The chart below shows the developments of S&P500 index and Deere's stock during 2012. The prices are normalized to the beginning of the January 2012. It shows that Deere's stock have an unclear trend during the year while S&P500 index has risen in the past several months. Thus, S&P500 has outperformed the company's stock during the year. Further, during 2012 the linear correlation between company's stock daily changes and S&P500 index remained high and strong at nearly 0.7. This relation suggests that nearly 49% of the company's shifts, under certain assumptions, are due to the shifts in the S&P500 index.
There is also a mid-strong correlation between the price of oil and Deere's stock: during the year the linear correlation was 0.42. This relation could be via the relation oil has with the price of ethanol. Nonetheless, it could suggest that if commodities prices, including crude oil, will further rise it could affect the company's performance in the months to come.
The recent drought in the U.S, which was the worst drought in the past five decades, may have some adverse effects on agriculture so that farmers might not renew their equipment or at least impede some of their purchase plans. Despite this concern, there are reports that the recent drought won't affect sales of the company. Further, according to the U.S Department of Agriculture, the net farm income in 2012 will reach 122.2 billion in 2012, which is nearly 3.6% increase compared to 2011. Government subsidies could cover up to 85% of projected revenues. This means that despite the adverse effects of the drought on U.S crops, there seems to be little effect on farmers’ revenues. In the months to come it will become clearer if the bottom line of Deere will be affected by the drought. Keep in mind that the company's income rose by 3.6% in 2012, which is much lower than the rise in income from 2010 to 2011 – back then it hiked by 46.6%. If the company's income growth will further dwindle, it could adversely affect the company's stock.
The Foolish Bottom Line
Despite the positive reports of Deere, its growth will might be at jeopardy if the effects of the drought will affect the growth in revenues of farmers who are among the company’s top consumers. There are other perils the company may face in the near future including forex related shifts that could further adversely affect the company’s revenues.
For further Reading see: Is Chesapeake walking towards the right path?
Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.
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