A Love Letter That Tells You Why This Stock’s Good, but Expensive

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

Since I chanced upon that old dusty box of pen pal notes dating back to my college days last week, my hands have been itching to write a letter. When tractor king John Deere (NYSE: DE) popped last week, I thought -- why not write it one to express my love, and congratulate it on its superb run? Over to you Deere.

Dear Deere,

I’m going to skip the customary how are you doings, because I know you are doing just fine! I actually wanted to thank you for being such a good stock.

When I bumped into you some five months back, you looked quite pale at around $74. But I wanted to see the glow back on your face (remember the CAPS Call I gifted you at $74.45); and oh, how handsome you look today near $94!

Marvelous, how you managed it despite the less-than-upbeat outlook you held out for 2013 last quarter. Psst…is it the Berkshire effect? Or perhaps Mr. Market feels you under-estimate your own capabilities.

Really, why do you expect to sell just 4% more agricultural equipment this year?  You rule the North American market, and everyone’s betting on record plantations again this spring as prices of essential crops soar. Did you check out seed bunny Monsanto’s (NYSE: MON) latest outlook? It sees 96 million acres getting sown this year. I know the drought was hard on you, but with crop insurance payouts getting doled out fast and heavy, I think you could do better.  You can easily play up with the huge line-up of products launched last year; and of course, there are other markets like Latin America to keep you growing.

But I must admit, I was pretty surprised to see your share of sales from outside the U.S. and Canada dip 4 percentage points to 38% last year. I hope you make it up this year, because outside markets are driving many to new highs. Heard how AGCO (NYSE: AGCO) is pumping $100 million in Africa? Though it seems to be a pretty bold choice, it takes the company to a great unexploited frontier.  AGCO already dominates the Brazilian tractor market, and derives more revenue from Latin America and Asia-Pacific combined than it does from North America.

Hey, don’t get upset, I remember you told me about your aim to get 50% sales from overseas market by 2018. I am particularly glad you are increasing focus on construction and forestry business. Four factories in two years isn’t bad, especially when all are based in China and Brazil. Taking cues from Caterpillar (NYSE: CAT) and Terex (NYSE: TEX)? I like it!

While the former wants to lead in China, the latter is forging tie-ups with some big local names like Sinomach Heavy to get a foothold. Yes, China is a priority on their expansion list. Brazil’s another one (Terex recently acquired equipment maker Ritz do Brazil). Even Manitowoc is busy rolling out its first rough-terrain cranes from a newly-built 250,000 square-foot plant in Brazil. Competition’s tough, but don’t worry Dear, oops, Deere. With the World Cup 2014 and Summer Olympics in 2016 around, you’ve got timing on your side in Brazil. And China’s so huge that there should be room for all.

It’s great that you are upping the ante in construction-equipment business in Brazil, but why don’t you also work a bit on growing your farm equipment there? Despite being one of the world’s top producers of most important crops like corn, soybeans, and cotton, tractor penetration in Brazil is quite low, suggesting massive potential. Do you know, Monsanto’s sales jumped 21% year-on-year in what is seasonally one of the weakest quarters, thanks to Latin America? This is what its management had to say in the last earnings call: “In particular, we expect the continued ramp-up of the corn opportunity in Brazil and Argentina will become one of the single largest sources of growth in the next few years.”

Hey wait, even you are expecting sales from South America to grow 10% in 2013, aren’t you? That’s far better than your outlook for other markets. After the U.S., I’d love to see you ruling the Brazilian market, Deere. Hope you give it some serious thought. You really shouldn’t find it difficult what with the solid reputation and brand name you have built for yourself over the past 175 years. I mean you are among the 100 best global brands, wow! 

I see you growing bigger this year, Deere. You’ll keep me waiting for another three weeks before your first quarter, but I am already excited. Oh, I know Europe is a hard nut to crack, accounting for 20% of your revenue. But take heart, you’re not alone. Terex gets 30% revenue from Europe, while AGCO derived over 50% sales from Europe, Africa, Middle East (EAME) region in 2011. EAME is also about a quarter of Caterpillar’s total construction business sales. So it’s a shared pain.

Caterpillar sold off its farm-equipment business to AGCO nearly a decade back, and here you are, preparing to take it head-on in its own business now. Smart fellow! This diversification should take you a long way. After record earnings in 2012, I don’t see why you cannot break another one this year. Unless, of course, Mother Nature plans to ruin it all.

I love you because you are the undisputed leader in farm-equipment business, and even boast an amazing dividend history. I’m not taking away my CAPS Call from you yet, but one quick question: Will you be able to hold on for long at such high valuations? At a P/E of 12x, you’re expensive than every company mentioned above. And a Price/ Cash flow of 32x is freaking scary. That’s more than double what Cat and AGCO are trading at. Ouch! Get those cash flows rolling Deere, and just give your 2013 outlook a boost when you report in February. Mr. Market will take care of the rest.

Yours truly,
A happy investor.


Nehams has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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