The Perfect Time to Get This Stock on Your Radar

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

Record quarterly numbers that easily trampled Street estimates should have ideally charged up the bulls. Instead, Deere’s (NYSE: DE) stock has lost about 7% since it announced results last week. The markets behaved as unpredictably in February when Deere’s stock was punished for another record quarter.

What is wrong with the market? Wasn't the cautious outlook expected? It doesn't even sound as murky as the market makes it to be! Now this is what rare opportunities are made of.

As good as it gets

To begin with, Deere’s second quarter was great. Both top and bottom lines hit record quarterly highs. Revenue rose 9% and net income improved around 3% year on year. So why did the stock tumble? Deere’s guidance fell short of Street’s expectations. But as I said, it wasn't really that disappointing.

Deere scaled back its full-year revenue growth guidance by a percentage point to 5%, but left its net income projections untouched. If you ask me, a target of $3.3 billion on the bottom line looks good enough considering that it would be a near 10% jump over Deere’s last-year earnings. For those who didn't know, 2012 was a record year for Deere.

The brighter side of things

That Deere expects its bottom line to grow at double the pace of its revenue is also a strong indication of the tight grip Deere has, and expects to have, over its costs. Best margin in the industry is one reason Deere is among my favorite stocks. I've picked out two competitors each in Deere’s two businesses and charted their quarterly gross and net margins over the past three years to see where Deere stands.

AGCO (NYSE: AGCO) is primarily a farm-equipment company while CNH Global (NYSE: CNH), like Deere, gets a part of revenue from construction equipment. Caterpillar (NYSE: CAT) and Terex (NYSE: TEX) are major players in the construction-equipment space. 

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DE Gross Profit Margin Quarterly data by YCharts

Deere has consistently generated the highest gross margin in the industry over the past few years. The gap with the closest competitor Caterpillar is considerable as well. The other three companies are way behind Deere. It’s a closer race on net margins but Deere still manages to walk away with the crown. 

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DE Profit Margin Quarterly data by YCharts

Caterpillar has faced tremendous margin pressure since last year as sales of mining equipment slowed down on low commodity prices and reduced spending by customers. The result is the sharp dip in its net margin from 10% to nearly 6% in the past two quarters.

Meanwhile, CNH’s gross and net margins appear to be on an upward trajectory, thanks to higher sales volumes of agriculture equipment and lower costs.

Higher margins are among AGCO’s top ‘financial goals’ for 2013. New products and better marketing techniques, apart from higher pricing and cost control are helping AGCO maintain its gross margin above the 20% mark. Yet, AGCO has a long way to go to catch up with Deere’s solid margins.

Terex is a great example of management efficiency as its gross margin has expanded rapidly since 2011. But its net income growth still leaves much to be desired. One reason for Terex’s uninspiring low single-digit net margin is higher interest outflow following the acquisition of Europe-based Demag Cranes in 2011.

Going by Deere’s outlook, it should continue to generate some good margins helping it maintain the lead. In fact, investors shouldn’t read much into its reduced revenue guidance either because its core business of farm equipment, which makes up as much as 80% of sales, is still expected to generate 7% higher revenue this year. That’s way better than CNH’s projections of flat to 5% lower revenue for the full year, and pretty much in line with AGCO’s expectations of between 5% and 7% growth in farm equipment revenue.

Industry-wide struggle

Deere’s other business, construction and forestry, is the one that is struggling as global markets remain sluggish. It is also the reason behind Deere’s lower revenue expectations. But Deere is not alone in ringing the cautious bell, so why punish it so hard?

If Deere reported 6% lower sales for the business this past quarter, Caterpillar’s sales tumbled a whopping 17% year on year. Deere investors can take heart that the largest construction-equipment company is projecting 7% to 12% lower revenue for 2013. Terex didn’t fare too well either with 5% lower sales in its last quarter, though it sounds upbeat about the rest of the year unlike peers, expecting between 6% and 12% higher revenue for the year.

Europe remains a concern for Deere as it accounts for nearly 20% revenue and makes up a good chunk of its forestry division sales. But if construction activity in North America ramps up, it might be able to offset some of the weakness in Deere’s forestry business.

The Foolish bottom line

Deere is an enviable mix of two businesses that are great to follow and be in. Agriculture will never go out of fashion unless the world stops eating. Spring planting in the U.S. is expected to hit a record this year. If the weather doesn’t play truant, it might as well turn out to be a great year for the tractor king. Moreover, Latin America too is expected to plant record crops this year which could help Deere outrun its own sales estimates. Meanwhile, any uptick in the construction market could mean extra revenue for Deere.

At less than 11 times P/E, Deere is currently trading cheaper to Caterpillar though both boast similar dividend yields of around 2.2%. Both are leaders in their respective industries, but Deere’s exposure to the resilient agriculture sector makes it a safer bet. I feel it’s a good chance to give Deere a space in your portfolio. To stay updated about how Deere progresses through the year, click here to add Deere to your stock watchlist.

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Neha Chamaria 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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