Will These Equipment Companies Manufacture Profits?

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

After my article on Caterpillar (NYSE: CAT) I have decided to take a closer look at one of its rivals, Deere (NYSE: DE). Calling these two behemoths rivals is not strictly true, while CAT operates mainly in the mining sector, DE operates in the farming and forestry sectors with a mining division. 

Like Caterpillar, John Deere has sold off recently. In my article about Caterpillar I mentioned there was nostalgia around Caterpillar and their toys trucks people played with as kids. Deere has the same nostalgia and rich history.

A brief history of John Deere

  • 1837: John Deere fashions a polished-steel plow.
  • 1849: A work force of about 16 builds 2,136 plows.
  • 1868: After 31 years, the concern is incorporated under the name Deere & Company. 
  • 1889: The company's five key branches are in place at Kansas City, St. Louis, Minneapolis, Council Bluffs/Omaha, and San Francisco.
  • 1912: The modern Deere & Company emerges. It consists of 11 manufacturing entities in the U.S. and one in Canada, and 25 sales organizations. The company also operates a sawmill and owns 41,731 acres of timberland in Arkansas and Louisiana.
  • 1943: Deere makes military tractors, ammunition, aircraft parts, and cargo and mobile laundry units during the war. About 4,500 employees serve in the military, some in the "John Deere" Battalion, a specialized ordnance group that sees service in Europe.
  • 1966: Total sales surpass $1 billion for the first time. 
  • 1979: Sales top $5 billion, earnings $310 million, both records.
  • 1988: The economy rebounds after six years of recession. Deere & Company sales soar 30 percent from 1987. Profit, following two years of losses, exceeds $315 million, a record. A joint venture is formed with Japanese company Hitachi to assemble excavators in the United States.
  • 1997: Overseas sales top $3 billion, more than the company's entire sales total prior to the mid-1970s.
  • 2004: Record full-year earnings of $1.406 billion.
  • 2011: Deere is listed among the 50 most-admired companies by Fortune magazine and ranked as one of the 100 best global brands by a leading brand-consulting firm. As a sign of the company's emphasis on global growth, sales outside the U.S. and Canada jump by 38%.

Deere has played its part in history and is now one of the biggest manufacturers of agricultural equipment in the world.

Deere has five main bull points:

  1. The company is well run, with experience and global exposure.
  2. The world demand for food will double by 2050.
  3. The world demand for paper and wood will increase with a resurgence in housing construction and population growth.
  4. The company has a strong free cash flow - providing good shareholder returns.
  5. The need for farming equipment has a less cyclical nature than mining.

The outlook for Deere is largely dependent upon farm output. Deere has forecast farm earnings in the US to be up 5% next year, leaving more room for CAPEX. Deere also has a large forestry division, which will benefit from a resurgence in house building. This is already showing through, as profits in this division were up 38% in Q4.

John Deere is no CAT. It is not as big, its product portfolio is not as vast, but its strength lies in its cash flow. 

This free cash flow shows through in shareholder returns:

  • During 2012, DE had $2.9 billion in free cash flow from operations.
  • Since 2010, Deere has increased it dividend 64%.
  • 2004-2012, 60% of cash from operations returned to shareholders.
  • 160 million shares repurchased since 2004, (no share repurchase in 2009).

Comparing the margins and resulting cash flow between Deere and its competitors shows a surprising result.

<table> <tbody> <tr> <td> <p>$US Billions</p> </td> <td> <p>CAT</p> </td> <td> <p>DE</p> </td> <td> <p>CNH</p> </td> <td> <p>JOY</p> </td> </tr> <tr> <td> <p>Revenue</p> </td> <td> <p>60</p> </td> <td> <p>32</p> </td> <td> <p>19.2</p> </td> <td> <p>4.4</p> </td> </tr> <tr> <td> <p>Gross income</p> </td> <td> <p>16</p> </td> <td> <p>9.7</p> </td> <td> <p>4.45</p> </td> <td> <p>1.5</p> </td> </tr> <tr> <td> <p>Net Income</p> </td> <td> <p>4.9</p> </td> <td> <p>3.1</p> </td> <td> <p>0.94</p> </td> <td> <p>0.63</p> </td> </tr> <tr> <td> <p>Gross Margin</p> <p> </p> </td> <td> <p>26%</p> </td> <td> <p>30%</p> </td> <td> <p>23%</p> </td> <td> <p>34%</p> </td> </tr> <tr> <td> <p>Net Margin</p> </td> <td> <p>8%</p> </td> <td> <p>10%</p> </td> <td> <p>5%</p> </td> <td> <p>14%</p> </td> </tr> </tbody> </table>

Deere has a stronger free cash flow than both of its major competitor's CAT and CNH (NYSE: CNH). Surprisingly, however,  the star is Joy Global (NYSE: JOY)

Joy Global

Surprisingly, the chart above shows that Joy Global has the biggest margins in the group. Joy is by far the smallest in the group, with a market cap of only $6 Billion. However despite its tiny size Joy could provide one of the best investments in the sector.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p>JOY</p> </td> <td> <p>CAT</p> </td> <td> <p>DE</p> </td> <td> <p>CNH</p> </td> <td> <p>S&P 500</p> </td> </tr> <tr> <td> <p>10 Year return</p> </td> <td> <p>980%</p> </td> <td> <p>289%</p> </td> <td> <p>237%</p> </td> <td> <p>214%</p> </td> <td> <p>57.5%</p> </td> </tr> </tbody> </table>

Over the past 10 years, Joy Global has outperformed all of its major competitors and the S&P 500 - with the stock at one point up one 1500%!

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p>Forward P/E</p> </td> <td> <p>2012 Predicted EPS growth</p> </td> <td> <p>PEG</p> </td> <td> <p>5-Yr EBITAR Growth</p> </td> <td> <p>5-Yr EPS Growth</p> </td> <td> <p>Debt to Equity</p> </td> <td> <p>Interest Coverage</p> </td> </tr> <tr> <td> <p>Joy Global</p> </td> <td> <p>8</p> </td> <td> <p>21%</p> </td> <td> <p>0.4</p> </td> <td> <p>89%</p> </td> <td> <p>128%</p> </td> <td> <p>60%</p> </td> <td> <p>17x</p> </td> </tr> <tr> <td> <p>Industry Average</p> </td> <td> <p>16.3</p> </td> <td> <p>17%</p> </td> <td> <p>0.95</p> </td> <td> <p>40%</p> </td> <td> <p>-4.4%</p> </td> <td> <p>200%</p> </td> <td> <p>4.3</p> </td> </tr> </tbody> </table>

A closer look at Joy's figures show the strength of this firm. The P/E ratio is about half of the industry average,  the same can be said for the PEG ratio. Debt is about a quarter of the industry average and 5-yr EPS leaves the industry average trailing in the dust.

One of the most important points about Joy Global is its resilience to global slowdowns. Most of the industry saw a fall in revenue and profits in 2008/2009, Joy actually saw a rise.

<img src="/media/images/user_14485/eps-joy_large.jpg" />

Revenues for Joy could come under pressure from falling CAPEX in the mining sector. On the other hand, Joy has a services and parts division, this provides valuable recurring revenues.

John Deere is the bigger company, but Joy Global could provide better future returns. 

RupertHargreav owns shares of Caterpillar. The Motley Fool owns shares of Joy Global. 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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