Why Did Buffett Buy This Equipment Manufacturer?

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

Warren Buffett recently announced his investment in Deere & Company. He bought ~4 million shares in the company, thus making one of the  top ten holdings by Berkshire, accounting for ~5% of Buffett’s 13F portfolio. I see this news as a positive factor for the company’s stock appreciation which has seen a growth of ~15% in the last 6 months.

Deere is a leading manufacturer of agricultural & forestry equipment with ~50% market share. To improve its market position further, it is also now focusing on larger non-residential and infrastructure construction contractors.

As the company operates in various segments, it competes with some of the big names in the industry. Looking at the financial figures, Deere has the highest Return on equity ratio (ROE) of 40.85% which gives it a competitive edge over its peers & makes it an investor friendly stock.

CNH Global is the world's second largest farm equipment manufacturer after Deere & Company. It recently posted 3Q12 results with its revenue up by 18% with a huge demand of agricultural equipment. The company also rejected the offer by Fiat Industrial to buy the remaining 11% shares in CNH Global. Fiat might again revise the terms of its offer as it wants to close the deal soon. I expect the stock to see a downside after the closure of this deal.

Another strong competitor for Deere is Caterpillar with the lowest PEG ratio of 0.64 among its peers. This stock has seen lots of movement in the last 6 months with its value down by ~8%. With the leadership change in China and the signs of economic recovery, Caterpillar is hoping to tap the huge growth potential from its Chinese distributors.

Deere's Japanese competitor, Kubota Corp has shown a tremendous growth in its stock prices with ~22% return in last 6 months. The company has strong cash flow growth of 69.52% but offers less dividends than its peers.
Let’s have a look at the figures:

Company

PEG (5 yr. expected)

ROE

Deere & Company (NYSE: DE)

1.1

40.85%

CNH Global  (NYSE: CNH)

1.1

13.46%

Kubota  (NASDAQOTH: KUBTY)

1.88

10.11%

Caterpillar  (NYSE: CAT)

0.64

40.34%

Here are some of the other factors that make me confident about this stock in the long run:

1. Growth in Agriculture Sector

A recently published report from the UN has estimated food production to double by 2050 to keep up with the rising levels of population across the world. This is a huge opportunity for a company like Deere to increase its footprint in Brazil, India, Russia and China that have emerged as the new agricultural powers. The company has already invested in the world’s largest growing economy, China, with a $250 million investment in its site which includes R&D facilities and an assembling plant. I see this investment reaping positive results for the company, considering the scope in the Chinese agricultural sector.


2. Global Ambitions

The company dominates the US and Canada markets for farming equipment by generating ~60% of its sales through them. For the fiscal year ended Oct., Deere posted record sales of $32 billion and net income of $2.8 billion. With the US being a huge market for this equipment, I see this as a money maker for the company in the future. Also, with growing farm cash receipts in North America and Europe, the demand for its equipment will increase in 2013.

The company pins its hopes on the Brazilian market with strong growth opportunities in sugar cane, soy, corn, and cotton. The BNDES (Brazilian Development bank) recently reduced the financing rates on farming equipment, which paves the way for the company to increase its sales of tractors, harvesting ranges, and the complete suite of products in Brazil for all farms.

3. Focus on Construction Equipment

Despite the overall economic uncertainty in the US market, Deere construction equipment sales performed well and the company was second largest player in the North America. With the macro environment slowly softening up after a downturn and the rapidly increasing urbanization, the demand for construction equipment is expected to reach 1.76 million units by 2018. The company can leverage on this segment in future to boost up its sales & revenue figures.

Summing it up, I can see Deere as a solid investment, as the company promises to perform well backed by its continuous technological improvement and a healthy market presence. And the icing on the cake would be Buffett’s confidence in the company. Also, the company has increased its dividend payouts by ~14% over the last five years and has a decent forward dividend yield of 2.1%, making it a popular dividend stock to own. Looking at the company’s strong free cash flow generation and past records of generating returns to shareholders, I expect an upside in the company’s dividend in future. Thus, Deere can be recommended for the long term investor.

 


ShwetaDubey has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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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