Deere: Near Term Headwinds, Bullish In Long Term
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On August 15th, Deere Company (NYSE: DE) reported its 3Q EPS of $1.98 on sales of $8.93 billion, falling short of consensus estimate of $2.31 and sales of $9.56 billion. Earlier this month, its peer CNH Global (NYSE: CNH) also reported lower than expected results. However, CNH EPS miss was just $0.02 against the $0.33 miss reported by Deere. We believe that disappointing results of Deere were primarily driven by execution mishaps and manufacturing inefficiencies in Agriculture & Turf (A&T) segment. Going forward, we believe that the combination of strong crop prices, high farmer incomes, and Deere's focused globalization will drive double-digit volume growth and continued mix improvement as well as margin expansion in 2013. Additionally, continued improvement in rental market fundamentals, as well as firming housing data, support the outlook for US construction equipment demand. We suggest Deere’s stock for those investors who can look past near term volatility and will hold the stock long term.
Near term headwinds but longer term story still intact
The company is facing headwinds from the drought situation in the Midwest. Although it is still early to estimate the impact from the drought, we believe the long‐term fundamentals are still supportive. In near term, given the solid sales over the past five years, reduced tax incentives, and most importantly unprecedented drought conditions, we believe farmers (even though they are in good financial shape), may delay or reduce equipment purchases towards year-end.
We’ve seen Deere rebound from similar issues in the past. As an instance, in Q1FY12 , Deere encountered some timing-related issues in production schedules that resulted in lower volumes, which then rebounded sharply in Q2FY12 (while incremental margins also increased to ~33%+ from ~4.5% in FY1Q).
New initiatives are expected to deliver growth
On August 1st, Deere opened early combine order program which has been running ahead of last year’s levels. Also, other seasonal programs for planters, sprayers, and tillage equipment are up more than 15% vs. last year. It seems to be a good start to strong order trends heading into next year as this is really the first incremental data we’ve seen around FY13 demand.
Visibility over Crop Prices
Futures markets are indicating strong crop prices in FY13. Higher prices and insurance together suggests that gross receipts from crops will be strong in FY13. The markets are clearly signaling the need for much more output in the coming season in both the Southern and Northern hemispheres. We are optimistic about high cash receipts next year to a new peak level in U.S, which we believe is a good indicator of machinery demand.
Don’t look relative, look absolute.
We believe that the company’s guidance was too aggressive and second‐half‐weighted and negative sentiment in the second half of 2011 on the 2012 outlook turned out to be correct. The reason that AGCO (NYSE: AGCO) and CNH put up better quarters is that they guided more conservatively from the onset.
Despite disappointing results, Deere has the benefit of the doubt given its track record of relatively consistent execution, and we believe Deere could bounce back quite quickly. Management seems to dedicate significant resources to rectifying the recent execution issues. Although there is a lack of a near‐term catalyst to move the stock materially higher, we believe a bottom has been reached. We believe higher crop prices, combined with an initial 2013 cash receipt forecast of $400 billion +, are both encouraging and could push Deere's earnings higher in 2013. We suggest this stock for investors who can look past near-term drought volatility.
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