This Equipment Manufacturer Is Best in Class

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

Deere & Co's (NYSE: DE) stock price experienced a massive run-up starting in 2006 and lasting until late 2007. Then it crashed to 1/3 of its high during the depths of the financial crisis. However, the stock price has since regained steam and currently trades near an all-time high. So it's worth asking whether Deere still has room to run or whether the stock is too risky to own at this point.

Keeping pace with the competition

Deere's strong brand and efficient production of agricultural and forestry machinery allows it to compete effectively against both its largest rivals and its smaller niche competitors. For example, Deere's $36 billion in sales is less than Caterpillar's (NYSE: CAT) $60 billion in sales and more than Terex's (NYSE: TEX) $6.5 billion in sales. Yet Deere regularly produces higher margins than both companies.

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Deere's outperformance is due in part to its product mix, but primarily to its superior pricing power as a result of its strong brand name. Deere's products are regarded as more dependable and durable than the competition's.

Despite Deere's superior pricing power, Caterpillar remains the largest manufacturer of heavy construction equipment in the world. Due to its vast scale and distribution superiority, it is unlikely to ever give up its position as the biggest company in the industry. However, Caterpillar took a lot bigger hit to earnings in 2009 than did Deere, showing that even superior size could not protect it from a weakening in demand. However, the company is back on track to earn record profits and it should continue a steady growth in sales for the foreseeable future. However, the stock is fairly valued at $63.5 billion.

Terex Corp is much smaller than Deere and Caterpillar. Its market capitalization is only $3 billion, compared to $36 billion for Deere and $63 billion for Caterpillar. The company is unique in that it sells all of its products directly to customers instead of building out a dealership network. However, the company has struggled mightily since the recession, and only recently eked out its first profit since the downturn. The words 'small' and 'manufacturer' generally do not go well together; Terex has made it work during good years, but the bad years reveal its flaws. As a result of its small size, Terex's ROIC significantly lags that of Deere and Caterpillar.

Future looks bright

Deere's main opportunity is to supply the BRICS -- Brazil, Russia, India, China, and South Africa -- with state-of-the-art agricultural technology, the likes of which have yet to gain widespread adoption in many parts of these countries. Russia is particularly in need of more advanced equipment; the agricultural segment of the Russian economy significantly lags the sophistication of modern western economies.

In addition, agricultural subsidies in many developed nations keeps a floor on agricultural commodities. This guarantees a certain level of income to farmers who produce a certain volume of the commodity, which gives the farmers added confidence in buying expensive machinery.

Valuation

It is easy to get caught up in the hysteria over the world's food supply and soaring agricultural commodity prices in the future. However, it is usually unwise to buy a stock with such a drastic backdrop for a thesis.

Deere trades at 7.6x last-year's record-high pre-tax earnings. If it sustains $4.6 billion in pre-tax earnings, a 9x multiple would value the stock at $105 per share. At a current share price of $92, the stock price allows for some weakening in demand before investors lose money. And if the food apocalypse does come, then investors will be well-rewarded for buying now.


titans8904 owns shares of Deere & Co. 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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