We reiterate our Neutral recommendation on Deere & Company (DE), a global manufacturer of agricultural and forestry equipment, construction equipment and engines. Deere’s first quarter fiscal 2011 earnings more than doubled to $1.20 per share from the year-ago quarter. The outperformance was largely driven by strong demand for farm machinery coupled with improving conditions in construction and forestry markets.
Deere’s worldwide total sales increased 27% year over year to $6.1 billion in the quarter, beating the Zacks Consensus Estimate of $5.9 billion. Net sales of equipment operations (which comprise Agriculture and Turf, Construction and Forestry) were $5.5 billion, reflecting a 30% year-over-year increase including an unfavorable currency translation effect of 1% and a price increase of 2%. On a geographic basis, equipment net sales were up 35% in the United States and Canada and 22% in rest of the world.
Deere expects equipment sales to grow 25% in the second quarter and 18% to 20% for fiscal 2011. Net income is estimated at $2.5 billion in 2011. Region wise, Deere expects industry farm-machinery sales in the U.S. and Canada to grow 5% for 2011. Western and Central Europe is expected to increase 10%, while sales in the Commonwealth of Independent States are expected to witness moderate gains. In South America, the company expects industry sales to be comparable with the strong levels of 2010.
Farm cash receipts are the best gauge for farm machinery sales. Farm cash receipts reflect levels of farm commodity prices, acreage planted, crop yields and government policies, including the amount and timing of government payments. Deere’s forecast for farm cash receipts for 2011 stands at $359 billion compared with $321 billion in 2010. The forecast exceeds the previous record high of $330.5 billion in 2008 by almost 9%. The United States Department of Agriculture forecasts net farm income to reach $94.7 billion in 2011, up nearly 20% compared with 2010, the second highest inflation-adjusted value for net farm income in the past 37 years. This will drive farmers to invest in the latest machinery to maximize their productivity, thereby benefiting the company.
Deere’s strong cash flow puts it in a good position to fund future growth opportunities, while also returning cash to shareholders. Deere recently hiked its quarterly dividend by 17% to 35 cents, in sync with its intention of delivering a series of moderate dividend hikes while targeting an average 25%–35% payout ratio. The company has increased its dividend eight times between 2004 and 2010. Further, Deere commands industry leading net margins; its trailing twelve months net margin is 7.78%. We believe Deere has ample scope to increase its dividend yield and payout ratio, given its cash rich position.
Expanding its product range and entering attractive new businesses are vital to Deere’s growth. To capitalize on growth in the Indian tractor market, the largest in the world, Deere invested $100 million for building a new factory and expanding the existing tractor facility in Pune. Deere also opened a joint venture facility in India for the manufacture of backhoes and four-wheel-drive loaders, and broke ground for a new combine-harvester facility.
Deere also plans to build a construction-equipment factory in China for the production of four-wheel-drive loaders and excavators. In Russia, Deere is doubling the manufacturing space at its Domodedovo production facility. This will enable Deere to expand its product line in Russia by adding new equipment such as log forwarders, which are extensively used in the Russian forestry industry. Deere’s construction and forestry segment operates in the highly competitive North American markets and seeks to grow its competitive position in other parts of the world, including China, Russia and India.
Deere has to comply with the Tier 4 emission standards. Meeting these standards require significant new and expensive technology. There also remains the risk of higher-than-normal maintenance and repair costs as 2011 will be the first year of implementation of the new technology. Production limits and transitional issues associated with the broad launch of Interim Tier 4 emissions-compliant equipment are expected to have a moderating effect on the near-term sales potential.
Furthermore, margin expansion will be constrained in 2011 given the increased costs for the New Tier 4 products, as well as raw material inflation, increased overhead associated with new facilities and SAP implementation at two of Construction & Forestry plants that will be shut for two weeks. Furthermore, production inefficiencies associated with the transition to the initial Tier 4 products as well as heightened R&D expense will also affect margins. Given these concerns, we maintain our Neutral recommendation on Deere.
Illinois-based Deere & Co. is engaged in the production and distribution of agricultural and forestry equipment, construction equipment and engines worldwide. The company sells products in the U.S. and Canada through branch offices as well as through distributors and dealers for the resale of products internationally. Deere competes with Caterpillar Inc. (CAT), CNH Global NV (CNH) and Kubota Corporation (KUB).
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