Published May 23rd, 2015
Deere & Company (DE) has been a Top 10 dividend stock using The 8 Rules of Dividend Investing for all of 2015. The company’s stock gained over 4% yesterday on better-than-expected earnings.
Deere & Company is the world’s largest manufacturer of farming machinery. The company was founded in 1837 and has paid steady or increasing dividends for 27 consecutive years.
2nd Quarter Earnings Release
Deere & Company released its 2nd quarter 2015 earnings this morning. The company reported earnings-per-share of $2.03 per share versus $2.65 per share for the same quarter a year ago.
Earnings-per-share are down due to lower crop prices. When crop prices fall, farmer income falls. This in turn causes Deere & Company’s farm and agriculture equipment sales to decline. Several key crop price declines over the last 12 months are shown below:
- Wheat down 31%
- Soybeans down 27%
- Corn down 23%
Deere & Company operates in 3 segments: Agriculture & Turf, Construction & Forestry, and Financial Services. Each segment’s percentage of total operating earnings generated for Deere & Company in the most recent quarter is shown below:
- Agriculture & Turf: 58% of operating income
- Construction & Forestry: 17% of operating income
- Financial Services: 24% of operating income
Agriculture & Turf Outlook
Deere & Company expects its agricultural & turf equipment sales to decline by around 19% on a constant currency basis this year.
Agricultural sales in the United States and Canada are expected to decline 25%. The company’s European agricultural operations are expected to decline 10%. Finally, South American agricultural operations are expected to decline 15% to 20%. The decline is due to low grain prices.
Turf and utility equipment sales are expected to grow 5% on the year. These sales are benefitting from economic growth in North America.
Construction & Forestry Outlook
Construction sales are expected to increase 5% on the year for Deere & Company on a constant currency basis.
Growth in the company’s construction products is coming from an improving housing market in the United States. On the downside, low oil prices are reducing energy sector sales.
The forestry segment is expected to show no growth on the year and produce the same amount of sales it did in 2014.
Financial Services Outlook
The financial services segment is expected to show slight growth in net income. Net income for the segment is projected to reach $630 million in fiscal 2015 versus $624 million in fiscal 2014.
The slight increase comes primarily from the company’s recent sale of its insurance companies (John Deere Insurance & John Deere Risk Protection) to Farmers Mutual Hail Insurance of Iowa. The company realized an after-tax gain of $38 million on the transaction.
In addition to the sale of the company’s insurance business, John Deere is expecting its credit portfolio to grow in 2015 versus 2014. These gains are being offset by less favorable financing spreads, an increase in provisions for credit losses, and a higher tax rate in 2015 versus 2014.
Dividend Stock Growth Analysis
Deere & Company has compounded its earnings-per-share at 12.7% over the last decade. The company is highly cyclical. Earnings-per-share tend to rise and fall with grain prices. The company is currently in a cyclical trough. When grain prices recover, the company should see rapid earnings-per-share growth.
Deere & Company’s stock gained over 4% yesterday on better-than-expected second quarter results. Since it is in a cyclical trough, the market expected Deere & Company to show declining earnings-per-share. The company’s outlook for full fiscal 2015 increased from $1.8 billion to $1.9 billion. The company’s increased outlook likely drove the 4% share price increase.
John Deere’s Competitive Advantage
Deere & Company’s competitive advantage has given it a 60% market share of the farming equipment industry in the US and Canada. A company does not grow to become an industry leader without a strong competitive advantage.
Deere & Company’s competitive advantage comes from its brand recognition and reputation for quality in the farming machinery industry. The company charges a premium price for its farming equipment, because its high quality equipment reduces downtime, which increases farm production.
Dividend Stock Valuation
Deere & Company’s earnings-per-share are highly cyclical. In full 2015 the company is expected to have earning-per-share of $5.35. At current prices, this comes to a price-to-earnings ratio of 17.4. While a price-to-earnings ratio of 17.4 is very reasonable for a high quality industry leading business with a 12.7% earnings-per-share growth rate over the last decade, Deere & Company is cheaper than it appears.
The company is near the bottom of its cyclical earnings cycle. Earnings are depressed relative to mid-cycle numbers. Deere & Company’s peak earnings-per-share and trough earnings-per-share in its last 2 cycles are shown below:
- 2008 peak earnings-per-share of $4.70
- 2013 peak earnings-per-share of $9.08
- Peak-to-peak growth of 93%
- 2009 trough earnings-per-share of $2.82
- 2015 trough earnings-per-share of $5.35
- Trough-to-trough growth of 90%
While we can’t be certain what year will be the bottom in earnings-per-share, 2015 is a likely candidate. The numbers above show that Deere & Company has grown earnings-per-share somewhere around 90% adjusting for cyclicality. If Deere & Company continues its current growth trend, the next peak earnings year could see earnings-per-share of somewhere around $17.25 per share.
Deere & Company traded at a price-to-earnings ratio of around 16 during 2008, and around 10 during 2013 during its last 2 peak earnings years. Based on the data above, the company’s peak-to-peak cycle takes around 6 years (though this is not a rule in any way). Peak earnings may come around 2019 for Deere & Company. If the company does earn $17.25 a year in 2019 and has a price-to-earnings ratio of 10 – this implies a share price of $172.50. This comes to an annualized share price growth rate of 13% a year. While this analysis is fraught with many ‘what ifs’, I believe it to be a likely scenario given Deere & Company’s history of strong earnings-per-share growth.
Deere & Company appears undervalued at this time. Cyclical troughs cause negative sentiment which causes risk-averse shareholders to sell shares and brings the company’s price down. Deere & Company did have a good 2nd quarter which pushed the price up somewhat, but the company still appears to be significantly undervalued.
Who Else is Buying Deere & Company?
Deere & Company currently has a dividend yield of 2.6%. The company’s combination of value, growth and yield should appeal to investors looking to improve their dividend growth portfolio.
Warren Buffett has taken notice of Deere & Company. He recently purchased shares of Deere & Company. Deere & Company fits with Warren Buffett’s strategy of purchasing high quality businesses in stable industries for fair or better prices.