Deere & Co.: Global Agriculture Play
Like many of the farmers it does business with, Deere & Co. tends to be conservative, perhaps a little understated -- especially when it's giving guidance to Wall Street analysts on what they can expect from the company in the future. On February 14, the Moline, Ill.-based farm equipment giant reported earnings for its first fiscal quarter of 2007, which ended on January 31. Results were well above what the company had estimated in November, and likewise trumped Wall Street analysts' more upbeat projections. So the company revised its full-year outlook upward. Even so, many analysts think that Deere might still be hiding its light under a bushel -- a bushel of corn, that is.
A surge in production of corn-based ethanol, along with growing global demand for other grains, is just beginning to translate into equipment orders from increasingly prosperous farmers. Accordingly, Deere said its income for the first quarter came in at $239 million, or $1.04 a share, compared with $236 million, or 99 cents a share for the same period last year. In November, Deere had said it expected to earn $150 million to $175 million in the first quarter; Wall Street was looking for $180 million. For the year, Deere now says that sales could be up slightly instead of flat, and that earnings could reach $1.4 billion, versus its previous forecast of $1.3 billion. Increased sales of farm machinery are expected to more than offset a slowdown in Deere's residential and commercial construction division.
Despite Deere's cautious optimism, its stock (symbol DE) rallied 11% in the two days after the earnings announcement (it rose 0.4% on February 16, closing the week at $113.93). Clearly, the bulls are betting that Deere's typically conservative outlook understates a remarkably rosy outlook: that we're embarking on a multi-year agricultural boom the likes of which hasn't been seen since the 1970s, and that Deere is uniquely positioned to benefit from it. "The company's guidance seems to be incredibly conservative," says Igor Maryasis, an analyst with Prudential Securities who rates the stock a "buy." Depending on assumptions about the company's share count, which could fluctuate as stock is repurchased and options are exercised, the company's net income forecasts point to earnings of $6.15 to $6.25 per share for the fiscal year ending next October. Wall Street analysts collectively expect $6.57, with some bulls coming in as high as $7.12 a share. "We're on the cusp of a global super-cycle for agriculture," says Maryasis.
Typically, farmers see skyrocketing prices for key crops only when bad weather shrinks harvests. But today, better fertilizers, better seeds and benign weather conditions are boosting yields.
And this is occurring at the same time that demand for major crops is strong. Corn is priced at about $4 a bushel, double what it brought this time last year, thanks in large part to demand for ethanol. The worldwide supply-demand balance for corn is tipping toward demand for the first time in a decade as China is about to become a net importer.
It's a similar story for wheat, with stores down to the lowest levels since the '70s as demand from emerging economies continues to grow. "We're the Saudi Arabia of food," says Maryasis. "Wheat, corn, soybeans -- we're by far the biggest exporter, and the U.S. farmer is the biggest beneficiary." A weak U.S. dollar doesn't hurt.
What's good for the farmer, both here and abroad (Brazil in particular), is good for John Deere -- and its investors. Maryasis believes the stock could reach $120 a share over the next six to 12 months, which, based on estimated earnings of $6.75 a share for fiscal '07, would give the stock a price-earnings ratio of nearly 18 -- about what it carried at the beginning of the last cyclical upturn in ag stocks, back in 1992. Citigroup analyst and super-bull David Raso bases his 12-month target price of $137 in part on his fiscal 2008 earnings estimates of $9.57 a share. What's more, he's estimating an annual dividend of $1.80 a share (up from a current annual rate of $1.76) -- giving the stock a potential total return of more than 20%. With few stocks in the field (AgCo is a competitor), Deere has "scarcity value," he adds.
There are no guarantees, of course, in farming or investing. If the U.S. economy slows sharply or the housing downturn worsens, the company's construction and consumer equipment (lawnmowers) divisions could suffer. An about-face in political support for renewable fuels could be disastrous. If the dollar were to strengthen, Deere's exports would be less attractive to foreign buyers. Ditto for U.S. crops, which would hurt Deere indirectly.
There is also risk in the nascent ethanol boom that particularly troubles analyst Eli Lustgarten, of Longbow Research. "We have lingering questions about ethanol euphoria," he says. "Such a dramatic increase in capacity is going to strain the infrastructure. How do we move ethanol from production plants in the Midwest to blending plants in the Gulf on rails that are already at capacity?"
Nonetheless, Longbow, which had recommended that investors sell Deere shares in September, upgraded the stock on February 15 to a "hold." Lustgarten's rationale: "When the momentum is moving against you, you stand aside and wait for the train to go by." Or, you get on and ride it.