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Markets

John Deere: Still Running

Shares of the famous machinery builder continue to climb the proverbial wall of worry. After a fair first quarter, could Deere run past $100?

John Deere is a powerful economic force in rural downstate Illinois. It has also made hay on Wall Street, where its stock has had a terrific run over the past five years and especially the past 12 months. And there's no reason to think this heartwarming story of regeneration in the heartland is at an end.

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Deere (symbol DE) on Tuesday reported a big jump in quarterly earnings. For the second quarter of the fiscal year that ends in October, profits came in at $3.17 per share, compared with the $2.43 Deere earned in the same quarter of the previous year. In truth, however, the number isn't as wonderful as it appears. One-third of this latest quarter's profit was the result of a one-time gain from the sale of Deere's managed health-care business. If you ignore that and also dismiss a couple of smaller charges against the company's earnings, Deere basically had a flat quarter. That still beat some analysts' expectations, which took into account the sale of the managed-care unit and cautious "guidance" that business was slowing. But investors normally are annoyed when a company's profits from operations fail to grow.

Deere candidly continues to advise that its sales of tractors, combines and other farm machinery -- its best-known product line -- will be weak the rest of fiscal 2006. For example, Deere forecasts that sales to U.S. farmers will fall 5% to 10% for the rest of the year. That sounds ominous, but Deere can offset that (and has been doing so) with stronger results in its other product areas, such as construction and landscaping equipment and lawn mowers. So if farmers get squeezed more by higher fuel and fertilizer costs, Deere should be able to ride out any turbulence well, helped by its practice of keeping inventories low.

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Still, the absence of growth, the downbeat guidance and analysts' lukewarm reaction to the company's fresh numbers suggest that the stock will take a breather for a quarter or two. On Wednesday, a miserable day for the overall market, Deere shares fell 3%, to $86. The question is whether the next major move will be up toward $100 or down to the $60s.

Odds favor hitting $100 first. One bullish argument is the expected surge in world demand for biofuels from corn and sugar cane. As these replace gasoline and gasoline additives, world prices for these agricultural commodities will keep rising (corn prices are already 23% higher than they were a year ago). That eventually has to recharge farm-equipment sales. Deere also has a bunch of new products in the works, so farmers and construction companies will have reason to replace older machines.

The First Call poll of analysts calls for earnings of $6.97 per share for the fiscal year that ends in October 2007. To get to $100, that means Deere has to sell for just 14 times earnings. That's not asking a lot for a global powerhouse that sports a 25% return on equity (a measure of profitability), isn't drowning in debt, and is diversified enough that it's not as cyclical as it used to be. Deere is well-hedged against changes in interest rates and currency exchange rates. And its price-earnings ratio over the past five years has been as high as 30.

Investors have been the losers when they've tried to outsmart themselves and dump Deere because of spiking oil prices or slow European growth or problems at competitors or what-have-you. The truth is that in a race between bears and Deere, you know who wins.

--Jeffrey R. Kosnett

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