DE - John Deere

[OnTheShouldersOfGiants]

I wrote this up last year, so the information is a year old but still relevant and the company is cheaper now than it was then.

 

The intended audience was my friends and family who have very little investing experience.  No mention of EV or EBITDA anywhere in this write up :).

 

Link to OneDrive:

http://1drv.ms/1njPiiv

 

 

[One World Trader]

John Deere is selling for nine times earnings.

[Palantir]

The company does not strike me as very cheap. (If you look at it from an EV rather than Market Cap perspective). That being said, it could still be a good investment. Do you feel there is a case for their earnings rising substantially above their trend rate, or do you expect current rates to continue?

[Evolveus]

A large chunk of that EV is the debt from the in house financing division which imho skews the EV/ebitda to the more expensive side. The loan portfolio has average loan terms of five years or less and loss ratio has been under 3% for many years now. The finance arm contributes around $450m to net income if memory serves correct.

[kevin4u2]

I think your analysis has a number of holes as your understanding of the industry is from a 1000ft above.

 

Some comments, inflation resistant? This section is bogus. Take a look at commodity prices during the recession. That was a major tailwind during the past 5 or more years. I know of a private direct competitor to Deere in one subsector that has had unheard of growth over that time periods too. It was a function of commodity prices. Those days are over and the industry is in more normal times.

 

Much growth in past decade has been in eastern Europe, including Ukraine and Russia. As you can likely guess, sales to those areas will be tough given what has happened over there.

 

As a whole, the industry has headwinds not tailwind. The easy boom years are over.

 

Another big issue in this industry (here in Canada) is the railway crisis. There was a record crop in Canada and the railways have been very slow taking crop to the US or to port. This has created a huge cash flow crisis for some Canadian farmers. The rail companies are also moving more oil by rail which is further creating problems. You cannot truck the production out of central Canada, simply too much product and road restrictions in US. I have heard of some people trucking product to Winnipeg and shipping via BNSF to the US, which was music to my ears.

 

In summary the sector has had huge tailwinds for the past 5 years, you may not be looking at normalized earnings.

[OnTheShouldersOfGiants]

Palantir and Evolveus,

In regards to the debt, Evolveus is correct about the Financial services division being responsible for most of the debt. Write offs in the ag division have a ten year average of 5 bps, this is crazy low.  Below is a quote from the write up that addresses the balance sheet strength and loan write off history.

 

Balance sheet

 

* Zero net debt on the equipment operations side (Cash - Debt = 0)

 

* Financial services: $34.5B assets, $30.6B Liabilities, $3.9B equity (equity = 11.3% of assets)

 

Financial Services Loan Quality

 

* Write offs have equaled 30 basis points of portfolio on average over the last 8 years (this is very low)

 

* Write offs kept very low since large down payments are required and the equipment has a high resale value. This results in a situation where the value of the outstanding loan is less than the resale value of the equipment, if the equipment was repossessed it could be sold for more than the value of the outstanding loan. Deere has a history of being a very conservative lender.

 

Kevin4u2,

I don't think I'm wrong about the inflation resistance of the business.  Buffett has written many times that a business is inflation resistant if it can earn an above average return on the unleveraged tangible assets they employ. Deere earns well above average returns on unleveraged assets. Buffett wrote about this in appendix to the 1983 letter http://www.berkshirehathaway.com/letters/1983.html

 

You claim "Much growth in past decade has been in eastern Europe, including Ukraine and Russia. As you can likely guess, sales to those areas will be tough given what has happened over there. "  The reality is that only 4.6% of sales come out of Central Europe and CIS. Much of Deere's growth has come from success in markets all over the world.  Deere sells 4.5 times more outside of North America than they did in 2000.  I touched on this in the write up

 

5 Year Historical Revenue Growth per Region

 

* 9% CAGR US and Canada

 

* 18% CAGR Central and South America

 

* 2% CAGR Western Europe

 

* 21% CAGR Asia, Africa and Middle East

 

* 11% CAGR Central Europe and CIS

 

* 20% CAGR Australia and New Zealand

 

You said "Another big issue in this industry (here in Canada) is the railway crisis. There was a record crop in Canada and the railways have been very slow taking crop to the US or to port. This has created a huge cash flow crisis for some Canadian farmers. The rail companies are also moving more oil by rail which is further creating problems. You cannot truck the production out of central Canada, simply too much product and road restrictions in US. I have heard of some people trucking product to Winnipeg and shipping via BNSF to the US, which was music to my ears. " I don't think that a harsh Canadian winter is going to affect the long term economics of a dominant international company like Deere.  This is just noise.

 

You're right that crop prices have been high and a decrease in crops would likely result in farmers holding off on replacing their equipment a little longer, but in the long term crop prices will probably continue to move up and farm productivity will probably continue to improve largely from better equipment from companies like Deere. Buffett makes these claims in his 2013 annual letter in reference to the farm he purchased in 1986 "I also thought it was likely that productivity would improve over time and that crop prices would move higher as well. Both expectations proved out."

 

I think the real story here is the trends. In North America farms are getting very large where newer more reliable equipment is necessary. Internationally, as developing economies create wealth, a smaller and smaller percentage of their GDP will come from agriculture as farms get larger and mechanized. Deere is showing very good success at growing in these developing economies, as mentioned previously Deere sells 4.5 times more outside of North America than they did in 2000.

 

The Construction and Forestry division is something I didn't touch on much, but it represents about 15% of earnings and survived reasonable well through the housing "depression".  This division will continue to get stronger as US housing comes back.

 

In summary I believe Deere is a company with an incredible brand, value conscious management,  strong balance sheet and trend tailwinds.  At today's valuation it doesn't take much to end up with a great long term result.

 

[constructive]

Analyst 2015 estimates are low - any idea where that is coming from? China slowdown fear?

 

I think a lot of Deere's advantage is its position as a consumer / "prosumer" brand. CNH and AGCO don't have that broad positioning. The consumer market is more brand sensitive and less cyclical than the commercial market.

[frommi]

I think it has to do with low wheat prices. And given the fact that analysts are seldom right, i like low analyst projections. The whole agriculture sector has a relative high short ratio, LNN has 47% of the float shorted. So the pessimism in this sector seems to be high and given that the numbers are not so bad i think DE is a good buy here.

[kevin4u2]

Sorry I meant to say recession resistant not inflation resistant.

 

I didn't realize CIS growth was so small.  That makes sense now in some ways because their product is better suited for South America vs CIS.  I also don't think their price point helps them over there either.  The CIS is a huge untapped market and just to give perspective, Kazakhstan has more arable land than western Canada.  They are also technologically way behind the west in farming technology. 

 

As someone who works in a subsector of the industry I can assure you it has headwinds, not tailwinds.  Commodity prices drive sales and these are down huge, especially corn but also wheat.  Moreover, just to be a little anecdotal, a lot of speculative money has been flowing into the sector.  Starting a couple years ago but expanding big time last year we these little signs along major highways in western Canada for investors to buy up farmland.  The price of land has doubled in the past couple years.  Once this type of speculative money flows into any sector the end is near.  Again all driven by commodity prices.

 

I guess my big question for you is have you tried to kill this investment?  Why is the stock cheap?  What are the reasons.  Once you full understand, appreciate and can explain the opposite side you will have a complete investment idea.  For example, by saying the rail crisis is just noise, means you don't understand it and are trying to tell yourself it won't affect sales.  Wishful thinking doesn't change the fact that it has and will.  The fact that the Canadian government has mandated rail car movements should tell you that the situation is very serious (besides making me feel like I live in a communist country). 

[mikazo]

Did some research on brand perception for John Deere, these links give you some idea:

 

http://www.ar15.com/forums/t_1_5/1298652_Whats_the_best_brand_of_riding_lawn_mower_.html

 

http://www.yesterdaystractors.com/articles/artint49.htm

 

http://www.tractoroftheyear.com/toty_Winners.html

 

http://www.ranker.com/list/best-tractor-brands/werner-brandes

[mikazo]

Farm income forecasts for Canada and the US:

 

http://www.agr.gc.ca/eng/about-us/publications/economic-publications/alphabetical-listing/farm-income-forecast-for-2013-and-2014/?id=1392144307317

 

http://www.ers.usda.gov/topics/farm-economy/farm-sector-income-finances/highlights-from-the-2014-farm-income-forecast.aspx#.Uxs_uPldWX9

 

The US report is forecasting quite a decline in farm net income for 2014. Would this be part of why DE is cheap?

[loganc]

 

Financial Services Loan Quality

 

* Write offs have equaled 30 basis points of portfolio on average over the last 8 years (this is very low)

 

* Write offs kept very low since large down payments are required and the equipment has a high resale value. This results in a situation where the value of the outstanding loan is less than the resale value of the equipment, if the equipment was repossessed it could be sold for more than the value of the outstanding loan. Deere has a history of being a very conservative lender.

 

 

Where are you getting the data to support the claim that the equipment has high resale value?  The above line of reasoning sounds great, if it can be substantiated. 

 

 

[mikazo]

Found some interesting info on how Deere manages during harsh economic times.

 

From the deere.com company timeline:

 

1874 - Despite economic problems among farmers, the Deere business grows. More than 50,000 plows are sold.

1933 - Business is almost at a standstill. Sales plunge to $8.7 million. Though it is losing money, the company decides to carry debtor farmers as long as necessary, greatly strengthening farmer loyalty.

1969 - Overall sales level out due primarily to a downturn in farm equipment sales. Overseas operations expand but do not produce profits. The John Deere Insurance Group is created.

1987 - Deere celebrates its 150th anniversary. Continued low farm income and lower Deere sales lead to a net loss of $99 million.

1988 - The economy rebounds after six years of recession during which weaker farmers, dealers, and equipment companies go out of business. Deere & Company sales soar 30 percent from 1987. Profit, following two years of losses, exceeds $315 million, a record. A joint venture is formed with Japanese company Hitachi to assemble excavators in the United States.

1998 - Despite late-year weakness in the farm sector, agricultural-equipment sales hit a record. Company net earnings reach $1 billion for the first time.

1999 - While challenging by financial standards, 1999 is a breakthrough year for John Deere. Not only does the company record a meaningful profit in the face of a major downturn in the farm economy, but the actions of recent years to create a more-resilient world-class enterprise successfully faced their first severe test.

 

Also quite a good description of how they behave during hard times in another company history article: http://www.answers.com/topic/deere-company

 

There's too much else to copy-paste here, but it seems like whenever commodity prices drop or the economy slows down, Deere & Company rely on sector/industry diversification and creativity to keep cash flows going, rely on keeping indebted farmers loyal and able to continue payments, and rely on global diversification with operating units all over the world.

[ukvalueinvestment]

Do you think that the Deere PR machine might have an interest in talking up how good they are at surviving advertisity?  I am always wary when investors point me to information provided by the company itself.. of course they are going to present things in an optimistic way.

 

More broadly, is Deere a blue chip company with great brand recognition and a long term record of delivering shareholder returns?  Yes.

Is there a lot of bad news priced in? Yes.

Will they be around in 10 or 20 years?  Yes.

Will they probably outperform the market over the next five or ten years?  I think they probably will.

 

To properly analyse how cheap it is, you need to work out how bad things can get in terms of farm and commodity prices.  You need to work out what the analyst community is thinking, and you need to work out if you have a variant perception to the street's thesis.

[OnTheShouldersOfGiants]

loganc,

 

The comment about loan value outstanding and resale value came from slide 43 of this presentation (I've also attached it) http://www.deere.com/en_US/docs/Corporate/investor_relations/pdf/presentationswebcasts/2013/2013july_presentation.pdf

 

My thesis for Deere is very simple, in 10 years Deere will be selling far more equipment than they do today, they will have far fewer shares outstanding and will trade at a higher earnings multiple.  DE is not a ten bagger but I feel confident it will outperform the overall market by a significant margin.

[loganc]

loganc,

 

The comment about loan value outstanding and resale value came from slide 43 of this presentation (I've also attached it) http://www.deere.com/en_US/docs/Corporate/investor_relations/pdf/presentationswebcasts/2013/2013july_presentation.pdf

 

My thesis for Deere is very simple, in 10 years Deere will be selling far more equipment than they do today, they will have far fewer shares outstanding and will trade at a higher earnings multiple.  DE is not a ten bagger but I feel confident it will outperform the overall market by a significant margin.

 

Thanks for the response.

[thefatbaboon]

Anyone understand the receivables/payables from unconsolidated subs and affiliates?  Last year it looks like it took a $2bn jump up.  Is this a way that the equip biz funds the finance biz?

[Picasso]

Anyone else looking more deeply into DE?

 

If I try to smooth out the cyclical nature of the business and take the average since 2004 I get $2.06 billon of net income.  At the current share price I am paying about 13.5x.

 

Then add in the $8 billion dollar buyback over the next several years.  This is going to be a stock trading for under 10x earnings as long as Deere can earn more than $2B.  The current dividend yield is now over 3% which when added to the buybacks is a pretty substantial.

 

Returns on invested capital excluding the finance arm is over 20%.  Comparing those returns to bonds or the S&P and it looks pretty good.  Lots of sell and neutral ratings on the stock which I like.

 

 

[Fat Pitch]

I've been following John Deere for a while now. I just started digging more into it recently and came across this website: http://johndeeremanagementstrategy.blogspot.com/

 

Pretty decent business overall. They sell a product that's mission critical for farmers. Can't miss out on your planting and harvesting schedules or you won't put food on the dinner table. The price isn't tempting enough for me to pull the trigger just yet. I'm hoping for a terrible quarter to get in.

 

[lincolnc]

I'm a city slicker (please accept my apologies upfront for lack of technical knowledge and experience in the "field"):

 

1) Aren't we growing more and more corn? (Forcing corn futures to a current multi-year low, given significant supply)

2) A LOT of which is GMO? (I don't know percentages, but this seems like what everyone is talking about with Monsanto enforcing their seed distribution, etc.)

3) Isn't this GMO corn more bug resistant? (That's part of the reason they grow more/better)

4) One of the aspects of bug resistance is stalk/fiber strength/hardness (Making it more challenging for bugs to penetrate the fibrous material) Obviously "Round-up Ready" has other features as well.  Again, please excuse lack of technical knowledge/terminology

5) Stronger/harder corn stalks will be that much tougher on assets (Making combines, for instance, wear out sooner; in the same way, holding all else the same, a used car in San Francisco will have been driven that much harder with the engine revving to go up the hills and then harder on the brakes going down the same hills, compared to a similar used car in Orange County)

6) Causing a bit of "arms race" so to speak between the farmer and the crop (or seed company really)

7) DE, AGCO, CNHI, etc. sell equipment that will have to be maintained/repaired/replaced with increasing frequency

8) Echoing Fat Pitch, given the importance of planting and harvest "windows" you need your equipment to be in excellent condition at those times, so as a "commercial" farmer (as opposed to a "hobbyist") you will do what you have to do to make sure that you plant, fertilize, protect and harvest with the best tools you can finance/buy/rent/borrow/barter? 

 

So you don't put a crop at risk with rickety older machines when you are faced with a larger and larger crop that is engineered to be tougher and tougher....

 

[CorpRaider]

If it comes in, maybe 20% more, I'm interested.  It has to be one of the all-time durable brands.

[Dustin T]

I spent a half dozen years working as an Engineer at a smaller Deere plant, just left in May. I still have family who work for Deere.

 

A few observations.

 

They pay competitive wages so not a lot of turnover in salary or hourly employees.

 

They are best at making the big farming machines, large tractors and combines etc... Huge GPS enabled machines that can do massive amounts of work.

 

They are not as competitive with small tractors or road construction equipment. With the smaller tractors I think you can draw comparisons to the auto industry where foreign competition eroded US automakers market share. If they start to compete with the larger equipment Deere may get into trouble.

 

IMO they are more likely to succeed long term because of macroeconomic trends then anything they do in house. They are well run, but have high labor costs and legacy union pensions and health care plans, that may leave them vulnerable to foreign competitors.

[lincolnc]

http://mobile.bloomberg.com/news/2014-10-10/wheat-set-for-biggest-rally-in-two-months-on-smaller-inventories.html

[Libs]

http://seekingalpha.com/article/2567615-contributor-call-short-john-deere-says-bluepacs-chris-sommers

 

The bear case in an nutshell. I think this guy worked at Greenlight?

 

Deere is an iconic brand and I hope to buy it some day, but is it not highly correlated to farm/corn prices, both of which have gone up a lot in the last decade?

 

He makes a good point about margins, and how much they will shrink if revenue keeps declining.

 

 

 

 

 

[AJDelphi]

An Elephant For Berkshire, Or Rather a Deere

 

http://delphivalueinvestments.blogspot.com/2016/05/an-elephant-for-berkshire-or-rather.html

 

Quick little blog post on the chances of Deere being purchased by Berkshire. Seems like a business Buffett would like to own over the long-term. If the board is open to an offer maybe it could happen.