Agricultural & Turf Equipment Division Is A Long Term Growth Driver For Deere

August 1st, 2014 by Trefis Team
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Deere’s (NYSE:DE) Agriculture & Turf Equipment division has the highest contribution towards overall revenue compared to its other two divisions – Construction & Forestry and Financial Services. In the fiscal year 2013, Deere generated 77% of its revenue from the segment. [1] We believe that the division is a long term growth driver for Deere, given the ever increasing requirement for food for the growing population. However, we expect to see a dip in the segment’s revenue in the next two years. Given the segment’s significant contribution to the company’s revenue, it forms 80% of our stock price estimate of Deere.

Deere’s Agriculture & Turf Equipment segment manufactures and distributes agriculture and turf equipment and related service parts. It offers tractors, harvesters, balers, mowers, forage, tillage equipment, sprayers and seeding equipment under its agriculture product portfolio and utility vehicles, mowers, snow and debris handling equipment, golf and turf care under its turf equipment portfolio. The segment also offers agricultural management systems technology and solutions that help farmers control costs and improve yields.

We have a price estimate of $100 for Deere, which is about 17.0% above its current market price.

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Food requirements to support the growing population will drive sales of agricultural equipment

The primary factor that will ensure growth in revenue of Deere’s Agriculture & Turf Equipment division is the level of food production that is needed to support the growing population. The global population is expected to grow by another 2 billion by 2050, crossing 9 billion. Population growth will drive demand for food for sustenance, necessitating an increase in agricultural output. The United Nations believes that agricultural production will have to be increased by 60% in order to cater to the additional 2 billion population of the world by 2050. [2] In order to increase agricultural production, farmers will resort to equipment such as tractors, harvesters, sprayers, tilling and seeding equipment. This will help drive growth in sales of agricultural equipment, the market for which is expected to grow at an average rate of 8% through 2018. [3]

Declining crop prices will temper agricultural equipment sales in the short term

In 2013, favorable weather conditions helped drive up production levels of crops such as corn and soybean in the U.S. In 2013, corn production increased 30% and soybean by 8%. [4] The high production levels have forced prices of crops to decline. Currently, corn and wheat are trading at its lowest point since 2010. Given the good weather conditions in Midwest U.S., harvest levels are expected to remain elevated in 2014 as well, which may lead to price declines through 2015. [5] Adding to the problems is the shelf life of crops such as corn. In very cold and dry conditions, corn can be stored for  up to 150 months. [6] If crops can be stored for long periods, high production levels can continue to keep prices depressed for a long time.

Declining crop prices will negatively impact farmers’ income since receipts from corn and soybean alone account for around 50% of crop receipts or 28% of overall commodity receipts. [7]  The USDA forecast a 27% decline in U.S. net farm income in 2014 due to the declining crop prices. [8] As income declines, farmers will be forced to put off or cancel purchase or maintenance of equipment. This will have a significant negative impact on sales of agricultural equipment in the short term. However, farmers’ income is expected to increase post 2015 as the build-up of stocks is utilized to serve consumption requirements.

Given the expected reduction in farmers’ income, Deere expects its fiscal year 2014 revenue from Agriculture & Turf Equipment division to decline by 7% year-on-year.

Sale of business units will have a negative impact on market share and revenue

Deere’s Agriculture & Turf Equipment commands 18% of the global agriculture and turf equipment market. However, moving forward we expect to see a small decline in its market share due to the sale of its John Deere Landscape and Water units. John Deere Landscape generated around $1 billion [9] in revenue for the company whereas John Deere Water generated around $220 million. [10] Deere has retained a 40% equity stake in John Deere Landscape unit whereas it has sold 100% ownership of John Deere Water.

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Notes:
  1. Deere’s 2014 10-K SEC Filing, www.deere.com [↩]
  2. UN warns world must produce 60% more food by 2050 to avoid mass unrest, March 2014, www.rt.com [↩]
  3. Global Agriculture Machinery Market 2014-2018, March 2014, www.marketwatch.com [↩]
  4. Crop Production, www.usda.gov [↩]
  5. U.S. Corn Farmers Face a Cash Crunch, July 24 2014, online.wsj.com [↩]
  6. 2009 Corn Quality Issues – Storage Management, www.extension.iastate.edu [↩]
  7. Cash receipts by commodity rank and share of U.S. total 2012, www.usda.gov [↩]
  8. USDA Projects U.S. Net Farm Income to Decline 27% in 2014, February 11 2014, online.wsj.com [↩]
  9. CD&R Buys John Deere Landscapes in $465 Million Carve-Out, October 28 2013, www.bloomberg.com [↩]
  10. FIMI wins auction for control of John Deere Water, February 17 2014, www.haaretz.com [↩]