Declining Grain Prices Will Temper Deere’s Earnings

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Deere & Co. (NYSE:DE), an agricultural and construction equipment manufacturer, is set to release its third quarter fiscal year 2014 (fiscal year ends October 31) on August 13. We expect to see continued decline in its Agriculture & Turf division driven by declining grain prices. However, this should be partially offset by gains at its Construction & Forestry division.

In the second quarter fiscal year 2014, Deere reported revenue of $9.9 billion, a 9% decline over the previous fiscal year’s second quarter. [1] The decline was primarily driven by the low sales volume of its Agriculture & Turf equipments, partially offset by single-digit revenue growth at its Construction & Forestry division. The sell-off of John Deere Landscapes and currency translation effects also contributed to the decline.

Given the performance in the second quarter, the company revised its revenue guidance for the fiscal year 2014. It now forecasts revenue to decline 4%, compared to the previous guidance of a 3% decline, primarily due to a higher expected decline in revenue from its Agriculture & Turf division.

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We have a price estimate of $100 for Deere, which is about 15% above its current market price.

Declining grain prices will continue to impact Agriculture & Turf revenue

At present, corn, soybean and wheat are trading at its lowest point since 2012. [2] This is because of the high grain production levels in 2013, which created an imbalance between supply and demand, leading to a decline in grain prices. Declines in corn and soybean prices have a major impact on farmers’ income since receipts from corn and soybean alone account for around 50% of crop receipts or 28% of overall commodity receipts. [3] The USDA forecast a 27% decline in U.S. net farm income in 2014 due to the declining crop prices. [4]

As income declines, farmers are forced to put off or cancel purchase or maintenance of agriculture equipment. This trend has had a significant impact on Deere’s Agriculture & Turf Equipment revenue, which declined 12% in the second quarter fiscal year 2014. [1] We expect Agriculture & Turf revenues to continue to decline in the third quarter driven by the same trend.

Strong housing and construction activity will help drive Construction & Forestry revenue

Deere’s Construction & Forestry revenue is highly correlated to construction spending and housing starts in the U.S. Since the recession in 2008, construction and housing activity have improved considerably, driving growth at Deere’s Construction & Forestry division. In the previous quarter, revenue from the segment was up 2%. [1]

Construction and housing activity has been somewhat depressed in 2014 due to bad weather conditions. Despite the slowdown, construction spending and housing starts were higher than their year-on-year numbers. U.S. construction spending was up 8% and 5.5% year-on year in the months of May and June respectively. [5] Housing starts were up 7.5% and 7.6% in the months of May and June respectively. [6] This should help Deere’s Construction & Forestry division post growth in the third quarter fiscal year 2014.

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Notes:
  1. Deere’s Second Quarter 2014 Media Release and Financials, www.deere.com [] [] []
  2. U.S. Corn Farmers Face a Cash Crunch, July 24 2014, online.wsj.com []
  3. Cash receipts by commodity rank and share of U.S. total 2012, www.usda.gov []
  4. USDA Projects U.S. Net Farm Income to Decline 27% in 2014, February 11 2014, online.wsj.com []
  5. U.S. Construction Spending, www.yahoo.com []
  6. U.S. housing starts, www.yahoo.com []