Deere Could Turnaround On Long Term Agricultural Equipment Sales

August 28th, 2014 by Trefis Team
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Deere’s (NYSE:DE) third quarter fiscal year 2014 earnings (fiscal year ends October 31) declined 5% due to weak farm equipment demand. [1] Deere’s sales of agricultural equipment fell in response to declining crop prices such as corn and soybean, which have led to reduced farm incomes. Given the present conditions, Deere decided to cut down production to bring it in line with current market demand. Deere also cut down its revenue guidance for the fiscal year 2014 citing the weak farm equipment demand. Earlier, it had forecast revenues to decline 4% year-on-year, but now expects to see a 6% year-on-year decline. Additionally, the company lowered its net earnings forecast from $3.3 billion to $3.1 billion.

We believe that Deere’s weak performance could turnaround driven by the long term growth potential of its Agriculture & Turf Equipments segment. Also, strong growth in the U.S. housing and construction market should aid in offsetting the present revenue declines.

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Weak farm equipment demand pushes Deere to lay off workers and shutdown plants

Prices of crops such as corn, soybean and wheat are trading at its lowest since 2012 due to high production levels enabled by favorable weather conditions. [2] [3] [4] Decline in the price of these crops negatively impacts farmers’ income since receipts from corn and soybean alone account for around 50% of crop receipts or 28% of overall commodity receipts. [5] With price of major crops at their lowest in the past two years, farmers are becoming increasingly conservative in their capital spending, which includes purchase and repair of farm equipments. This has led to a decline in Deere’s sales of agricultural equipment.

The low grain price environment in the U.S. is expected to continue through 2014 and 2015, on account of record-high corn and soybean production expectations this year. [6] The USDA forecast a 27% decline in U.S. net farm income in 2014 due to the declining crop prices. [7] Deere expects to see weak farm equipment markets in Europe and South America as well due to similar reasons. The company has therefore decided to scale back production of its agricultural equipment in line with the expected demand.

On August 15, Deere announced it will be laying off more than 600 workers at four of its plants in Midwest U.S. in order to reduce production. [8] This included plants at John Deere Harvester Works, East Moline, IL; John Deere Seeding and Cylinder, Moline, IL; John Deere Des Moines Works, Ankeny, IA; and John Deere Coffeyville, Coffeyville, KS. In addition to the indefinite layoffs, the company will be implementing seasonal and inventory adjustment shutdowns and temporary layoffs at these factories. A week later, Deere announced indefinite layoffs of another 460 workers at its plant in Waterloo. [9]

It is likely that a decline in production will hurt margins due to loss of economies of scale. Agriculture & Turf margins are already under pressure due to implementation costs related to Tier 4 engines, developed in order to ensure compliance with the latest emission standards. The segment’s margins are expected to decline 2 percentage points in the fiscal year 2014, to reach 14% due to these trends.

Deere’s Agriculture & Turf Equipments segment is a long term growth driver

We believe that the weakness in global farm equipment demand will be short lived and Deere’s Agriculture & Turf Equipment revenue will soon grow. The primary factor that will ensure growth in revenue 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. [10] 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. [11]

Construction equipment sales should partially offset decline in Deere’s revenue

We believe that strong U.S. housing and construction market should provide some relief to Deere from the poor agricultural equipment sales. Driven by strong year-on-year construction and housing activity in the U.S., Deere’s Construction & Forestry segment posted 19.4% year-on-year growth in the third quarter fiscal year 2014. Construction spending was up 8% and 5.5% year-on year in the months of May and June respectively. [12] Housing starts were up 7.5%, 7.6%, and 21.7% in the months of May, June and July respectively. [13]

We expect the U.S. housing and construction market to continue to grow in the coming years driven by favorable macroeconomic factors, which includes declining lending rates and addition of jobs in the construction sector, and increase in new housing permits.

  • According to Freddie Mac, the average rate for a 30-year fixed-rate mortgage declined to 4.13% in July from 4.43% in January and 4.37% in July last year. [14] Low mortgage rates will make purchase of homes more affordable for potential buyers.
  • Addition of jobs in the construction sector is a good indicator of housing construction companies’ outlook. In the quarter ended July 31, 41,000 jobs were added in the construction sector, more than double the jobs added in the same quarter of the previous year. [15]
  • New building permits increased 8.1% to reach 1.052 million in the same month, indicating healthy demand for new homes. [16]

Continued growth in U.S. housing market will help drive demand for construction equipment, which in turn should boost Deere’s Construction & Turf Equipment revenues.

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Notes:
  1. Deere’s Third Quarter 2014 Media Release and Financials, www.deere.com [↩]
  2. US Corn Farm Price Received Chart, www.ycharts.com [↩]
  3. US Soybean Price, www.ycharts.com [↩]
  4. US Wheat Price Received, www.ycharts.com [↩]
  5. Cash receipts by commodity rank and share of U.S. total 2012, www.usda.gov [↩]
  6. USDA Forecasts Record-High Corn and Soybean Production in 2014 Cotton Production also Up from 2013, August 12 2014, www.nass.usda.gov [↩]
  7. USDA Projects U.S. Net Farm Income to Decline 27% in 2014, February 11 2014, online.wsj.com [↩]
  8. Deere Announces Factory Layoffs, August 15 2014, www.deere.com [↩]
  9. Deere Announces Waterloo Layoffs, August 22 2014, www.deere.com [↩]
  10. UN warns world must produce 60% more food by 2050 to avoid mass unrest, March 2014, www.rt.com [↩]
  11. Global Agriculture Machinery Market 2014-2018, March 2014, www.marketwatch.com [↩]
  12. U.S. Construction Spending, www.yahoo.com [↩]
  13. U.S. housing starts, www.yahoo.com [↩]
  14. 30-year fixed-rate mortgages since 1971, www.freddiemac.com [↩]
  15. Employment Situation, August 1 2014, www.bls.gov [↩]
  16. U.S. New Housing Permits, www.yahoo.com [↩]