USDA Corn Output Cut Unlikely To Have An Impact on Deere’s Agricultural Equipment Sales

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Deere’s (NYSE:DE) Agricultural and Turf Equipment segment has been under pressure because of the weak agricultural equipment environment. Prices of crops such as corn, soybean and wheat in the U.S. have been declining for some time due to the significant gap between supply and demand created by the strong harvest in late 2013 and first half of 2014. This has negatively impacted U.S. famers’ income, thereby reducing their purchasing power. Low income levels have pushed farmers to delay purchase of new agricultural equipment such as tractors and harvesters, and also led to fewer maintenance and repairs of such equipment. Deere’s sales of agricultural equipment have been declining year-on-year in 2014 due to this trend.

Given that the U.S. Department of Agriculture (USDA) has been revising upwards its crop production forecast for corn for quite some time, prices were expected to continue to decline in 2014 and 2015. However, according to its crop production report released on November 10, the USDA is now forecasting lower production levels of corn. Deere’s stock price jumped from $88.02 to $89.15 after the release for the USDA report and ended the day at $88.53. Though investors have taken the news in a positive manner, the question that arises is whether or not the lowered production forecast will have any substantial impact on Deere’s near term earnings.

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USDA lowers forecast for corn production on account of unfavorable growing conditions

In October, the USDA had raised its forecast for annual corn production to 14.475 billion bushels, making it the third consecutive increase. [1] However, in its November report, the USDA trimmed its corn production estimate to 14.407 billion bushels. Analysts were expecting another upward revision.

Though the USDA had not cited any specific reason for the downward revision, we believe that this may have been because of the unfavorable growing conditions in states such as Minnesota and Iowa. These regions had suffered due to heavy rains just after planting the crop in May, followed by a long dry spell. The USDA lowered its corn output forecast for Iowa, which is the largest corn producing state in the U.S., from 2.442 billion bushels to 2.415 billion bushels.

The Chicago Board of Trade U.S. Corn futures for December 2014 rose 0.5% on November 10, following the cut in output forecast. [2]

Deere’s near-term sales will likely continue to decline on higher year-on-year crop output

Though the estimated corn output for 2014 has been lowered, it still remains 3.5% higher than the 2013 output, which is high enough to keep corn prices low. Additionally, soybean prices are likely to remain low given an expected 17.9% increase soybean production in 2014. These two commodities, which together account for 50% of crop receipts or 28% of overall commodity receipts, should therefore continue to temper farmers’ incomes in 2014. [3] We believe that because of the lower farmer income, Deere’s agricultural equipment sales will likely continue to suffer in the short term.

Long term outlook is positive

Though the agricultural equipment market in the U.S. is expected to remain weak in 2014 and 2015, there have been indications that suggest a possible turnaround in the longer term. Rising demand for corn and lower inventory levels could help boost corn price and raise farmers’ incomes.

  • The USDA has lowered its ending corn reserves from 2.081 billion bushels to 2.008 billion bushels. [1] This indicates a higher demand for corn. If this demand continues to increase, then it is possible that it may narrow the demand-supply gap that forced corn prices to decline, leading to an increase in corn price.
  • Low corn prices have encouraged an increase in ethanol production. Ethanol production has increased from an average of 868,000 barrels per day in 2013 to 928,000 barrels per day by the end of August 2014. [4] If ethanol production continues to rise at the same rate, it is likely to create higher demand for corn, which in turn could underpin corn prices.

Deere’s agricultural sales could benefit from the increase in corn prices since it directly impacts farmers’ income and purchasing power. However, there is still a long way to go before corn prices begin to show a substantial increase that could help Deere’s sales

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Notes:
  1. Crop Production, November 10, 2014, www.usda.gov [] []
  2. Corn Futures Quotes, www.cmegroup.com []
  3. Cash receipts by commodity rank and share of U.S. total 2012, www.usda.gov []
  4. Monthly U.S. Fuel Ethanol Production/Demand, www.ethanolrfa.org []