Weak Agriculture Equipment Sales Will Likely Temper Deere’s Earnings

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Deere & Co. (NYSE:DE) is set to release its fourth quarter fiscal year 2014 results on November 26. Similar to the trend witnessed in the past few quarters, Deere’s revenue will likely continue to be tempered by poor sales of its Agriculture & Turf division. Deere will be relying on growth in U.S. construction activity to boost its Construction & Forestry division’s sales and somewhat offset the declines in Agriculture & Turf.

In its fiscal third quarter, Deere posted a 5% year-on-year decline in revenue, to $9.5 billion, as a result of weak conditions in the global farm equipment sector, which negatively impacted Agriculture & Turf revenue. However, this was partially offset by gains in Construction & Forestry and the Financial Services business. Net profits and earnings per share declined 14.6% and 8.9%, respectively. Deere revised its revenue guidance further downwards due to continued weakness in the global farm equipment sector. It now forecasts a full fiscal year revenue decline of 6% year-on-year, compared to its previous guidance of 4%. However, Deere revised it net income forecast slightly upwards, from a decline of $3.3 billion to decline of $3.1 billion.

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Declining U.S. Farm Income To Impact Agricultural Equipment Sales

The U.S. Department of Agriculture forecasts farm income to decline by 13.8% in 2014. [1] This is primarily due to the falling prices of crops such as corn and soybean, which together account for around 50% of crop receipts or 28% of overall commodity receipts. [2] Corn and soybean production has increased significantly in the past year driven by favorable production conditions, leading to a decline in their price. Most recently, the USDA released a report forecasting a 3.5% increase in corn output in 2014, even after taking into account the decline in production due to the unfavorable growing conditions this year in states such as Minnesota and Iowa. Soybean output is expected to be 17.9% higher in 2014.

The declining farm income limits farmers’ ability to purchase new agricultural equipment or repair existing ones. Looking at the previous quarter’s results and the continued weakness in crop prices, Deere revised its Agriculture & Turf revenue guidance for the full fiscal year 2014 to a decline of 10%, [3] compared to the previous estimate of a 7% decline. These trends lead us to believe that its fourth quarter revenues will most likely be soft.

Deere’s recently announced production cutbacks in line with expected demand. It is likely that a decline in production may hurt margins due to fixed costs. Deere’s Agriculture & Turf margins have already been under pressure due to implementation costs related to Tier 4 engines, developed in order to ensure compliance with the new emission standards.

Strong Construction Activity To Drive Construction Equipment Sales

Since Deere’s Construction & Forestry revenue is highly correlated to construction spending and housing starts in the U.S., we believe that its fourth quarter construction equipment sales will have likely benefited from the strong construction activity in the past few months. In the three months ended October 31, housing starts grew 12.1% year-on-year. [4] Also, in the two months ended September 30, overall construction spending in the U.S. increased 3.5% year-on-year. [5]

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Notes:
  1. USDA 2014 Farm Sector Income Forecast, www.usda.gov []
  2. Cash receipts by commodity rank and share of U.S. total 2012, www.usda.gov []
  3. Deere’s Third Quarter 2014 Conference Call Information Slides, www.deere.com []
  4. U.S. Housing Starts, www.ycharts.com []
  5. U.S. Construction Spending, www.ycharts []