Deere Earnings: Better Than Expected Results Overshadow Weaker Outlook

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Deere & Co. (NYSE:DE) released its first quarter fiscal 2015 earnings on Friday, February 20, which were better than expected despite heavy declines. Deere reported net sales of $5.6 billion, a decline of 19% year-on-year, compared to analyst expectations of $4.9 billion. [1] Its diluted earnings per share declined 38% to $1.12, compared to analyst expectations of $0.83. Since the market was expecting a plunge in earnings, the better than expected results helped Deere’s stock gain nearly 1% by the end of the day.

As expected, the primary driver behind the decline in revenue and earnings was Deere’s Agriculture and Turf division. Though the Construction and Forestry, and Financial Services divisions were positive, it was not enough to offset the decline in agricultural equipment sales.

Unlike the previous quarter, the market did not respond negatively to the weak earnings outlook for the fiscal year. Deere now expects its fiscal 2015 net sales to decline 17%, compared to previous guidance of a 15% decline. The change in outlook seems to be largely due to the strengthening U.S. dollar. Deere also expects its net income to reach $1.8 billion, compared to previous expectations of $1.9 billion.

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Weakness In Agricultural Equipment Demand To Continue

In the first quarter, Deere reported a 27% year-on-year drop in sales of its Agriculture and Turf equipment division, as it continued to be plagued by declining sales of its agricultural equipment. [1] Low crop prices across the globe, driven by bumper crop output in 2013 and 2014, have been severely impacting farmers’ income, discouraging them from purchasing new agricultural equipment or repairing existing equipment.

The U.S. Department of Agriculture (USDA) recently released its forecast of U.S. farm income in 2015. It expects a 32% drop from 2014, to reach $73.6 billion, the lowest since 2009. [2] This is primarily due to the falling prices of crops such as corn and soybean. Per the USDA’s estimates, corn prices will decline to an average of $3.50 per bushel in marketing year 2015, compared to $4.46 per bushel in 2014. [3] Soybean prices are expected to decline from an average of $13.00 per bushel in marketing year 2014 to $10.00 in 2015. The decline in price will likely continue to pressure Deere’s Agriculture and Turf equipment sales, which are now forecast to decline 23%, compared to the previous forecast of a 20% decline.

Reduced Production And Layoffs To Help Deere

Despite the agricultural equipment headwinds, Deere is confident about being able to sail through these turbulent times. The confidence stems from Deere’s quick response to the softening agricultural equipment demand, which involved reducing production and clearing out existing inventory.  As a result, Agriculture and Turf inventory declined by $1.4 billion in the first quarter, compared to an earlier forecast of $525 million. [4] However, it is likely that a continued decline in production may hurt margins due to higher per unit fixed costs as the division may be operating at less than 80% of normal volumes.

Deere has also been relying on cutting costs by layoffs. Deere had cut more than 1000 jobs in 2014 and in January, it announced the layoff 910 workers at its facilities in Iowa and Illinois. [5]

Construction Equipment Sales To Continue On Growth Path

Deere’s Construction and Forestry segment was the highlight of its first quarter earnings. The division’s sales grew 13% on the back of a robust U.S. construction sector, wherein housing starts and construction spending have shown strong growth. In the three months ended January 31, housing starts grew 4% year-on-year. [6] Also, in the two months ended December 31, overall construction spending in the U.S. increased 2% year-on-year. [7]

The outlook for the division’s performance in FY2015 looks good, given the National Association of Home Builders’ forecast of a 16% increase in housing starts in 2015, compared to an 8% increase in 2014. [8] Also, despite foreign currency headwinds, Deere maintained its forecast of 5% increase in Construction and Forestry sales for fiscal 2015.

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Notes:
  1. Deere’s Q1 FY 2015 Media Release And Financials, www.deere.com [] []
  2. U.S. and State-Level Farm Income and Wealth Statistics, February 10, 2015, www.usda.gov []
  3. USDA Agricultural Projections to 2024, February 10, 2015, www.usda.gov []
  4. Deere’s Q1 FY 2015 Conference Call Information Slides, www.deere.com []
  5. Deere Announces Factory Workforce Adjustments, January 23, 2015, www.deere.com []
  6. U.S. Housing Starts, www.ycharts.com []
  7. U.S. Construction Spending, www.ycharts []
  8. Housing and Interest Rate Forecast, February 2015, www.nahb.org []