Deere Could See A Turnaround On Long-Term Trends

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Deere (NYSE:DE) has been struggling of late. Its Agricultural and Turf Sales declined 9% year-on-year in fiscal 2014 and 27% in the first quarter of fiscal 2015, as the demand for agricultural equipment tanked. [1] U.S. farms have been generating lower revenues as a result of low prices of crops such as corn, wheat and soybean. Lower farm income has discouraged farmers from purchasing new equipment or repairing existing equipment, leading to a decline in demand for agricultural equipment and spare parts.  However, Deere’s Agriculture and Turf Equipment segment, which contributes 73% of its total revenues, could turn around on a few long-term trends.

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Weakness To Persist In The Short Term

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Given the present conditions, we expect the weakness to persist in the near-term. The U.S. Department of Agriculture (USDA) recently released its forecast of U.S. farm income for 2015. It expects a 32% drop from 2014, to $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 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. Looking at the decline in U.S. and global farm income, Deere forecast a decline of 17% in its fiscal 2015 net sales.

However, in the long run, there is still significant growth potential in the Agriculture and Turf Equipment segment, which should help with a long-term turnaround.

Food Requirements Of Rising Population To Drive Long Term Growth

The primary factor that should drive growth in revenue is the level of food output that will be 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 food and crop demand, 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 people in the world. [4]

In order to increase agricultural output, developing countries such as China and India will move towards mechanization of farm operations in order to increase efficiency, leading to an increase in the use of agricultural equipment such as tractors, harvesters, sprayers, tilling and seeding equipment. Developed countries already use agricultural machinery but are likely to replace existing equipment as technological innovations allow for equipment that operate at lower costs and also help improve yields. These trends are expected to drive the demand for agricultural equipment, the market for which is expected to grow at an average rate of 7% through 2018. [5]

Reduced Production And Layoffs To Help Deere In Short Term

Despite the agricultural equipment headwinds, Deere is confident that it will be 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. [6] 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 through layoffs. Deere cut more than 1000 jobs in 2014, and in January it announced the layoff of 910 workers at its facilities in Iowa and Illinois. [7]

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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. UN warns world must produce 60% more food by 2050 to avoid mass unrest, March 2014, www.rt.com []
  5. World Agricultural Equipment, July 2014, www.freedoniagroup.com []
  6. Deere’s Q1 FY 2015 Conference Call Information Slides, www.deere.com []
  7. Deere Announces Factory Workforce Adjustments, January 23, 2015, www.deere.com []