Deere Earnings Preview: Weak Agriculture Equipment Sales To Weigh On Top Line

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Deere & Co. (NYSE:DE) is set to release its fiscal second quarter earnings on Friday, May 22. We expect to see soft second quarter results, as continued weakness in sales of global agriculture equipment weigh on the company’s top line. It is because of this weakness that JPMorgan recently downgraded Deere, sending the company’s stock down 3.3% on May 15.

The weakness in Deere’s agriculture equipment sales in the second quarter will likely be partially offset by gains at its Construction & Forestry division, which is expected to have grown on the strength in construction activity in the U.S.

In the fiscal first quarter, Deere reported better than expected results despite heavy declines. Its net sales declined 19% year-on-year, to $5.6 billion, 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. On the earnings call, Deere announced revised full year guidance. The company now expects its fiscal 2015 net sales to decline 17%, compared to previous guidance of a 15% decline, 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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Weak Farm Income To Impact Agricultural Equipment Sales

The U.S. Department of Agriculture 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, which together account for around 50% of crop receipts or 28% of overall commodity receipts. [3]

Corn and soybean production has increased significantly in the past two years, driven by favorable production conditions, leading to a decline in their prices. Per the USDA’s estimates, corn prices will decline to an average of $3.50 per bushel in the marketing year 2015, compared to $4.46 per bushel in 2014. [4] The price of soybean is also expected to decline from an average of $13.00 per bushel in marketing year 2014 to $10.00 in 2015. As the prices for these crops continue to fall, farmers’ income will be negatively impacted. The declining farm income limits farmers’ ability to purchase new agricultural equipment or repair existing ones. Given the expectations of weak demand for agricultural equipment, Deere announced its forecast of a 23% decline in Agriculture & Turf revenue for fiscal 2015. [1]

Construction Equipment Sales To Remain Strong

In the previous quarter, Deere’s Construction & Forestry sales grew 13% on the back of a robust U.S. construction sector, as housing starts and construction spending showed strong growth despite tough comparables. We expect to see continued growth in the division in the second quarter as well, given that in the two months ended March 31, construction spending in the U.S. increased 2%. [5] Freddie Mac’s forecast of a 15% increase in housing starts in 2015, compared to a 9% increase in 2014, will also help Deere’s Construction & Forestry sales. [6] However, given its small contribution to the company’s overall revenue, growth in the segment may not be enough to offset the decline in the Agriculture & Turf division.

Reduced Production And Layoffs To Help Deere

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. [7] 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. [8]

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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. Cash receipts by commodity rank and share of U.S. total 2012www.usda.gov []
  4. USDA Agricultural Projections to 2024, February 10, 2015, www.usda.gov []
  5. U.S. Construction Spending, www.ycharts []
  6. April 2015 Economic and Housing Market Outlook, April 8, 2015, Freddie Mac []
  7. Deere’s Q1 FY 2015 Conference Call Information Slides, www.deere.com []
  8. Deere Announces Factory Workforce Adjustments, January 23, 2015, www.deere.com []