Deere Earnings Review: Stock Higher On Earnings Despite Weaker Outlook

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Deere & Co. (NYSE:DE) released its second quarter fiscal 2015 results on Friday, May 22, and despite heavy declines, they were better than expected. The company’s diluted earnings per share declined 23% to $2.03, compared to analyst expectations of $1.55. [1] Since the market was expecting a plunge in earnings, the better than expected results helped Deere’s stock gain 4.3% by the end of the day. Deere missed top line expectations by $130 million, as it reported net sales of $7.4 billion.

Similar to the previous quarter, the market did not respond negatively to the weaker outlook for the fiscal year. Deere now expects its fiscal 2015 net sales to decline 19%, compared to its previous guidance of a 17% decline. The change in outlook seems to be largely due to the strong U.S. dollar. Deere has now revised its profit outlook back to $1.9 billion, after having lowered it to $1.8 billion at its previous earnings conference.

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Deere To Continue Churning Through Inventory

As in the previous quarter, Deere’s inventory and receivables declined by a significantly larger amount than the company had earlier forecast. In the second fiscal quarter, Deere reported that it’s Agriculture and Turf division’s inventory and receivables declined by almost $2 billion, as a result of the company’s response to the weakening demand for agriculture equipment. [2] The reduction in inventory might have been a reason behind Deere’s increased operating efficiency, which led to higher than expected earnings. The sale of Deere’s crop insurance business also added to the company’s bottom line.

Deere expects its receivables and inventory to decline by $600 million by the end of fiscal 2015, as compared to its previous estimates of a $100 million increase. 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.

Agricultural Equipment Sales Weak On Low Farm Income

In the second fiscal quarter, Deere reported a 25% 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. Deere’s sales were also offset by strong foreign currency headwinds.

Though the decline in agriculture equipment sales has slightly moderated in the second quarter, we expect to see it continue through the year. 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. [3] 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. [4] 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 continue to pressure Deere’s Agriculture and Turf equipment sales, which are now forecast to decline 24% in fiscal 2015, compared to the previous forecast of a 23% decline.

Construction Equipment Sales To See Growth

Deere’s Construction and Forestry segment’s performance was sluggish in the second fiscal quarter. The division’s sales grew 2% on the back of a robust U.S. construction sector, partially offset by strong foreign currency headwinds. In the two months ended March 31, construction spending in the U.S. increased 2%. [5] Housing starts surged to a seven year high in April, after having declined in February and March due to weather related reasons. [6]

The outlook for Deere’s Construction and Forestry division’s performance in FY2015 looks good, given that Freddie Mac forecasts a 15% increase in housing starts in 2015, compared to a 9% increase in 2014. [7] Taking into account foreign currency headwinds, Deere revised its revenue outlook for the segment to a 2% increase in fiscal 2015, compared to previous estimates of 5%. However, given the division’s 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.

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Notes:
  1. Deere’s Q2 FY 2015 Media Release And Financials, www.deere.com [] []
  2. Deere’s Q2 FY 2015 Conference Call Information Slides, www.deere.com []
  3. U.S. and State-Level Farm Income and Wealth Statistics, February 10, 2015, www.usda.gov []
  4. USDA Agricultural Projections to 2024, February 10, 2015, www.usda.gov []
  5. U.S. Construction Spending, www.ycharts.com []
  6. U.S. Housing Starts, www.ycharts.com []
  7. April 2015 Economic and Housing Market Outlook, April 8, 2015, Freddie Mac []