Weakness In Agriculture & Construction Equipment To Persist In The Short Term For Deere

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A downturn in the global agriculture industry has led to the weakening of construction equipment market. And this has been impacting the performance of John Deere (NYSE: DE) for the last few quarters, as is evident with the results of Q2 FY 2016. (Fiscal years end with October.)  Revenues for the quarter decreased   4% to $7.9 billion and earnings per share were down by almost 25% to $1.56.  We expect the global agriculture as well as the construction & forestry industries to remain weak at least for the next year and believe that a recovery is likely only post 2017.

Deere claims the global agricultural output needs to nearly double over the first half of the century to support the needs of the expanding global population. To achieve this, the rate of productivity growth must accelerate over recent trend rates. Given Deere’s continued investment in making efficient agricultural equipment, the company should benefit from the long-term growth potential in the market. Additionally, the increasing migration of people from rural areas to urban areas also creates a big opportunity for Deere as it will increase the demand for its construction equipment. In short, the short-term outlook looks weak owing to the declining commodity prices, a slowdown in the Chinese economy and overall low farmer confidence.  That said,  Deere’s long-term growth potential remain strong.

We maintain a bullish stance on Deere’s stock and our price estimate of $94.23 stands at nearly 18% premium to the market.

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See our complete analysis for John Deere

 

Agriculture To Remain Weak Till 2017, Tough We Could See A Revival Therafter

Deere’s agriculture and turf segment sales remained flat year over year at $5.7 billion for the quarter. The company expects the current downturn in the world agriculture and turf equipment industry to persist for another few quarters, owing to the declining commodity prices. Except India, all the major agriculture and turf industries (including US, Brazil, EU-28 and China) are estimated to decline by 10% to 15% in 2016, due to the lower commodity prices, the economic slowdown in China and other short-term uncertainties.

However, the situation may start improving next year as commodity prices  stablizes and population growth drives increased demand. Also, we expect Deere’s market share to increase in the developing markets such as India, which has huge opportunity for growth in the next few years. Deere is focusing on attracting customers in the developing markets, which can help drive growth in its business over the long run.

 

Deere’s Construction and Forestry Business Could Revive In The Next Few Quarters

The global construction equipment industry was down 10% in 2015 from the prior year and the downward trend has continued so far in 2016. Deere’s Q2 2016 construction and forestry equipment net sales were down 16% year over year to $1.37 billion. The decrease was primarily driven by lower shipment volumes, higher sales incentive costs, and an unfavorable product mix. Sluggish economic growth outside the U.S. and availability of used equipment added to the worries. GDP growth and housing starts in the U.S. have also weakened from the past levels.

Deere expects the situation to improve going forward and estimates the global construction equipment market to be flat to up 5% in 2016. Brazil, EU-28 and Canada are expected to start reviving post 2016, leading to more housing starts and increased demand for new equipments. A revival of China’s economy thereafter and Deere’s increasing presence in other developing markets will be pivotal in Deere’s future performance.

 

Strategic Changes To Offset Losses On Lease Residual Values

Deere’s financial services business witnessed a 40% year-over-year decline in its net income in Q2 2016. The steep decline was primarily due to higher losses on lease residual values, less favorable financing spreads, and a higher provision for credit losses.  For its financial services operations, Deere expects a loss provision of about 23 basis points which is below the 10-year average of 26 basis points.

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