Deere and Caterpillar Will Continue To Feel The Demand Pressure

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Deere (NYSE: DE) and Caterpillar (NYSE: CAT) saw a decline in their revenues in the last couple of years, and this trend continued in the first quarter of 2016. Much of this can be attributed to weakened demand resulting from declining crude oil prices and economic slowdown in China. Commodity prices greatly influence Deere’s agricultural equipment business, which accounts for nearly 70% of the company’s total revenues. The prices have remained suppressed since 2013 and we do not expect the situation to change anytime soon. The U.S. and the Gulf countries are have not given any concrete indications to address the oil supply glut. Additionally, the construction industry is expected to remain weak for at least a year as Chinese economic growth remains relatively low. However, the long term demand for both agriculture and construction equipment remains strong because of growing world population and migration of people from rural to urban areas. We have priced in these expectations in our valuation for these companies. Our price estimate for Deere stands at $94.26, implying nearly 15% premium to the market. Additionally, our price estimate for Caterpillar stands at $80.11, roughly in-line with the market.

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Why are revenues of Deere and Caterpillar falling?

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The fall in Deere’s and Caterpillar’s revenues can be primarily attributed to the decline in commodity prices and economic slowdown of China. The fall in oil prices has led to lower commodity prices worldwide, thus resulting in lower farm incomes. As a result, the demand for agricultural and turf equipment has declined. About 70% of Deere’s sales come from Agriculture and Turf equipment segment. Geographically, North America accounts for nearly 65% sales and the rest is distributed in Latin America, Europe, Asia and Africa. Deere’s dependence on China is not significant, and the impact of the economic slowdown has been limited. However, about 20% of Caterpillar’s sales come from Asia Pacific, thus implying a meaningful exposure to Chinese economy.

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See our complete analysis for CaterPillar

What is the outlook for 2016 and 2017?

We expect both Deere and Caterpillar to continue to feel topline pressure from market forces, and we do no expect any revival in their revenue growth for at least 2 quarters.

Crude oil price have increased almost 37% since Q1’16 due to a range of factors such as production cuts in the U.S., geopolitical disturbances in Venezuela and Nigeria, and a wild-fire in Alberta, Canada. However, we believe that crude oil prices will not be able to bounce back to 2014 level for at least next one to two years. China, one of the biggest oil consumer in the world, witnessed a slowdown in their oil demand in the last couple of years and is expected to continue for the next few quarters. As a result, Commodity prices are still expected to be low, which will continue to impact earnings of Deere and Caterpillar negatively. Construction industry is also expected to remain weak following the United Kingdom’s vote in favour of Brexit which has created some uncertainties in European market. However, these markets will eventually be driven by long term fundamentals of increasing population, urbanization and energy consumption.

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively.

For precise figures, please refer to our complete analysis for Deere & Company and Caterpillar.

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