The Year In Review: Deere’s Sales Declined But Operating Efficiency Boosted Its Stock Price

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The year 2016 was a mixed one for the heavy equipment manufacturer Deere & Company (NYSE: DE). While the revenues for all the industrial segments of Deere declined, its stock price surged by more than 20% in 2016. This can be primarily attributed to both an increase in Deere’s net income from its agriculture and turf equipment division and improved operating efficiency. Weakness in commodity prices continued in 2016, due to the record harvest of U.S. farmers. Deere’s sales from Europe also declined due to the economic uncertainties caused by Brexit vote in the region. There were no major mergers and acquisitions this year, however, the U.S. Department of Justice opposed the acquisition of Monsanto’s precision planting business which was announced in November 2015. The recent OPEC deal to cut production is likely to result in increased commodity prices globally in the coming quarters, which in turn should boost Deere’s equipment sales.

 

Deere’s Stock Price Went Up Despite Continued Losses in 2016

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Deere’s revenues declined nearly 7.5% in 2016 compared to the 18% decline in 2015, primarily due to the continued downturn in agriculture and construction equipment industry. However, despite the decline in revenues, Deere’s stock price rose by about 20% in 2016 due to company’s improved income from its restructuring and cost cutting efforts. U.S. farm incomes in 2016 were lowest since 2009, due to a surge in corn and soybean production this year. Construction industry sales also declined due to weaker construction activity in China and Europe. These in turn were the result of lower commodity prices, the economic slowdown of China, uncertainty caused by the Brexit vote earlier in 2016 and pricing pressure from competitors.

So what changed this year? First, the revenue decline in Deere’s industrial segments slowed down in 2016 due to improvement in crude oil prices in the first half of 2016. Second, Deere’s net income from agriculture and turf equipment increased in 2016 due to Deere’s restructuring and cost-cutting measures this year. Third, construction equipment sales declined massively due to economic uncertainties such as Brexit vote and weakness in China. Fourth, the OPEC deal was reached in order to cap their oil production in November which led to the increase in crude oil prices above $50 for the first time since August 2015. Fifth, the U.S. Department of Justice opposed Deere’s acquisition of Monsanto’s Precision Planting business, which was announced in 2015.  The DOJ views this deal as a threat to other smaller precision planting companies and U.S. farmers, who may have to pay higher prices going forward due to reduced competition.

 

Low commodity prices continued due to Good harvest in 2016

About 66% of Deere’s Agriculture equipment sales comes from North America and the downturn in the agriculture equipment industry due to weak farmer sentiment and lower commodity prices continued in 2016. Bountiful harvests and depressed prices added to the multiyear downturn in commodity prices leading to stiff export competition. The Association of Equipment Manufacturers reported that sales of the agricultural tractor and combines have declined by 10-20% in last 3 months in both the U.S. and Canada. Lower commodity prices also resulted in nearly 24% decline year on year in the export of U.S. made construction equipment in the first half of 2016. However, with the OPEC deal finalized in November 2016, oil prices are expected to go up in the coming months and that may increase commodity prices globally.

 

Silver Linings: Deere’s EBITDA beat our expectation

Deere’s operating profit from its agriculture and turf equipment segment increased by 3% in 2016 despite declining revenues. Deere leveraged its existing supplier relationships, reducing product-related costs and implementing workforce reduction programs such as voluntary retirement in order to cut down costs. Deere plans to save around $500 million by the end of 2018 through its structural cost reductions and has already saved $90 million in 2016. Thus, we believe that Deere will be able to generate profits for its shareholders despite the continued downturn in agriculture and construction industry.

We will follow up this analysis with the expectations for 2017, and how our valuation fits in that. Meanwhile, please let us know your views by commenting in the box below.

 

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.

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