Deere Earnings: Strong Business Fundamentals, Cost Cutting Pay Off For Deere

Deere (NYSE: DE) recently reported its second quarter fiscal 2017 earnings, beating consensus EPS estimate by nearly 45%. Although its overall revenues grew by just 5% this quarter, net income and EPS were up nearly 60% due to the company’s cost cutting measures. The agriculture industry in North America remained weak last year, and the situation is expected to persist in 2017. However, the South American markets are expected to rebound due to record acreage expansion and yield expectations in Brazil and Argentina. We also remain optimistic about the fundamentals behind construction industry growth in North America including positive GDP growth, job growth, the expected surge in government spending and more housing starts this year. Deere’s expansion in emerging economies such as China and India is also fetching strong results for the company amid the slowdown in developed markets.

Oil prices remain volatile, which poses a risk to Deer’s construction business. Additionally, Chinese stock of grains, which now represents almost half of the world’s stock, also presents a risk for global agriculture industry as it is unlikely to be exported. This implies that the world market remains sensitive to major production setbacks, geopolitical disruptions or trade disputes.

Construction & Forestry Sales Rebound 

Deere’s construction and forestry sales were up by 7% in Q2 and the increase came in at a time when the industry witnessed huge declines in the last couple of years due to geopolitical risks such as Brexit and slow economic growth of advanced economies. Deere’s growth in construction sales this quarter was primarily the result of rebound in oil and gas prices, the decline in used inventory and higher shipments from Asia Pacific. China’s real estate prices increased in the last few months due to strong government support for housing and infrastructure projects which triggered Deere’s sales from the region. Deere’s customer base extension via its diversified offerings also contributed to its growth this quarter. Deere’s construction industry sales are expected to go up further as the North American construction industry is also expected to revive in the coming quarters due to positive GDP growth, job growth in the region, high infrastructure spending by the U.S. government and more housing starts.

However, the sales growth was not the most notable thing in Deere’s Q2 earnings. Deere’s operating profits from its construction and agriculture sales grew by nearly 45% and 65% respectively. The momentous increase was primarily the result of cost cutting and operational efficiency steps taken by Deere in the last one year. It also benefited from the sale of its partial interest in SiteOne and the cost savings from voluntary employee separation plans. We expect these to continue to deliver results for Deere in the short term while the agriculture industry downturn stabilizes.

Strong Rebound In South American Farm Industry Paves Way For Short Term Growth

The North American agriculture industry downturn is continuing in 2017 due to a record harvest last year and lower food commodity prices. However, the commodity prices have improved in the last couple of quarters due to OPEC deal to cap oil production which resulted in improved oil prices. We expect the commodity prices to improve further as OPEC members are planning to extend the cap for another couple of quarters. Deere’s agriculture equipment sales were also helped by a more diverse product offering, its growth in China and India and favorable price realization.

Although the North American farm sector is expected to remain flat to negative, the strong rebound in the South American agriculture industry will be the key growth driver for Deere in the coming quarters. The production of Soybeans and corn in South America is expected to be very high this quarter, which is likely to generate high farm incomes. In Brazil, Deere expects the agriculture production to increase about 9% in 2017 in U.S. dollar terms due to record acreage expansion and yield expectations. This is expected to result in about 20% increase in sales of tractors and combines in 2017 driven by positive industry sentiment in Brazil and Argentina.

For more information, please refer to our complete analysis for Deere

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