What’s Happening At Deere?

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Deere

The stock price of Deere & Company (NYSE: DE), the largest farm equipment company in the world, has seen a growth of a mere 5% since the end of 2017, compared to roughly 15% growth for S&P500. But what went wrong for the company to see such underperformance, despite revenue growth of 32% between 2017 and 2019? As it turns out, the investors have revised their expectations for future earnings growth from the company, first due to the trade war last year, and now due to the impact of the Covid-19 crisis on the construction and agriculture sector. Our dashboard on Deere Revenues And Stock Price Change Mismatch provides the key numbers behind our thinking, and we explain more below.

What Brought About A Change In Earnings And Multiple?

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The 32% growth in Deere’s Revenues between 2017 and 2019 was largely led by the Wirtgen acquisition and higher volumes, due to the overall economic growth and robust U.S. housing market over this period. That said, 2019 wasn’t a great year for Deere, given the impact of trade tensions on agriculture and, in turn, on Deere’s business.

Deere’s net margins expanded 100 bps from 7.3% to 8.3% over the same period, primarily driven by a lower effective tax rate, which declined from 31% in 2017 to 21% in 2019. This can be attributed to the tax reforms in 2017. The combination of margin expansion and strong revenues growth has meant that earnings per share grew a strong 52% from about $6.76 per share in 2017 to $10.28 a share in 2019.

Deere’s stock price change can be explained by two factors: 1) Change in EPS and 2) Change in P/E Multiple. Though the company’s earnings grew a strong 52%, its P/E Multiple has seen a meaningful decline from around 22x in early 2018 to about 15x currently. There are two factors that impacted Deere’s multiple over the recent years. Firstly, trade tensions particularly between the US and China has impacted the exports and income for farmers, which, in turn, led to lower spending on farm machinery. Finally, the global spread of coronavirus this year has led to lockdown in various cities across the globe, which has affected industrial and economic activity. The U.S. economy contracted by close to 5% in Q1 and is expected to see a sharper decline in Q2. Deere is likely to see lower demand for its construction as well as farming equipment. Construction activity is expected to be sluggish in 2020, due to lockdowns in several cities. Other than construction, the company’s farming equipment is also expected to face headwinds in 2020, given the decline in consumer spending, which will likely impact the agricultural produce pricing.

However, Deere does appear attractive compared to its own historical multiple. Over the coming weeks, we expect continued improvement in demand and subdued growth in the number of new Covid-19 cases in the U.S. to buoy market expectations. Following the Fed stimulus — which helped calm markets — investors have been willing to “look through” the current weak period and take a longer-term view. With investors focusing their attention on 2021 results, the current valuations vs historic valuations become important in the search for value. Considering this, we think there is a possibility for the P/E multiple for Deere to return to levels of over 19x, midpoint of the range seen over the recent years.

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