After A 2x Rally Deere & Company Stock Looks Expensive

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Deere

Deere & Company stock (NYSE: DE) is up 32% since the start of the year and it has gained over 2x from its March lows. Deere faces downside risk as the company’s revenues in the last two quarters have declined by 15%. The ongoing Covid-19 crisis and the economic uncertainty is likely to result in lower demand for its Construction & Forestry equipment. This is likely to impact the revenue growth rate of the company – leading to a drop in the stock price.

Following a large 2x rise since the March 23 lows of this year, at the current price near $233 per share, we believe DE stock has reached its near term potential. DE stock has rallied from $111 to $233 off the recent bottom compared to the S&P which moved 53% over the same time period. Better than expected demand for agricultural equipment has helped the stock in beating overall markets. Moreover, the stock is up 50% from levels seen in early 2018, over two years ago. DE stock has fully recovered to the level it was at before the drop in February due to the coronavirus outbreak becoming a pandemic, and it is now 32% above the pre-Covid highs. This seems to make it fully valued as, in reality, demand and revenues will likely be lower this year than last year. Our dashboard ‘Buy Or Sell Deere & Company Stock’ provides the key numbers behind our thinking, and we explain more below.

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Some of the stock price rise over the last 2 years is justified by the roughly 32% growth seen in Deere revenues from $29.7 billion in 2017 to $39.3 billion in 2019. This combined with a 13.6% growth in the company’s net income margin, helped its earnings grow by 50% over the same time period, providing a boost to the company’s stock price. Overall, earnings on a per-share basis grew by 52% as shares outstanding decreased by 1.9% due to repurchases.

Finally, Deere’s P/E ratio decreased from 23x in 2017 to 17x in 2019. While the company’s P/E has now increased to 23x, it seems to be trading much higher compared to the levels seen over the recent years, P/E of 20x in 2018, and P/E of 17x as recently as late 2019. We believe there is a possible downside risk for Deere’s multiple, and the stock is unlikely to see much upside after the recent rally and the potential weakness from a recession-driven by the Covid outbreak.

How Is Coronavirus Impacting Deere Stock?

The global spread of coronavirus has affected industrial and economic activity across the world, including Deere, as demand for agriculture as well as construction equipment has declined. This resulted in Deere taking a hit when the pandemic started. That said, now with economies gradually opening up, there has been an increase in demand for Deere’s equipment. For Q3 though, total revenues were down 11% to $8.9 billion while earnings declined only 8.5% (slower than revenue decline) to $2.57 per share, led by margin expansion due to lower SG&A and R&D costs.

Diving into the individual segments, Construction & Forestry saw the largest impact with sales down 28% to $2.8 billion, due to lower demand for the oil & gas sector after massive price erosion in oil prices in 2020. Construction & Forestry segment is expected to remain weak in the near term, with the company guiding for a 20% drop in sales for the full year, and this leads us to believe that the stock is currently overvalued. In fact, overall revenues are estimated to decline 14% to a little over $30 billion, while earnings are estimated to be $7.55 on a per share and adjusted basis for the full year 2020, much lower than the $9.94 figure reported in 2019. Not only is the impact on revenues and earnings high when compared to the previous year, the recent rally in the stock has meant an expensive valuation multiple for DE stock, making it vulnerable to downside risk. At the current price near $233, DE stock is trading at 31x its 2020 expected EPS of $7.55, compared to levels of 17x seen in 2019, making it vulnerable to downside risk.

Looking at the broader economy, the actual recovery and its timing hinge on the containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. Following the Fed stimulus — which set a floor on fear — the market has been willing to “look through” the current weak period and take a longer-term view. With investors focusing their attention on 2021 results, the valuations become important in finding value. Though market sentiment can be fickle, and evidence of an uptick in new cases could spook investors once again.

What if you’re looking for a more balanced portfolio instead? Here’s a high-quality portfolio to beat the market, with over 100% return since 2016, versus 55% for the S&P 500. Comprised of companies with strong revenue growth, healthy profits, lots of cash, and low risk, it has outperformed the broader market year after year, consistently.

 

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