After A Massive 3.4x Rise Has Deere & Company Stock Run Ahead Of Its Valuation?

After a massive 3.4x rise from its March 2020 lows, at the current price of $372 per share, we believe that Deere & Company stock (NYSE:DE), appears to be fully valued. DE stock has rallied from $111 to $372 off the March 2020 bottom compared to the S&P which moved 75%. DE stock has outperformed the market due to better than expected quarterly results led by increased demand for Agricultural equipment and a faster rebound in construction equipment demand. However, the stock is up a large 233% in the last one year despite revenue falling 5% y-o-y over the last four quarters. While the gradual opening up of the economy is expected to lead to higher demand for construction equipment, the stock appears to be richly valued when compared to its historical levels, making it vulnerable to downside risk. Our dashboard Buy Or Fear Deere & Company Stock provides the key numbers behind our thinking.

DE stock is also up 150% from the levels of $149 seen toward the end of 2018. Most of the stock price growth since 2018 can be attributed to the expansion of the company’s P/E multiple. Looking at fundamentals, total revenues declined 5% from $37.4 billion in fiscal 2018 to $35.5 billion in 2020, primarily due to the impact of Covid-19 on overall equipment sales. However, a 140 bps expansion of net income margin due to lower taxes, and a 1% drop in total shares outstanding, due to share repurchases, has meant that the company’s EPS actually increased 19% to $8.77 in 2020, compared to $7.34 in 2018.

Given the mixed fundamentals, with a decline in revenue but growth in earnings, this resulted in expansion of the company’s P/E multiple from 20x in 2018 to 31x in 2020. The P/E multiple is currently at 42x, which we believe is high and compares with levels of under 17x seen in 2019 and 20x seen in 2018.

Outlook

The coronavirus crisis induced lockdowns and along with increased unemployment and lower oil & gas demand has adversely affected the overall construction activity, weighing on Deere’s top-line growth in fiscal 2020. However, now with the economy gradually opening up, Deere’s businesses are also seeing an increase in demand. The company reported a solid 23% jump in its top-line in fiscal Q1 2021, led by growth in all segments. While an increased spending on agricultural equipment, primarily small tractors, led to a 27% growth in Small Ag & Turf segment revenues during the quarter, the Construction & Forestry segment also saw sales jump 21% y-o-y, driven by both volume gains and higher price realization. Furthermore, the company’s net income margin grew over 2x to 15.2% in fiscal Q1 2021, compared to 6.8% in the prior year quarter. The margin expansion can partly be attributed to lower R&D and SG&A expenses.

Deere will likely see an increase in demand for its products in the near term, as construction activities gain pace. That said, any further recovery in the economy and its timing hinge on the broader 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.

While Deere’s Q1 performance was great, we believe that the stock has run ahead of its valuations. Currently, investors seem to be buoyed by Deere’s positive revenue and earnings outlook based on the expected recovery in the economic activity, and that appears to be priced in the current stock price of $372. Now, even if we were to look at forward estimated earnings of $15.72 in fiscal 2021, at the current price of $372, DE stock is trading at 24x its 2021 earnings. This compares with levels of around 20x seen over the recent years. Overall, we believe that Deere will see strong revenue and earnings growth going forward, but investors should wait for better levels to enter, and the stock remains vulnerable to downside risk in the near term, going by the valuations.

While Deere stock could see some correction, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for Honeywell vs. Roper Industries.

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