Timing is everything — and for Deere & Company (NYSE:DE), its second quarter financial release couldn’t have come at a worse time.
On August 18th, the agriculture and construction machinery maker crushed Wall Street’s Q2 earnings per share (EPS) estimate by nearly $2.00. Despite the beat, Deere’s fourth in a row, its share price dipped below $400 in a down market. Had the announcement happened a few weeks earlier (instead of during what’s likely to be the S&P 500’s worst month of 2023), the reaction may have been much different.
Instead, the market brushed aside an impressive quarterly report highlighted by growth across all four businesses, 62% year-over-year profit growth and significant margin expansion. Oh, and management raised its full year outlook for a third time.
But with interest rate fears dictating investor sentiment, Deere’s stock has retreated some $60 from last month’s all-time high. Analyst remarks around a potential ‘agriculture peak’ have also factored into the dip. According to some, farm equipment sales are bound to slow as the hot industry cools.
Most analysts have adjusted their price targets — some upward, others downward — sending mixed messages to investors. What is a clear signal, however, is that no one downgraded the stock to hold or sell. Translation: Deere’s latest correction is an opportunity.
#1 - Farm Commodity Prices Are Trending Higher
Prices of most agricultural commodities have trended higher this year even though there have been several dips along the way. With prices trending up in recent days, the latest dip is looking like another blip in a longer term uptrend.
The combination of healthy global demand for food inputs and more frequent adverse weather events that limit supply could continue to be a winning formula for ag-related companies. With orange juice, cocoa, sugar and other commodities trading well above last year’s levels, elevated pricing should continue to elevate demand for Deere equipment and supplies. Management’s increased forecast for as much as 41% profit growth in fiscal 2023 suggests the benefits of commodity inflation and cost cuts have staying power for at least another couple of quarters.
#2 - Tech Will Drive Long-Term Growth
Even if the agriculture industry is at or near the end of an upswing, Deere remains a solid long-term investment. A perennial leader in its ‘field,’ the company has persevered through many up and down cycles. Forty-five years removed from its IPO, Deere endured countless farm recessions and split its stock twice en route to reaching a record high in July 2023.
One constant throughout is Deere’s constant pursuit of innovation. Technological advances that make things easier for growers and industrial customers have long been a competitive advantage.
Going forward, intelligent, connected machines and apps that improve crop production and lower costs represent the next wave of innovation. From self-driving tractors for ‘precision ag’ to smarter earthmoving equipment for infrastructure development, Deere products will play a big role in the global economy for many years to come — and throughout many more cycles.
#3 - Deere Stock Is Undervalued
At the midpoint of the latest guidance revision, Deere is trading at 11.6x this year’s earnings. This is a significant discount to the stock’s five-year historical average P/E of 19x — and a small price to pay for a company that is on track to deliver 40%+ profit growth in 2023.
Even if 2023 turns out to be peak profits, Deere shares are still inexpensive relative to next year’s estimate. At 11.9x projected 2024 EPS, they are undervalued relative to all but one S&P 500 industrial machinery peer — Cummins has a slightly lower 2024 P/E of 11.8x. The remaining 15 peers trade at 12x to 26x.
#4 - A Dividend With Plenty of Acreage to Grow
Deere’s growth characteristics are nicely balanced by its $5.00 annual dividend payout. While this equates to a modest 1.3% forward yield, the dividend has a lot of room to expand. Only 15% of the company’s next 12 months profits will be returned to shareholders as dividends. This affords the board of directors ample leadway for dividend hikes — and makes Deere an ideal long-term growth and income investment.
#5 - Bill Gates Is a Bull
Microsoft co-founder turned philanthropist Bill Gates is a major Deere backer. As of the end of June 2023, the Bill & Melinda Gates Foundation owned approximately $1.6 billion worth of Deere stock, making it the portfolio’s sixth-largest holding.
Last quarter, hedge fund managers like Mr. Gates increased their collective stake to more than eight million shares. ARK Invest’s Cathie Wood trimmed her Deere position by 5% but hung onto $47 million.
Known more for his leadership prowess in the software space, Bill Gates deserves praise for the foundation’s performance as well. The fund has produced a 22.3% annualized return over the last three years. Microsoft’s surge is responsible for much of it, but so too are Berkshire Hathaway, Canadian National Railway, Waste Management — and yes, Deere.
