In the world of business and commerce, industries sometimes come and go. Progress dictates that certain products and businesses that are innovative and popular in their infancy can eventually go the way of the buggy whip.
However, there are also industries where long-term demand is virtually assured and thus, investing in companies on the leading edge of those industries can be a way to unlock the potential for high returns; one such industry is agriculture.
The need for humans to eat has been around since the beginning of history and will be forever. A huge proportion of that is down to the agriculture business and given that the world’s population continues to grow, it is a safe bet that this demand will continue to rise over time as well. Agriculture stocks can be volatile in times of economic weakness or commodity price changes, but over the long-term, they offer access to ever-expanding demand from a growing world.
Deere & Company Offers Strong Fundamentals and Capital Returns
One stock in the agriculture sector that offers investors a chance to be on the forefront of the industry is Deere & Company (DE). Deere was founded in 1837 after its namesake founder invented a plow that was designed for tough Midwestern United States soil. The company has grown by leaps and bounds since then, subsequently becoming a leader in tractors and other machinery. It now makes a variety of equipment for agriculture, forestry and construction applications. Deere also has a significant financing business that has helped it grow by providing in-house access to loans for its customers. This combination has afforded Deere a wide and deep customer base from a variety of industries, but agriculture is still the company’s core business, as it was 181 years ago at its founding.
Business Overview and Growth Prospects
Deere has consistently made acquisitions as well as investments in organic growth that have not only diversified its revenue streams, but offered access to complementary lines of business to its legacy products. This has afforded the company the ability to become a more complete machinery solution for its existing customers and drive additional revenue to the top line over time as well. In total, we are forecasting Deere to produce mid- to high single digit earnings-per-share increases annually on average for the foreseeable future.
Deere’s appeal is not only its long history of being a leader in the agriculture business, but also in long-term demand factors for the sector itself.
Source: Investor presentation, page 41
This slide from a recent investor presentation shows the past 25 years of global grain supply and demand, which is a key indicator for the health of the agriculture business. Given the importance of grain to the global food supply and indeed, Deere’s own demand from its customers to farm it, this gives a good indication of the potential for this company to continue to take advantage of demand tailwinds for the long-term.
In addition to its core agriculture products, Deere has spent significantly in recent years to diversify, as it did with its relatively recent purchase of the Wirtgen Group. This acquisition was the largest in the company’s history and gives it another sizable, long-term revenue stream outside of agriculture.
Source: Investor presentation, page 49
This graphic shows how Wirtgen completed Deere’s road construction portfolio and how at this point, Deere can sell customers every major piece of equipment needed to construct a new road. With infrastructure being a lucrative, long-term global market, Deere has prudently acquired its way into being a market leader, similarly to its agriculture business.
The company’s Q3 earnings report was released on 8/17/18 and results were very strong once again. Deere has been rebounding from years of very weak equipment sales and 2018 has seen some enormous gains. Q3 sales rose 36% year-over-year, while earnings-per-share increased 31%. The company continues to take advantage of resurgent global demand for agricultural equipment and it is showing up in rapid rates of revenue growth, which the company said would be 26% for the full year.
Deere’s primary competitor is Caterpillar (CAT) and to a lesser extent, some of the smaller names that build like equipment for agricultural work. However, Deere has proven during this current upswing in demand that it is in a leadership position in the sector as it continues to grab market share. Recessions are, of course, quite harsh for agriculture businesses as commodity prices tend to fall sharply during downturns, and Deere will be susceptible to this next time around. However, there is no indication of such weakness on the horizon, so we see strong growth continuing for Deere for the foreseeable future.
The one thing that this recent upcycle has produced is a higher valuation for Deere, which trades at 16.4 times our earnings-per-share estimate of $9.53 for this year. That is slightly in excess of our fair value estimate of 14 times earnings, implying that Deere is somewhat overvalued at present. However, given that the company is in the midst of a huge resurgence in global demand, it is unsurprising that the stock is being valued as highly as it is.
Source: Investor presentation, page 20
In addition, the company continues its impressive rate of dividend growth as the payout has grown 146% since 2010. With very strong cash production and surging demand from its customers, we believe Deere will be a strong dividend growth stock for years to come.
Deere has strongly outperformed the S&P 500 over the past two years as the upcycle in demand has led to enormous gains in revenue and earnings. While the pace of earnings growth this year isn’t sustainable, we see continued demand growth as a long-term catalyst for higher earnings. We therefore rate Deere a buy despite the valuation being slightly in excess of our fair value estimate. In addition to a strong growth outlook, Deere offers investors a high rate of dividend growth, a strong competitive position, and a diversified heavy machinery revenue model.