This Market Can Take Deere to Never-Seen-Before Heights

China’s growth potential is unparalleled, and Deere’s at the right place at the right time…

Apr 4, 2014 at 3:21PM

Farm and construction equipment major Deere (NYSE:DE) is looking to reach new heights by harnessing the emerging Chinese economy's growth potential, especially now when emerging markets are nudging world grain demand to a record high in crop year 2013-2014. The bounties are not limited to agriculture, though, as Deere will also gain from the healthy growth visible in construction machinery sales.

Let's check out China's potential and Deere's position.

The China story: agriculture
China's Herculean task of feeding the world's biggest population has turned the country into a net importer of agriculture products in a short span of eight years. From January to July 2013, its ag exports were $37.52 billion, whereas imports were $66.43 billion, up 7.8% and 2.8%, respectively.

Strangely, the boost came from the country's meat-eating habits -- the people of China are eating meat like never before. So much so that in 2013, China consumed half of the estimated 107 million tons of pork eaten by the world, and was home to more than half of the planet's pigs! This is putting immense pressure on agriculture as meat comes from livestock (chicken, pigs, etc), and grains like corn and soybean serve as animal feed. According to Bloomberg data, corn consumption could grow 8% globally in 2014. Needless to say, China, being the second-largest corn consumer, will play a big role.

Farmer Liu Guiyang at her pig farm in Shunyi County outside Beijing. Source: Flickr

China uses around 60% of its corn to feed livestock. It purchases more than three-fifths of the globe's soybean exports for the same reason -- to feed livestock! From exporting 10 million tons of grain in 2006, to staring at a whopping 22 million tons of grain imports in 2013-2014, China is struggling big time to feed its livestock and satiate its people's appetite for meat.

The Chinese government has been relentlessly trying to increase productivity through greater mechanization. Over the years, government subsidies and schemes have borne fruit -- from 36% of farm labor performed by machines in 2006, the number went up to around 52% in 2011 -- yet the aim is to touch 70% by 2020. No wonder then that ag equipment makers such as Deere, Agco (NYSE:AGCO) and CNH Industries (NYSE:CNHI) have a bright future in China.

Slide 28 of John Deere Market Fundamentals March 2014. 1 RMB = $0.16 at current rates

Another healthy trend in ag equipment sales is the bend toward using high-powered heavy machinery that generates higher margins. Small-tractor sales went down considerably in 2012, while medium and large tractors saw steady growth. At present, the total power use of ag equipment has crossed 1 billion kilowatts.

Deere's ag exposure in China
Deere has been steadily expanding production in China; it has three ag equipment factories in the country, and two new units were set up in 2013 that will start production in 2014. In November 2013, it launched a series of new products: 28hp-70hp tractors, the R40 tracked harvester, and the Y210 corn harvester.

The company has further spread its reach through acquisitions. In 2007, Deere took over southern China's biggest tractor manufacturer, Ningbo Benye, that makes tractors in the range of 20hp-50hp. Deere is not the only one to do so.

In 2012, rival Agco acquired 80% equity in Shandong Dafeng Machinery Co that makes rice, corn, and soybean harvesting machines. Other than this, Agco has two manufacturing sites in the country. CNH has farm equipment factories in Harbin and Shanghai, and opened two new plants in 2013. Evidently, the three biggies have their eyes set on the growth promise of the Mainland.

The China story: construction 
According to Bloomberg research, construction machinery sales could rise because of the recovery in the emerging economies, especially China, which accounts for 24% of global revenue. Construction equipment sales in the country have grown in double digits in the past five months, with both residential and commercial new construction recording healthy growth.

A construction site in China. Source: Deere

China's construction sector is gigantic. A European Union report sums it up nicely:

In residential real estate alone, China is building about 1.8bn [meters squared] per year. To put this number in perspective, China is building more than one third of all the buildings in the world, producing and consuming 55% of the cement globally in doing so. It builds the equivalent in square [meters] of living space of a city like Rome in about two weeks and a country like the UK or Spain every single year.

The sector has grown between 20% and 25% and estimates show that it could continue to expand faster than the country's GDP.

Deere's construction exposure in China
Though Deere has a comparatively lower exposure to construction machinery than ag equipment, it has been building new factories to boost revenues.

Outside the U.S., China is the only country where Deere opened a wholly owned construction equipment manufacturing facility in 2011. In 2013, its new factory in Tianjin  started production of wheel loaders, excavators for the domestic market and exports.

Summing up
China's potential in the ag and construction sectors is gigantic, and companies are doing all they can to grab a share of the pie. The Chinese government's support behind increasing mechanization of agriculture is giving equipment makers an added advantage. Deere has sensed the opportunity and is consolidating its position in both sectors in order to secure a solid future of higher top and bottom lines.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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