The Subtle Clues on Why John Deere & Company Investors Should Remain Confident

Farm and construction equipment maker Deere (NYSE: DE  ) has an impeccable record for growing revenue and earnings. Despite several ups and downs that included a recession, it has nearly doubled its revenue in the past 10 years. Still, it wouldn't be a bad proposition to test its commitment toward its investors.

Let's look back and see how it's fared in terms of cash generation as a company's ability to regularly generate cash flows from day-to-day operations speaks volumes about its true potential and profitability. It's also a good idea to see how Deere has utilized its cash to reward and create value for its investors. The conclusions can tell a lot about the company's future.

Cash generation
In the past decade, Deere has generated nearly $24 billion cash from operations, the consistency being greater in recent years. Last year was an excellent one for the U.S. ag sector, and Deere lapped up the opportunity. It increased domestic ag equipment sales by 5% to $2.2 billion, while companywide sales went up 5% to $3.8 billion and earnings surged by 15% to $3.5 billion. Cash from operations touched a record high of $4.7 billion.

Posting good numbers when the market conditions are favorable is the easy part. A company's true caliber comes out when the going gets tough. The current year is going to be a difficult one for Deere as U.S. farm cash receipts, which are a good indicator of farm equipment sales, are expected to be down 10%. South America, another key market for the ag major, is also dangerously close to a recession. Deere has forecast a 5%-10% reduction in demand for ag equipment in the U.S. in 2014 and expects companywide sales and earnings to drop 6% and 5.7% respectively in the fiscal. However, it's heartening to see that despite the headwinds, it's kept its earlier forecast for cash from operations unaltered at nearly $4 billion.  


Source: Morningstar, chart prepared by author

These results are the fallout of the operating discipline that Deere has maintained over the years. In its March/April presentation, the company provided some excellent numbers to vouch for this. Deere has reduced its working capital requirement by $8.5 billion in fiscal 2013 from 1998 levels. It's also maintained its trade receivables at approximately the 1998 levels despite tripling sales.

It's not enough to just generate the cash, though; investors would only benefit if the cash comes back to them through dividends and share buybacks, or is put to use in growing the business. Let's see what Deere has been doing with its cash.

Capital spending
Deere spends more than $1 billion every year on capital expenditures, but the returns it generates from its investments are at best modest.

The chart below shows Deere's returns on invested capital (ROIC) over the past 10 years. Let's keep in mind that the company's weighted average cost of capital (WACC) based on last three years' average is 7.41%, and Deere should at least match it to justify its investments. Though that has not been the case in the past, the company is approaching that level. In the trailing 12 months, Deere's ROIC has been closer to its WACC at 7.31%.


Source: Morningstar, chart prepared by author

The trend should be music to investors' ears, but we'll have to keep track of whether Deere is able to sustain this. This is especially important now that the ag major is seriously trying to tap into new markets by building factories and capabilities.

In its endeavor to generate 50% of its targeted $50 billion sales from outside of the U.S. and Canada by 2018, Deere has been investing in the key high-growth markets of Brazil, Russia, India, and China (BRIC.) It has opened seven factories in the BRIC over the past three years to cater to the farm and construction machinery needs of the countries and make the most of the enormous opportunities.


Source: Deere Factbook 

Returning cash
By its own admission, returning cash to shareholders is one of Deere's key priorities. The company's done a good job of it so far. Deere has regularly increased its dividend, with its annual dividend increasing from $0.53 per share in 2004 to $1.99 per share in 2013. While the quantum of increase has varied each year depending on profits earned, the company has ensured that the growth remained above the inflation rate. The current payout ratio is a comfortable 28.2%. Management wants to keep the dividend payout within the range of 25-35% of its mid-cycle earnings.


Slide 16 of Deere March/April presentation

Deere doesn't believe in hording surplus cash, and in the past 10 years it has repurchased shares at a cumulative cost of nearly $11 billion. There's still $8.5 billion left as part of earlier authorizations, and investors can expect more buybacks over the coming quarters. This can continue to be an added attraction for shareholders.


Slide 15 of Deere March/April presentation

Final take
Deere comes across as a solid candidate for generating cash from its daily operations, reflecting its operating discipline and profitability. It's true that the ag major has only fared moderately in terms of garnering returns from its capital investments, but the numbers are improving, which should give some comfort to investors. Management has been generous in paying dividends and buying back shares, showing its commitment to the owners of the company.

You don't want to miss this
The Economist compares this disruptive invention to the steam engine and the printing press. Business Insider says it's "the next trillion dollar industry." And everyone from BMW, to Nike, to the U.S. Air Force is already using it every day. Watch The Motley Fool's shocking video presentation today to discover the garage gadget that's putting an end to the Made In China era... and learn the investing strategy we've used to double our money on these 3 stocks. Click here to watch now!


Read/Post Comments (0) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2932220, ~/Articles/ArticleHandler.aspx, 10/20/2014 12:28:10 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement