John Deere (NYSE: DE ) has done it once again -- run over Street estimates, that is. But the story's a little different this time, with shares of the farm-equipment maker cooling off since it reported numbers Wednesday. Deere trampled estimates on its second-quarter earnings per share by a gaping margin, but fell considerably short of expectations on its top line. Worse yet, the company rolled back its already muted full-year revenue guidance by a percentage point.
Those who were pinning hopes on Deere's construction-equipment business after Caterpillar's (NYSE: CAT ) strong 20% growth in its last-quarter equipment sales were also in for a rude shock when Deere reported a marginal increase in sales from that division. After all, both companies have a fairly overlapping product portfolio.
Clearly, everything's not all right, and there's much more to Deere's numbers than meets the eye. Here are three worrying things that the headlines didn't tell you about.
What the markets didn't see
Deere's second-quarter revenue slipped 9% year over year, versus Street estimates of a 6% drop. That wouldn't have gone down well with investors had the company not reported about 4% lower earnings per share, when analysts were expecting an 11% drop.
But wait... Deere's year-over-year operating and net profits slumped 15% and 10%, respectively, in the second quarter. In other words, if you're happy that the company's EPS didn't fall as much, you should also know that share repurchases are acting as a cushion.
While buybacks mean more money in shareholders' hands, they can also artificially inflate EPS when the company's top and bottom lines aren't growing, like in Deere's case. First, that's not a sustainable strategy. Second, that doesn't count as real growth for the company or its investors.
In short, Deere's Q2 numbers were worse than what the headlines told you, and its bottom line is under as much pressure as its revenue.
Are we jumping the gun?
Second-quarter sales from Deere's construction and forestry division increased only 2% year over year, compared to Caterpillar's double-digit growth in its last-quarter equipment sales. That could indicate that end markets are still not as robust as many think they are. I'll explain why.
Caterpillar attributed rising dealer inventories for higher last-quarter sales, which simply means that most of what it sold was to its dealers, and not to direct end-equipment users. Deere, on the other hand, works closer to retail customers, who may not be making big-ticket purchases yet; that may explain why its equipment sales improved only 2% year over year. In Deere's own words, its competitors are pushing "significant inventory in the field ahead of those sales materializing."
While it's encouraging that both Deere and Caterpillar expect their full-year construction-equipment sales to grow 10%, investors should remain cautious about the persistent slowdown in China, and the Russia-Ukraine crisis. And back home, as Caterpillar put it: "The U.S. construction industry is still well below its 2006 peak, and we have a real need for infrastructure improvement." In other words, there may still be time until end demand really picks up.
Getting hit from all sides
Deere expects its farm-equipment sales to decline 7% for the full year versus an earlier forecast of a 6% drop. You've heard analysts blame a softer U.S. market for the lower guidance -- but that's not the case.
Lower expected farm income in the U.S. may be hurting sales of high-horsepower tractors and combines, but Deere is also seeing considerable signs of weakness in another key market, Latin America. If lower commodity prices and unfavorable weather conditions have hurt corn planting in recent months, the Brazilian government dealt a double blow to farmers by increasing interest rates late last year.
Ironically, Deere has just gone big in Latin America with the launch of more than 60 new machines in the month of April. The timing is anything but perfect -- Deere projects its farm-equipment sales from the region to decline 10% this financial year.
To add to Deere's woes, farmer confidence in Europe remains weak, tension in Ukraine has hurt corn acreage, and import policies are hurting demand in markets like Russia and Belarus. Clearly, Deere is under pressure from all sides right now, and the road ahead could be very bumpy.
Deere's lower guidance shouldn't have surprised investors because broader industry trends already pointed at trouble ahead. Deere will likely end 2014 on a soft note; but what's important to understand is whether the challenges will extend beyond this year. Keeping an eye on farm fundamentals, like those mentioned in the link above, should prepare you well in time.
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