3 Reasons Deere & Company's Stock Could Fall

A look at the risk in holding or buying stock in John Deere.

Aug 27, 2014 at 12:03PM

Having recently disappointed the market with its guidance, investors will be wondering if Deere's (NYSE:DE) fortunes have now hit a trough and are about to turn up, or whether the stock has further to fall? The purpose of this article is to look at the three downside risks, so investors can make an informed decision as to whether they want to buy, hold, or sell the stock.

Deere equity research
This article is part of an ongoing series on the company, intended to give readers a balanced viewpoint. Fools have already read a summary of Deere's recent earnings linked here. Essentially, full-year expectations for net income and equipment sales were reduced in the earnings report, as the Deere's agricultural machinery sales are taking a hit from weak crop prices. There is a summary of the five key takeaways from the conference call linked here, and a look at potential upside drivers linked here.

Deere's deteriorating trends
On a positive note Deere's management is being proactive in taking measures to deal with declining machinery sales. For example, two of the takeaways discussed in the conference call article linked above are measures to scale back production in order to adjust to declining sales and the launch of a certified pre-owned program. While these moves are fine and worthy, they will not reduce Deere's dependence on crop prices. If they continue to fall, Deere's prospects will get bleaker. Unfortunately, the company, and the United States Department of Agriculture, or USDA, have been reducing estimates for key crop prices.

Here is how Deere recently reduced its own forecasts for key crop prices.

  2012/2013 2013/2014 Previous Forecast 2013/2014 Forecast 2014/2015 Previous Forecast 2014/2015 Forecast
Corn $6.89 $4.70 $4.50 $4.35 $4.10
Wheat $7.77 $6.90 $6.87 $7.00 $6.60
Soybeans $14.40 $13.00 $13.00 $10.25 $10.25
Cotton $0.73 $0.77 $0.78 $0.65 $0.70

Source: Deere Presentations.

Clearly, Deere is facing a difficult environment in 2015; with corn and wheat prices looking set to drop significantly, its agriculture & turf machinery sales (already forecast to be down 10% in 2014) could come under even more pressure going forward.

Sales falling, so will margins
The second reason to worry about Deere is that its margins and profitability are likely to take a substantial hit if sales keep falling. The following chart demonstrates the relationship and shows how wildly its margin can oscillate with movements in revenue.

DE Operating Revenue (TTM) Chart

DE Operating Revenue (TTM) data by YCharts.

It's one thing for analysts to have earnings numbers penciled in for 2015, but if crop prices continue to weaken, earnings guidance will have to be reduced. In other words, however cheap the stock looks now, it could start to look expensive if margin and earnings collapse.

Deere facing operational challenges
Aside from the normal cyclicality of its margins, Deere is facing a couple of challenges that I will loosely bundle together as operational. First, it's having to meet Tier 4 emissions standards, and as management disclosed on the recent conference call:

...many of our small mid AG and C&F products will be transitioning to final Tier 4. In 2015 when higher material cost and higher spending your transition should be expected and we will not fully recover the material cost increases of the pricing in year one especially for these products.

Essentially, Deere has been able to pass on the increased cost of the new emissions standards so far, partly because its end markets were good, but it will be a tougher challenge in 2015.

Second, Deere has initiated a certified pre-owned program for used Deere equipment. This is intended to help its dealers better sell used Deere equipment, and therefore support Deere's sales of new equipment. While this program makes perfect sense, there is a potential warning sign here. Management talked about how...

...the spread between used prices and their original new prices has widened from the tightest ever spreads of 2008 and 2009. Specifically, Deere prices are holding up as well or better than the competition. 

It could be a problem if the market weakens, because the spread is then likely to fall, and with a lot of used inventory around, Deere will face pricing pressure for its new equipment.

The bottom line
All told, Deere is facing a deteriorating environment with falling crop prices likely to challenge is margins in future. Moreover, a weak end market would put pressure on the current spread between prices of used and new equipment sales -- with a decline in the latter hurting Deere. It puts into question Deere's hopes of achieving a 1% price increase in the fourth quarter; leading to a 2% price increase for the full-year.  In addition, the transition to Tier 4 emissions standards will pressure margins in 2015. Deere faces downside risk.

Leaked: Apple's next smart device (warning, it may shock you)
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early, in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

Lee Samaha has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers