Is Deere & Company Stock Headed for a Freefall After Losing 8% This Year?

John Deere (NYSE: DE  ) investors have had to put up with a bumpy ride this year. Just when the stock rekindled investors' hopes by hitting its 52-week high in April after a soft start to the year, unfavorable news from the industry pulled the plug on its run. Deere shares are down nearly 8% year-to-date, as of this writing.

DE Chart

DE data by YCharts

Even as I write this, the United States Department of Agriculture, or USDA's latest report has confirmed some of the fears that have been weighing heavily on John Deere's stock price. Does that mean the stock is headed even lower? 

What's ailing John Deere tractors?

Deere shares lost heavily over the past four months after the market got a whiff of softening farm conditions. One of the major factors that have caught Deere unaware this year is a drop in demand for large farm equipment. Anticipation of bumper crop production has sent prices of key crops tumbling to lows not seen in four years: Corn and soybean is down nearly 20% and 30%, respectively, since May.

So how do crop prices affect Deere? While I'd urge you to read an earlier post to understand the entire cycle, to quickly reiterate, farmers' decisions to purchase equipment are closely linked to their income, or more specifically, to the cash that they receive from sale of crops and through government subsidies. Naturally, farm cash receipts take a hit when crop prices fall, thus compelling farmers to postpone large purchases, especially that of high-horsepower tractors and combines.

The following chart from the USDA's just-released Farm Sector Income Forecast report shows how net cash and farm incomes are projected to fall this year.

Source: USDA

This bodes ill for Deere, especially since large equipment makes up more than half of the company's agriculture sales, and is typically high-premium and high-margin product. That explains why Deere's agriculture equipment sales slipped 8% year-over-year during the nine months ended July 31. What's more, the outlook for the farm-equipment industry has weakened further, as shown in the chart below.

Agriculture & Turf retail Sales-Industry Outlook-Fiscal 2014. Source: Deere Q3 Earnings Presentation

Note the dour projections for two of Deere's most important markets – U.S. and Canada, and South America. Investors may recall how Deere launched more than 60 new machines in Latin America this past April. That aggressive expansion may appear ill-timed, going by the above projections and the ongoing economic challenges in the nation. These warning signals, coupled with Deere's weak numbers in the past couple of quarters were enough to make investors jittery.

More trouble ahead?

What's worrisome is that if Morgan Stanley is to be believed, the farm-equipment industry may be entering a downcycle. In other words, the industry could be headed for a downturn, which will be terrible news for Deere, and its investors.

I'm not trying to scare investors, but Deere's recent actions also raise some concerns. For instance, the company plans to scale back agriculture equipment production for the rest of the year, indicating weak demand expectations. More importantly, Deere has announced two major layoffs so far this month that will affect more than 1,000 workers at four of its plants. The company made it clear why it was taking the bold step: "To align the size of its manufacturing workforce with market demand for products." That doesn't sound good.

There's a strong side to Deere's business, but...

Perhaps the only silver lining for Deere investors is that the company also sells construction equipment, the market for which has strengthened considerably in recent months. Construction-equipment leader Caterpillar (NYSE: CAT  ) , for instance, reported 11% higher year-over-year construction machinery sales during its last quarter. Deere is reaping the benefits as well – While it expects farm equipment sales to fall 10% this year , it sees its construction equipment sales grow 10%.

A Deere wheel loader. Source: Deere

Unfortunately, construction business contributes less than 20% to Deere's total sales, so it can barely offset any slowdown on the company's agriculture side. Moreover, Caterpillar sounded the warning bell for some of the developing markets during its last earnings release, and even tightened its own full-year sales guidance as a result. Any weakness in global construction markets will prove double whammy for Deere.

So what should you do with your Deere shares now?

Deere expects to close 2014 with 6% and 12% lower sales and net income, respectively. Its cash from operations is also projected to fall by nearly $1 billion this year. In other words, 2014 is turning out to be a challenging year for Deere.

Nevertheless, Deere should still emerge financially strong despite the headwinds, going by its projection of roughly $3.7 billion in cash from operations for the full year. It's also worth noting that the company held cash and equivalents worth $3 billion as at the end of its last quarter.

A good portion of that cash could go into shareholder pockets if capital spending takes a backseat in the wake of weak market conditions. Deere already raised its quarterly dividend by 18% this past May, thus taking its total dividend increase since 2010 to 114%. That should give Deere investors a good reason to stick around, even if it gets hard to be bullish about the stock in the near-term.

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Read/Post Comments (3) | Recommend This Article (7)

Comments from our Foolish Readers

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  • Report this Comment On September 03, 2014, at 4:38 PM, notyouagain wrote:

    Deere is iconic for farm equipment. Deere having a durable competitive advantage is a radical understatement. Sure, a bad year could depress earnings and the share price will probably take a temporary hit.

    But that is only advantageous to long-term shareholders. I grew up in Iowa. This company isn't going anywhere, but especially not to the poorhouse...

    Deere's payout ratio is only 25%. There is no danger of a dividend cut.

    Deere has a direct stock purchase plan available through Compuetershare. My copy of the prospectus for it should arrive in my mailbox any day now.

    Deere at 9.5X earnings...you gotta be kidding me...

    I know its been at a low PE for awhile now, but being from Davenport, Iowa, and knowing Deere's iconic status and knowing the company like any Iowa farmboy does, just makes it unbelievable.

    Deere at a PE of 9.5, with a payout of 25%, and a rapidly-growing dividend?

    This is a no-brainer.

  • Report this Comment On September 03, 2014, at 4:38 PM, notyouagain wrote:

    Computershare

  • Report this Comment On September 16, 2014, at 9:15 AM, rook09 wrote:

    Something else that is probably hurting Deere has to do wtih the 179 deduction, which is bonus depreciation. In prior years someone buying farming equipment could write off the full amount of the price in the year purchased. In 2014 the 179 deduction is more or less limited to around $25,000 I believe. You may need to check that to be sure. Anyways This is the reason my father bought a new tractor a few years back, so he could write it off against his taxable income. If not for that he probably would have gotten a much cheaper used one.I think this coupled with the lower crop prices are greatly hurting sales for Deere.

    My father in-law was a farmer until about a year ago, and he said crop prices are at or below where they were when he started farming some 25-30 years ago.

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