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Deere Stock Gets 2 Upgrades: 3 Things You Need to Know

By Rich Smith - May 31, 2016 at 12:00PM

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The main thing: What goes down must come up -- but it may take a long time for this stock to grow.

With shares down 13% over the past year, investors in Deere & Company (DE -1.96%) stock haven't had a lot to cheer about lately -- until just this past week. Over the past two weeks, Deere stock has collected two separate upgrades, both of which advise investors to buy the stock.

Last week, analysts from Canada's BMO Capital upgraded Deere shares to outperform and assigned a $96 price target to the $83 shares. This morning, analysts from UBS agreed with BMO, upgrading Deere stock to an equivalent buy rating, and assigning a $94 price target.

But are these analysts right or wrong? Here are three things you need to know.


Is it morning in America for corn growers -- and for Deere stock? Or is that a sunset I see?

Thing No. 1: Deere's not caught in the headlights

Deere stock has underperformed the rest of the stock market since at least 2011, reports TheFly.com. But that underperformance isn't for lack of trying. Reading from BMO's report, TheFly notes that Deere has lowered costs, output, and inventory, all in the interests of salvaging profits in a weak market for agricultural equipment.

Granted, profits are down. But at least Deere is still earning profits -- $1.9 billion last year. That's due in large part to the fact that since revenue peaked in 2013, Deere has slashed its operating costs by nearly 20% (according to data from S&P Global Market Intelligence).

Thing No. 2: But Deere is caught up in forces it cannot control

But why are Deere's sales down 30% over the same time period, you may ask? Well, as UBS explains (in a write-up covered by StreetInsider.com), the reason is quite simple: "Deere still trades with corn." When corn prices are low, as they are today, farmers make less money and have less money to spend on farm equipment -- and less incentive to spend money on farm equipment, because the crops that equipment would be harvesting are worth so little.

That's necessarily bad for Deere's business. (It's also pretty bad for rival Caterpillar (CAT -0.08%), for that matter. Down 16% over the past year, Caterpillar stock has suffered even worse than Deere. But last quarter, as you may recall, Caterpillar won an upgrade in April -- from Goldman Sachs.)

Thing No. 3: Times change, and weather changes, too...and so do corn prices

But here's the good news for Deere, for Cat, and for the agriculture industry in general: Now that the El Nino weather pattern has gone away, and the Pacific Ocean is cooling again, it's likely that a La Nina weather pattern is not far off. And that could result in less rainfall in the continental United States, worse conditions for growing corn crops, and consequently, higher prices for the corn that farmers do grow.

The way UBS looks at it, corn prices are at about $4.10 right now. U.S. farmers only need corn prices to rise to about $4.34 per bushel to earn enough money to start buying farm equipment again. And by the time corn hits $5 a bushel, a bull thesis begins to emerge.

UBS predicts $5 average prices for corn this year, initially putting "a floor in ag equipment sales in 2017, and" then driving "growth in sales in 2018 if the prices are sustained throughout 2017." In turn, these higher corn prices produce wealthier farmers who begin buying enough Deere equipment to produce 8% operating profit margins, and $4.50 per share in net profit for Deere by 2018.

Now, is all of this enough good news to justify buying Deere stock today?

The most important thing: Valuation

Here's the thing: Over the past 12 months, Deere earned nearly $5 per share on weak corn prices. So if growing strength in corn prices is only going to produce $4.50 per share in profits, that's really not much of a bull thesis.

Basically, what UBS (and BMO) are telling investors is that Deere's profits will continue to weaken before getting any better. That largely tallies with consensus estimates of 1% average annual earnings growth at Deere over the next five years.

Against this backdrop, Deere stock that sells for 17 times earnings today looks even more expensive at 18 times UBS' optimistic prediction for 2018 earnings. Now granted, Deere does pay a nice dividend -- about 3% annually. But even so, the total return of 1% earnings growth plus 3% dividend yield seems a pretty meager harvest on an investment of 17 or 18 times earnings.

Much as I'd love to be able to tell you that BMO and UBS are right about Deere stock being a buy today, I fear they've jumped the gun. I think Deere stock still has farther to fall.

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Stocks Mentioned

Deere & Company Stock Quote
Deere & Company
DE
$308.03 (-1.96%) $-6.15
Caterpillar Inc. Stock Quote
Caterpillar Inc.
CAT
$187.44 (-0.08%) $0.15

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