Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
It's been four days since Deere & Co. (DE 0.94%) wowed Wall Street with its second-quarter 2017 earnings report -- and the waves of applause just keep rolling in. According to the latest tally on StreetInsider.com, since Deere reported earnings on Friday, its stock had received no fewer than six separate hikes to its price target through Monday -- from Stifel Nicolaus, Deutsche Bank, Barclays, and others.
This morning, Deere won yet another pair of price-target hikes, this time from Bank of America's Merrill Lynch unit and Citigroup. Here's what you need to know.
Brazilian sales were key to Deere's earnings beat last quarter. But will Brazil also be Deere's undoing? Image source: Getty Images.
1. Why Deere is jumping
Let me be clear: There's good reason for analysts to be happy with Deere. On Friday, the tractor maker reported that "demand for farm and construction equipment" is "improving," with Q2 profits up 60% from one year ago at $2.49 per share on sales growth of 5%. What's more, Deere thinks it has more profits in store.
The company's forecast for the rest of this year (now more than half over) anticipates a year-long sales gain of 9% over 2016 levels, with profits likely topping $2 billion. While not quite 60%, that would still work out to 33% profits growth for 2017.
2. What Wall Street said
Wall Street likes these numbers -- a lot. Responding to Deere's news, Barclays Capital (a bear on Deere stock in general), grudgingly hiked its target price on Deere stock to $90 a share. UBS, slightly more optimistic with a neutral rating on Deere, pushed its price target up to $122, while Baird, a confirmed bull with an outperform rating, went to $135. Both Stifel Nicolaus and Deutsche Bank raised their price targets on Deere stock to $135, while Wells Fargo went to $140.
This morning, the news got even better for Deere shareholders, as Merrill and Citi both estimated Deere shares are now worth about $145.
3. What Wall Street said, specifically
In justifying their higher target prices, most analysts referred to Deere's growing profit margins and higher sales. This morning, Merrill noted that if Deere's sales predictions bear out, 2017 could be the company's strongest revenue growth year since 2011.
For its part, Citi focused on the strong state of Deere's "row crop tractor orders." The analyst expects global grain prices are likely "to move gradually higher from here," putting more money in farmers' pockets to buy Deere tractors.
At a more granular level (pun intended), Citi notes that Deere is seeing special strength in "high horsepower markets," which should benefit its "product mix" -- boosting sales and profits on those sales alike. Citi sees Deere earning perhaps $6.30 per share by year's end -- a 31% jump from last year's diluted earnings per share of $4.81.
The elephant in the cornfield
Profits of $6.30 per share would be enough to slice Deere stock's price-to-earnings ratio (currently 21.9 based on trailing results), knocking it down to 19.3. On 31% profits growth, that looks like a pretty great bargain. The question, though, is how long Deere will be able to maintain such a breakneck growth pace. After all, according to data from S&P Global Market Intelligence, even if 2017 in particular turns out to be an especially good year, most analysts still estimate that Deere will grow earnings at only 7% annually over the next five years.
To push that 7% average growth rate up to a level that can sustain a 19x multiple on Deere stock, Deere probably needs to grow ultrafast in the first few years of its recovery, before things settle down and get back to normal in the agriculture market. So how likely is that to happen?
Merrill Lynch seems to think it's at least possible, arguing that "large agriculture appears to be bottoming out" in the U.S., "allowing for some level of replacement demand" to boost Deere's sales. At the same time though, I see a possible fly in the ointment (or elephant in the cornfield) somewhat south of U.S. borders.
Down in South America, you see, Deere credited "farm machinery sales in South America experiencing a strong recovery" as part of the reason for its success in Q2, and predicted Deere's Brazilian (and Argentinean) sales will grow 20% this year -- twice Deere's overall rate of hoped-for growth -- "as a result of improving economic and political conditions."
Yet at the same time Deere was saying that, a wave of new political crisis broke over Brazil. On May 18, just one day before Deere reported its earnings, Brazil's Bovespa stock index crashed 9% as newspapers reported on a new bribery scandal that could bring the presidency of Michel Temer crashing down. With the crisis ongoing, the index has regained fewer than 2 of the points it lost -- suggesting that no matter how optimistic Deere may be about its prospects in Brazil, investors in general aren't nearly so sanguine about the country's prospects.
Hopefully, one country's troubles won't be enough to derail Deere's recovery. But at 21 times earnings (or hopefully, 19 times) and consensus growth rates still stuck at 7%, there's not a lot of room for error here. For this reason if no other, I'd be cautious about buying Deere stock until we know more about how Brazil will play out.
