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Here's Why Deere & Company Stock Rallied 14.4% in November But Is Already Losing Ground

By Neha Chamaria - Dec 6, 2018 at 10:07AM

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After important updates in November, this is what Deere stock needs to head higher.

What happened

After taking a near-10% hit in October, shares of Deere & Company ( DE -0.08% ) jumped right back on track last month, ending November with a solid 14.4% gain, according to data provided by S&P Global Market Intelligence.

I was watching Deere stock closely last month in anticipation of its upcoming fourth-quarter earnings and outlook for 2019 on Nov. 21. But if you think a stellar earnings report sent shares of the agricultural equipment powerhouse soaring, wait: Deere's numbers, in fact, fell short of Wall Street estimates. Instead, the stock's surge seemed to have more to do with management's views on one of the biggest concerns for Deere investors: tariffs.

So what

Deere's net equipment sales jumped 18% year over year in Q4, driving its fiscal 2018 equipment sales up 29% to $33.35 billion. The company netted a profit of $2.37 billion, clocking 10% growth over fiscal 2017.

A tractor sprayer on a green farm.

Image source: Getty Images.

For fiscal 2019, Deere foresees 7% growth in equipment sales and expects to earn $3.6 billion in net income. Now that sales growth pales in comparison to what the company achieved this fiscal year, but its earnings forecast is as solid as it can get. Four factors should help drive Deere's margins higher next year:

  • Lower cost of sales as raw material and freight costs are expected to ease.
  • Decremental selling, administrative, and general expenses as acquisitions fueled costs in 2018.
  • Decremental research and development expenditure.
  • Effective tax rate of around 25%-27% compared with an unusually high rate of 57% in 2018 thanks to the U.S. tax reform.

In short, Deere is on its way to another strong year. But there was more to the market's enthusiasm than just the numbers.

First, Deere's acquisition of the world's largest manufacturer of road-construction equipment, Wirtgen Group, in a $5.3 billion deal late last year appears to be paying off. In FY 2018, Deere's construction and forestry segment sales rocketed 78% and operating income grew nearly 1.5 times, with the bulk of it coming from Wirtgen. Deere projects segment sales to grow 15% in FY 2019.

Second and more importantly, Deere's management projects U.S. crop cash receipts next year to be around $120 billion, in line with this year's estimate despite the trade war between the U.S. and China, especially the latter's retaliatory hefty tariffs on agricultural commodity exports that has sent demand for key crops like soybeans from the U.S. plummeting. Because cash receipts and farm income directly influences how much farmers spend on equipment, the market welcomed Deere's views and drove the stock higher.

Now what

The November enthusiasm has failed to spill over to December, what with Deere shares losing nearly 7% in just the past two trading days as of this writing, partly because of a decline in sales of tractors and combines in October as reported by the Association of Equipment Manufacturers.

On the other side, President Trump's recent meeting with President Xi Jinping of China has fueled hopes of trade renegotiations, and China is reportedly already working on plans to boost trade with the U.S. As it stands, a truce between the two nations is all investors need to back up the truck on Deere even as they enjoy a 10% dividend hike that the company has just announced.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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