Deere & Company (DE -0.65%) crushed fiscal 2022 second-quarter (ended May 1) revenue and earnings on Friday -- reporting a 17% year-over-year increase in net income and excellent growth despite supply chain and inflation headwinds. Yet the stock collapsed by over 14% on the day following the release, its worst daily decline since 2008. The sell-off contributed to a 23.7% decline since the stock's all-time high -- which was achieved a little over a month ago on April 14.
Here's what's going on with Deere and why the agriculture stock is a buy despite some concerns.
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Deere is operating a booming business
Deere is a cyclical stock whose earnings tend to rise and fall to the tune of the broader agriculture, construction, and forestry industries. And right now, business is booming.
In Q2 of fiscal 2021, Deere achieved record quarterly sales of $12.06 billion and record quarterly net income of $1.8 billion. Despite the tough comps, it crushed those records this quarter, posting $13.37 billion in sales and a staggering $2.1 billion in net income.
Low interest rates and increased demand from Deere's customers certainly helped its results offset supply chain issues. Deere sees demand remaining strong for the rest of the year. "Looking ahead, we believe demand for farm machinery will continue benefiting from positive fundamentals in spite of availability concerns and inflationary pressures affecting our customers' input costs," said Deere CEO John C. May in a press release.
Deere is guiding for $7 billion to $7.4 billion in fiscal 2022 net income -- which would be a record high. The guidance gives Deere a forward price-to-earnings ratio of 13 to 13.7. For context, Deere's 10-year median P/E ratio is 16.2 -- signaling that the company looks relatively cheap despite its stock price doubling over the last two years.
Deere expects operating cash flow of $5.6 billion to $6 billion in fiscal 2022, which sounds like a lot, but it's quite a bit lower than Deere's record high of $7.3 billion in fiscal 2021. One reason for the lower operating cash flow is higher operating expenses due to inflation. Despite the strong performance, Deere is another example of a booming business that is getting its margins squeezed and could see profits suffer if growth comes down.
Deere's long-term focus
The company prioritizes maintaining its top-rated balance sheet, investing in research and development, and improving its own product portfolio. Long-term investments are more important to Deere than buybacks or dividends.
Deere's 1.2% dividend yield and relatively low buybacks aren't all that attractive for investors who want passive income. Additionally, Deere only targets a 25% to 35% payout ratio. So even if earnings keep growing, the company isn't likely to suddenly hike its dividend by a large amount.
However, Deere's commitment to investing in technology, automation, and even artificial intelligence gives it a big long-term advantage as the industrial Internet of Things becomes increasingly sophisticated and interconnected. Although Deere may not provide short-term shareholder benefits, its track record suggests its long-term-focused model produces greater shareholder value in the end. Over the last 10 years, Deere is one of the few major industrial stocks that has beat the S&P 500, the Nasdaq Composite, and the industrial sector even when factoring in dividends.
DE Total Return Level data by YCharts
Meanwhile, Caterpillar and Cummins have underperformed the major indexes. This isn't to say that Caterpillar and Cummins are bad stocks. In fact, Caterpillar looks like a good buy now. It's just a testament to Deere's model of investing in its business instead of returning value to shareholders through oversized dividends and buybacks.
Playing devil's advocate
When you see a stock like Deere that looks like a good buy, a good habit to develop is to try and poke holes in your own investment thesis. I think there are a few good arguments against Deere right now.
For starters, a collapse in consumer, agricultural, industrial, and infrastructure spending would derail Deere's growth. Put a different way, if the cycle flips from boom to bust, Deere's valuation won't look so cheap. A complete bust seems unlikely, given the strength of the agricultural industry right now. But it is a risk worth monitoring.
The more likely scenario is that inflation lasts longer than expected and hurts Deere's margins to the point where a dollar added in revenue doesn't go as far in terms of actual profit. What's more, rising interest rates make it more expensive to borrow money. So even if business is good for Deere's end users, they may be less inclined to allocate capital expenditures toward Deere products if financing isn't as cheap or if they perceive the boom in business to be ephemeral. Customers may also shift buyer behavior toward agricultural machinery at a cheaper price instead of the premium-priced John Deere brand.
A reasonable buy now
Despite the risks, the collapse in Deere's stock price seems over the top. The company has a great track record and a long-term focus, and its stock isn't expensive even if growth slows. For investors looking to dip their toes into an industrial stock they can own for the long term, Deere looks like an excellent all-around value.
