Deere & Company (DE -0.60%) stock surged over 7% on Feb. 17 in response to better-than-expected first-quarter earnings and an increase in full-year guidance. Since then, Deere has given up some of those gains, but the stock is still up over 167% in the last three years -- easily outperforming the broader indices.
Let's look at why Deere's business is booming, some challenges ahead, and determine whether Deere is a buy even if its growth cools off.
Image source: Getty Images.
Deere's success in a nutshell
Deere has been one of the best-performing major industrial stocks over the last three years. A big reason for that is that Deere is heavily concentrated in both production and precision agriculture and small agriculture and turf -- which made up two-thirds of its fiscal 2022 operating profit. The rest comes from the company's construction and forestry segment and its highly profitable financial services arm.
Precision agriculture is larger in scale and is focused on sustainable business practices and cost savings to boost crop yield over time. Whereas the small agriculture and turf segment is more focused on small- and midsize customers. Both segments sell farm equipment and technology, tools and used equipment, tractors, and utility vehicles.
Unlike most of the industrial sector, the agriculture industry wasn't hit too hard by the COVID-19 pandemic. The table below shows that Deere's fiscal 2020 performance suffered only a slight slowdown compared to fiscal 2019. Deere's fiscal years end in October.
| Metric |
2018 |
2019 |
2020 |
2021 |
2022 |
|---|---|---|---|---|---|
| Revenue |
$37 billion |
$38.9 billion |
$35.3 billion |
$43.6 billion |
$51.9 billion |
| Net income |
$2.4 billion |
$3.3 billion |
$2.8 billion |
$6.0 billion |
$7.1 billion |
| Operating income |
$4.1 billion |
$4.2 billion |
$3.9 billion |
$7.6 billion |
$8.8 billion |
Data source: Deere & Company.
Global supply chain disruptions led to a boom in agriculture prices, which put more money in farmers' pockets and encouraged spending on new machinery. A healthy customer base supported Deere's ability to grow sales volumes and raise prices. Deere's customers had no issue absorbing Deere's higher prices in fiscal 2021 and fiscal 2022, contributing to a surge in profits.
Deere is forecasting higher price realization across the board in fiscal 2023, including a 14% increase for production and precision agriculture, an 8% increase for small agriculture and turf, and a 9% increase for construction and forestry.
If you've tuned into a Deere earnings call, chances are you've heard the term "price realization" frequently mentioned. And while it's not the same thing as price increases, the end result is quite similar.
Original equipment manufacturers (OEMs) like Deere set prices for their dealers like an auto OEM will have a suggested retail price for a car. However, due to negotiations and different financing options, the dealership rarely sells that product for the exact suggested price.
Higher price realization means customers are paying more for Deere's products. This could be because the difference between the list price and the sale price is narrowing. Or it could be because Deere is raising the list price and the dealers are also raising their prices too.
Either way, higher price realization is a good sign that demand for Deere's products is strong and that the company can help to offset rising costs through higher sale prices.
Price increases, paired with flat to moderate volume growth across Deere's core markets led to the company boosting its full-year fiscal 2023 net income guidance from a prior estimate of $8 billion to $8.5 billion to its new forecast of $8.75 billion to $9.25 billion. If Deere achieves these numbers, it would mean the company more than tripled net income in three years and grew net income by over 250% from its pre-COVID 19 annual high of $3.54 billion in fiscal 2013.
What to watch for Deere in the current fiscal year
Deere's brand power, high margins, impressive execution, and vertical integration have allowed it to capitalize on a booming agriculture industry. The test going forward will be whether Deere can keep raising prices without the hikes impacting sales.
It's also important to remember that Deere is a cyclical stock whose performance can ebb and flow based on its industry's performance.
Based on its market cap of $124 billion and 2023 fiscal net income guidance of $9 billion at the midpoint, Deere has a forward price to earnings ratio of roughly 14, which is inexpensive relative to the S&P 500. Moreover, Deere has a trailing price-to-earnings ratio of 15.5, which is below its 10-year median P/E ratio of 17.1. This is a green flag for Deere investors as during a growth cycle, a cyclical stock's P/E ratio should be well below the median, and likely above the median during a downturn.
Put another way, Deere stock still isn't expensive despite the fact it has surged so much over the last few years. However, if growth slows or if Deere has to reel in its price hikes, the stock could begin to look expensive.
Deere remains a compelling long-term stock
Deere deserves a lot of credit for surpassing its already impressive expectations and boosting guidance. The company continues to grow at a rapid pace on top of multiple years of phenomenal results. But in the short term, it's hard to imagine Deere will be able to sustain its pace. Its market in North America remains strong, but the company is already guiding for weakness in Europe and Asia.
That being said, Deere remains a very well-run company, a strong brand, and an industry leader. Its long-term investments in artificial intelligence and autonomous tractors open the door to disrupting a legacy industry by helping its customers save money and improve performance.
There's no reason to sell Deere stock, but there's also no rush to buy given the company's valuation and the challenges with sustaining its current growth rate.
