Since reporting excellent earnings and raising its full-year guidance on Aug. 18, Deere (DE -0.18%) stock is down 6.9%. The move may come as a surprise given Deere's upbeat report. However, the sell-off is likely due to fears of an industrywide slowdown in agriculture after a multiyear growth cycle.
Let's take a look at the blue chip stock to see if the sell-off was warranted or if Deere is worth buying now.
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Another beat and raise
In the first quarter of fiscal 2023, Deere's initial guidance was for full-year net income of $8.75 billion to $9.25 billion. In the second quarter, it raised that guidance to $9.25 billion to $9.5 billion. And in the recent quarter, it raised guidance again to $9.75 billion to $10 billion. If Deere hits that goal, it will mark a fourfold increase in net income in just five years.
DE Net Income (Annual) data by YCharts
At least for now, Deere is showing little signs of slowing down. The company is currently in its best growth cycle in company history. And it would be a big mistake to attribute all the credit to an industrywide boom.
What separates Deere from the competition is its execution.
Each quarter, Deere publishes retail sales and dealer inventories compared to the industry. Deere has been mostly underperforming the industry when it comes to two-wheel drive tractors, but outperforming on four-wheel drive tractors and combines -- which are Deere's bread and butter for its largest segment -- production agriculture. In fiscal 2022, production agriculture made up 41% of Deere's sales. Production agriculture is Deere's wheelhouse because it's where its services, tools, advanced product features, and technological capabilities are the most effective.
Deere has done a masterful job forecasting customer demand, managing inventory, and making improvements to its products that justify price increases. It's the combination of brand power and leading products that have allowed Deere to offset inflationary pressures and grow its bottom line.
Managing inventory levels
One of the hardest things for heavy equipment and industrial machinery manufacturers to do is forecast demand. Implementing production increases or the construction of a new factory to take advantage of a boom could leave a company vulnerable once the cycle shifts downward.
Deere uses a variety of data points to get a reading on customer demand. Since Deere sells its products through its dealer network, looking at how much inventory its dealers have is a good way to judge if dealers have too much product on hand or are anticipating a sustained boom and boosting their inventories. Another metric is pre-orders.
Deere has gone through a lot of its inventory. North American large agriculture production is already sold out for fiscal 2023. The company's order book for construction equipment goes into Q2 fiscal 2024. Based on demand, Deere expects order activity to justify similar production rates in fiscal 2024 as fiscal 2023.
On its third-quarter fiscal 2023 earnings call, Deere said it expects both new and used inventory to be below historic levels by year-end. Low inventory typically implies strong demand and gives a green light for manufacturers to ramp production to meet customer needs. High inventory tends to signal that supply is outpacing demand and that manufacturers need to brace for a slowdown in sales. But given the multi-year boom we have seen in recent years, the current inventory situation seems to indicate that dealers are lowering their inventory in anticipation of slowing demand, which isn't great news for future profit growth. However, it also means that Deere should enter fiscal 2024 in the catbird seat because if there is a slowdown, it won't have to impose steep discounts because there's little inventory as it is. And if there is better-than-expected demand, it can take a stairstep approach to meet that demand while remaining nimble enough to pull back when needed.
The right way to look at Deere stock
Deere can't control customer demand or the strength of the broader industry. But it can control how it manages inventory, when to ramp or pause production lines, and its development pipeline to ensure it is making the necessary improvements to justify price hikes.
Deere isn't shying away from a potential slowdown in its key end markets. But it is also doing a good job of avoiding speculation and focusing on the data points it has on hand. A lot of those data points point to flat or slightly lower demand in fiscal 2024, not a massive drop-off.
Given the run that Deere had the last few years, it's unlikely fiscal 2024 will bring another record year of profits. And there's likely going to be a slowdown in fiscal 2025 as well. A good outcome would be if Deere can post profits somewhere between the fiscal 2022 to fiscal 2023 range of $7.1 billion to $10 billion over the next few years. That level of profit supports dividend raises, buybacks, and a sizable research and development budget that ensures Deere stays ahead of technological improvements and can directly respond to customer needs.
Add it all up, and Deere isn't a boom-and-bust industrial stock. Rather, it's an incredibly well-run, industry-leading company that is worth owning over the long term.
