After Deere & Company (NYSE:DE) shares were slapped with a ratings downgrade by the ISI Group and Bank of America Merrill Lynch earlier this month, investors must be hoping that the worst is over. But they might as well wait until the end of this week before heaving a sigh of relief. The world's leading tractor maker is set to release its fourth-quarter numbers Wednesday, and judging by Caterpillar's (NYSE:CAT) and Joy Global's (NYSE:JOY) dour last-quarter numbers and dismal full-year guidance, Deere investors may not have much to look forward to.
While Deere doesn't depend heavily on the beleaguered mining industry like its peers mentioned above, it faces similar macro headwinds. With both Caterpillar and Joy Global signaling tougher days ahead, Deere too may sound the warning bell in its upcoming earnings report. If that happens, Deere stock – which is already trending close to its 52-week low – may head further south. What are the chances that Deere will disappoint the market on Wednesday?
Why you could be disappointed
While analysts project Deere's fourth-quarter revenue to fall 4% year over year, I won't be surprised if Deere posts a bigger decline in sales. There are two reasons why I think so.
Caterpillar, which specializes in loaders and excavators like Deere, reported a 7% drop in its third-quarter construction equipment revenue as sales volumes dipped globally. Likewise, Joy Global's last-quarter sales fell 7% even as new bookings declined 36% year over year.
Worse yet, Caterpillar's and Joy Global's equipment sales from North America fell 9% and 11%, respectively, year over year. Since it's also the most important market for Deere, the company's sales in the fourth quarter and beyond could take a substantial hit. Also, Deere's fourth quarter in 2012 was a particularly strong one, with revenue soaring 14% backed by a 26% increase in sales from the U.S. and Canadian markets. So year-over-year comparisons for Deere's fourth quarter could look particularly unpleasant.
Are Deere's tractor sales dwindling?
Another problem is that unlike recent quarters, Deere's farm equipment sales may not be strong enough to offset the weakness in its construction equipment division. According to Deere's monthly data release, sales of its utility tractors as well as combines lagged industry sales during the month of September.
Peer AGCO (NYSE:AGCO) too missed Street estimates when it reported its third-quarter numbers a couple of weeks back. Despite an 8% increase in year-over-year revenue, AGCO kept its full-year guidance unchanged. At the higher end, AGCO expects to end the year with a 10% and 13% improvement in sales and net profit, respectively. That's way better than Deere's projection of just 5% growth in its full-year equipment sales. Since Deere will also report its full-year numbers Wednesday, investors should keep a close watch.
Look for the silver lining
All is not lost for Deere investors, though. Keep an eye on the company's gross margin, which improved two percentage points to 31.7% during the third quarter. Because Deere largely caters to the agriculture sector, which is somewhat resilient, it hasn't felt the need to cut costs as aggressively as Caterpillar and Joy Global.
Nevertheless, Deere recently announced plans to sell majority stake in its landscape business, and is weighing options for its irrigation operations, better known as John Deere Water. In Deere's upcoming earnings call, look for updates on these and other cost-reduction moves that the company has planned. If Deere's gross margin continues to grow into the fourth quarter, it's a great sign for the company and investors.
Also, look for information on Deere's product pipeline, especially for high-potential markets like Latin America. The region could be the game changer in the future. Most of AGCO's last-quarter growth in sales also came from South America.
The Foolish bottom line
Even as the construction business revives, farm economics have weakened in recent months on lower crop prices. That might leave farmers with lower income to spend on new farm equipment purchases, which is bad news for Deere. So in the company's upcoming earnings release, investors should focus on its outlook for next year, and its plans to overcome challenges in the near term.
If Deere continues to increase its foothold in key markets, investors shouldn't fear one weak quarter. In fact, with the stock trading under 10 times earnings, most of the concerns may already be baked into its share price. Of course, a weak outlook may push the stock lower, but if investors can find enough clues in Deere's earnings report that suggest long-run sustainability and growth, any dip in the shares could be even considered a buying opportunity.