Deere & Company (NYSE:DE) delivered an acceptable set of third quarter results, but its guidance was disappointing and, on balance, the earnings report was a net negative. In common with many of its peers, Deere is seeing an ongoing divergence in prospects between its agricultural and construction based operations. The former is suffering due to falling agricultural prices, while the latter is gaining traction with an improving construction outlook.
Unfortunately, Deere's revenue and profit is heavily skewed toward the agricultural sector. For example, more than 81% of its equipment sales came from its agricultural and turf segment, with the remaining 19% coming from its construction and forestry segment. It's time to look more closely.
Deere's third quarter results
A quick summary of the key numbers in the earnings report:
- Net sales of $8.72 billion vs. analyst estimates of $8.75 billion
- Diluted EPS of $2.35 vs. analyst estimates of $2.20
- Full-year company equipment sales forecast to decrease 6% vs. a previous company forecast of a decrease of 4%
- Full-year net income attributable to Deere forecast to be $3.1 billion vs. previous company forecast of $3.3 billion
Looking at the results and guidance on a segmental basis reveals the divergence in performance. In short, the reduction in full-year sales and income expectations is due to a worsening outlook in agriculture.
|Previous 2014 Forecast||Current Forecast|
|U.S. & Canada Ag||Down 5%~10%||Down ~ 10%|
|EU 28 Ag||Down ~ 5%||Down ~ 5%|
|South America Ag||Down ~ 10%||Down ~15%|
|CIS Countries Ag||Down Significantly||Down Significantly|
|Asia Ag||Up Slightly||Flat|
|Agricultural & Turf Total Net Sales||Down~7%||Down~10%|
|Construction & Forestry Net Sales||Up~ 10%||Up~ 10%|
|Total Equipment Sales||Down 4%||Down 6%|
The table demonstrates that the decline in the outlook for agricultural and turf is pretty much broad based, indicating that it isn't really about any geopolitical issues, -- although Ukraine and Russia have enough of them right now -- it's about weakness in key crop prices.
Surprises, disappointments and confirmations
There are two key takeaways from the earnings. One is a confirmation, and the other is a slight disappointment that will interest investors in Deere's rival, Caterpillar (NYSE:CAT).
First, the decline in the agricultural and turf segment shouldn't really come as a surprise, because the price of key farming crops continues to weaken. For example, wheat and corn are notably lower this year.
Furthermore, the United States Department of Agriculture, or USDA, recently predicted that this year's U.S. soybean harvest would be the largest in history -- therefore putting pressure on prices with another key crop. This is all bad news for Deere, because farmers tend to cut back on spending when crop prices are low.
The second takeaway is the slight surprise that Deere didn't upgrade expectations for its construction and forestry segment. In fact, the company's management cited a few economic indicators that suggested a better outlook for the construction industry. For example, total U.S. construction investment is expected to increase by 4.3% in 2014 vs. a previous forecast of just 1.7%.
However, the decline in the outlook for housing starts in 2014 from 1.07 million to 1.05 million appears to have created some caution. Fools already know that the housing market has slowed in the first half, but conditions remain good for long term growth. It will be interesting to see what Caterpillar says in its next set of results, because it's relying on a better outlook from construction in order to offset some ongoing weakness in mining.
The bottom line
I will discuss Deere in greater depth in future articles, but for now the key conclusion is that weakening crop prices are hurting its agricultural sales -- investors should keep an eye out for developments in crop prices. It's disappointing, but it's also a facet of the industry and it's not necessarily a long-term trend. However, the company is scaling back production in line with the reduction in its outlook for agricultural sales -- a sign that it sees conditions continuing to weaken.
As for construction, it appears to be a case of conditions being ripe for an improvement, but a combination of weather issues and a slowdown in housing has forestalled any improvement -- at least for now.