Most of my readers know by now that I am a huge Deere & Company (DE) bull. This company is my largest long-term dividend investment, accounting for more than 8% of my total account value. In this article, I am going to update the bull case based on macro developments and the just-released 4Q20 earnings release. Not only are macro indicators turning into huge tailwinds, but the company also confirmed this by reporting blowout sales, earnings, and guidance. Needless to say, I remain extremely committed to this long-term investment and believe Deere is a must-own dividend stock, despite its relatively low dividend yield.
Source: Deere & Company
Macro, Macro, Macro
I would characterize myself as a value investor with a strong focus on macro research. Hence, I always base my investments on how the economic situation is expected to change. In this case, I started buying Deere because I liked the valuation given the expected surge in agricultural exports. Interestingly enough, agricultural exports might be the biggest reason why Deere is doing so well this year.
Especially China is giving the global agricultural industry a boost thanks to its need for corn and soybeans.
I think the fact is that China needs soybeans and grain. They have rebuilt their swine population a lot faster than many of us had predicted,” said Joe Glauber of the IFPRI think tank. “The United States has been a big beneficiary, particularly in recent months with problems in the Black Sea (region), the China trade dispute with Australia, and concerns about South American crops.
Additionally, and this is key, supply is under pressure.
A big rally this fast requires a “perfect storm” of unexpected events happening at the same time. In this case, carryout predictions among market participants for the 2020 crop have decreased from nearly 3.5 billion bushels in the spring to under 1.5 billion this month. A 2 billion-bushel drop in such a short time is unprecedented. The trade has been known to be a bit extreme with their prediction compared the USDA’s numbers, however even the USDA has shown a record drop this year as well from 3.3 billion in the May report to 1.7 billion earlier this month. For reference, in 2012 the USDA carryout reduction was only a 1 billion-bushel drop from spring until after harvest.
What happens when rapidly rising demand meets subdued supply can be seen below as the graph displays both corn and soybean futures.
Source: TradingView (Blue = soybeans, black = corn)
Additionally, future capital expenditure expectations have bottomed and gained significant momentum after the pandemic-related implosion in the first half of the year. While we could see some weakness due to elevated global COVID-19 cases, we are entering 2021 at relatively strong levels, which will more than likely support Deere’s construction and forestry sales (29% of FY2019 sales).
To quickly summarize this part, as expected, agricultural developments have turned into a huge tailwind for farmers as prices showed strong upside momentum after a very challenging first half due to the ongoing pandemic. I believe this strength is here to stay and expect 2021 to benefit both agriculture and construction sales.
With that said, let’s see what Deere has to say.
The Deere Shareholder Wins
One of the reasons why I like this company so much is because of its ability to turn agricultural equipment demand into high shareholder value. What do I mean by that?
The just-released 4Q20 earnings show what I mean. The Illinois-based equipment producer generated total net equipment sales of $8.66 billion. This is down 0.6% compared to the prior-year quarter as a 16% decline in net worldwide construction & forestry sales more than offset an 8% gain in net worldwide agriculture & turf sales. Regardless, the company beat net sales estimates by $1.04 billion. The same goes for GAAP EPS, which came in at $2.39, which is $1.05 above expectations.
Needless to say, these are blowout numbers. However, it still gets better as guidance was phenomenal.
For example, net income for FY2021 is expected to be in the range of $3.6 billion to $4.0 billion. In May, the company expected this range to be between $1.6 billion and $2.0 billion. As a comparison, FY2020 net income was $2.75 billion.
Basically, the company’s comments cover industry strength and the company’s ability to realize benefits through technology investments.
In the year ahead, Deere expects to benefit from improving conditions in the farm economy and stabilization in construction and forestry markets, according to CEO John May. “Higher crop prices and improved fundamentals are leading to renewed optimism in the agricultural sector and improving demand for farm equipment. At the same time, we are looking forward to realizing the benefits of our smart industrial operating strategy, which is designed to accelerate the delivery of solutions that will drive improved profitability and sustainability in our customers’ operations.”
The division outlooks confirm this as worldwide agriculture & turf net sales are expected to rise between 10% and 15% in FY2021. The operating margin is expected to rise from 13.3% to at least 15.5%. The company sees strength in all regions except for Asia, which is expected to report mild weakness in FY2021.
The good news continues as Deere also expects strength in its worldwide construction & forestry as net sales are expected to rise between 5% and 10%. The operating margin is expected to get a boost from 6.6% to at least 9%.
So, Now What?
While I am writing this, I am up roughly 50% on my initial Deere investment. Needless to say, this has pushed up the company’s valuation as investors and traders are frontrunning the expected fundamental boost in FY2021.
Based on a market cap of $80 billion and $2.75 billion in FY2020 net income, the stock is trading at 30x earnings (see graph below). Based on FY2021 guidance, the company is trading at a forward P/E ratio of 20-22x. That is far from being undervalued, but it’s a fair value and I cannot make the case that Deere is overvalued, despite being up 48% year-to-date.
However, what bothers me a little, is that the dividend yield has dropped to one of the lowest levels in recent history. However, note that Deere targets a 25%-35% payout ratio, which implies, based on FY2021 guidance, that the long-term dividend growth streak will continue.
Another thing I want to mention is the company’s outperformance. Over the past 5 years, Deere’s stock has even outperformed the Invesco QQQ Trust ETF (QQQ) – despite the massive rally in ‘big tech’ over the past few years.
Deere investors are in the right place. Not only is the stock price up 48% year-to-date, but it’s completely justified. After a challenging year in FY2020, management is looking to rapidly grow sales and earnings as FY2021 will see the benefits from a strong agricultural industry and a recovery in construction and forestry demand.
My strategy will remain unchanged. I will continue to add to my Deere position. I am not a big fan of the low dividend yield, but as it’s a result of the company’s stellar fundamental performance, I really cannot complain.
Even at current prices, I have little doubt that investors will achieve great results (and outperformance) with Deere.
Invest in Deere, don’t trade it.
Thank you very much for reading. Please make sure to click the like button and subscribe if you don’t want to miss any updates. All long-term holdings are listed in my Seeking Alpha bio.
Disclosure: I am/we are long DE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.