As a dividend growth investor, I constantly seek new opportunities to acquire income-producing assets. I own dividend-paying shares, and as the interest rate climbs, the shares must offer a more attractive yield to compete with lesser-risk options. I try to find attractively valued companies and increase my exposure to them.
One segment that can be very interesting is the agriculture segment. Some of the companies in the segment, like Archer-Daniels-Midland (ADM), are in the consumer staples sector. Industrial companies also build heavy machinery needed to work the modern fields. One of the leading companies in this segment is Deere & Company (NYSE:DE). I haven’t looked at the company for more than five years, and it is an excellent time to analyze it.
I will analyze the company using my methodology for analyzing dividend growth stocks. I am using the same method to make it easier to compare researched companies. I will examine the company’s fundamentals, valuation, growth opportunities, and risks. I will then try to determine if it’s a good investment.
Seeking Alpha’s company overview shows that:
Deere & Company manufactures and distributes various equipment worldwide. The company operates through four segments: Production and Precision Agriculture, Small Agriculture and Turf, Construction and Forestry, and Financial Services. The Production and Precision Agriculture segment provides mid-size tractors, combines, cotton pickers, strippers, sugarcane harvesters, and front-end equipment harvesting. The Small Agriculture and Turf segment offers utility tractors, related loaders, and attachments. The Construction and Forestry segment provides a range of backhoe loaders, crawler dozers, and loaders.
The company is very cyclical, as the ten years graph below shows. You can see two cycles over the last decade. Despite the cyclical nature of the business, the company managed to grow its revenues by 33%. It equates to an annual growth rate of ~3%. The growth is primarily organic as the company sells more equipment in more geographies. In the future, analysts’ consensus, as seen on Seeking Alpha, expects Deere & Company to keep growing sales at an annual rate of ~10% in the medium term.
The company’s EPS (earnings per share) has grown much faster over the last decade, with significant growth following the pandemic. The combination of buybacks, improved margins, and higher revenues fueled that EPS growth over the previous decade. In the future, analysts’ consensus, as seen on Seeking Alpha, expects Deere & Company to keep growing EPS at an annual rate of ~13% in the medium term.
The company is a very consistent dividend payer. The company was a dividend aristocrat until the pandemic. During the pandemic, the company froze the dividend due to uncertainty, but it didn’t reduce it for roughly three decades. The dividend payout is conservative at 20%, as the company is aware of the cyclical nature of the business. The current yield stands at 1.24%, and while it is not high, it will most likely grow annually.
In addition to the dividend, my favorite way to return capital to shareholders, Deere also returns money using buybacks. Over the last decade, the company has repurchased almost one-quarter of its shares. Buybacks are incredibly effective when the company grows and can be used during downturns when the valuation is low. Deere used buybacks wisely to support EPS growth.
The company’s P/E (price to earnings) ratio stands at 15 when considering the forecasted EPS for 2022. This valuation is somewhat higher than the lows we saw just two months ago. That valuation is around the average valuation of the company over the last twelve months. Paying 15 times EPS for a growing company often makes sense.
The graph below from Fastgraphs may tilt my opinion a bit. The company trades for 15 times earnings. In the last two decades, the average valuation was 16.5. While the company is more attractively valued, it also grows slower at the moment, with an annual growth rate of 20% in the last two decades. Therefore, it seems that the company is fairly valued, but there is not much of a margin of safety from the valuation perspective.
To conclude, Deere & Company is an impressive company. Despite the cyclicality of its business, the company managed to grow sales and EPS consistently. It leveraged that excess cash flow to pay growing dividends and return cash in the form of buybacks. At the moment, the shares of Deere & Company seem pretty valued when compared to their historical valuation.
The supply chain crisis following the pandemic affects the sales of Deere. Countries and companies realize they should have some capacity for agricultural production in broken supply chains and wars. The war in Ukraine involved two of the largest wheat producers, and the battle between them made it more complex and more expensive to export grains due to the Russian blockade on the Black Sea and the western sanctions on the Russian Federation.
The war in Ukraine has increased inflation as grains cannot be easily exported, and energy prices are higher, resulting in higher costs. The higher price of agricultural commodities makes it more attractive for companies to increase production to answer the demand as fewer Russian and Ukrainian products are in the market. Deere will support the growth in output by selling agricultural equipment.
The balance sheet is another important point of strength for Deere & Company. The Federal Reserve is raising interest prices, which may be risky for cyclical companies. However, the company enjoys a fortified balance sheet with net debt to EBITDA of just 1.2. The company benefits from it twice. One, by being on the safe side of the higher cost of debt, and two, by taking advantage of the situation and acquiring peers for lower prices if it finds them attractive.
A recession is the first risk for the company. A recession in the global markets may reduce consumption. While it will primarily affect the construction and forestry segment as the demand for housing and lumber may decline, it will also affect agricultural businesses. Clients will try to find more creative ways to maintain their current machines as they may seek to lower CapEx in times of higher uncertainty.
This risk is amplified by cyclicality. Right now, the situation looks bright for Deere & Company, but a downtrend may cause some short to medium-term struggles. Deere has already seen its sales increase significantly since the pandemic, which signaled the previous down market, and a recession may signal another end for the current cycle. At the current valuation, cyclicality may cause a short-term share price decline.
Due to its low leverage, interest rates may not pose a risk for Deere itself. However, it may affect its clients. The company has a financial arm that finances the acquisition of its machinery. Higher rates will mean its clients struggle to finance the machines, which may hurt agricultural equipment sales.
Deere is an excellent company to hold. The company has strong fundamentals with an excellent track record of growth. Despite the cyclicality of the business, the company steadily grows its top and bottom line, fueling dividend and buyback growth. The company has several growth opportunities supporting EPS growth in the medium term.
On the other hand, there are risks to the investment thesis. The recession looms as the interest keeps climbing and inflation hits the economy. Clients struggle to buy new equipment at the latest prices and with the higher interest, and the current valuation is fair yet doesn’t factor in the risks of investing in the company. Therefore, I believe that the existing valuation shares of Deere & Company are a HOLD, and investors should wait for a lower level of uncertainty or a more attractive valuation like we saw two months ago.