Back in May, Deere disappointed investors with a mixed second-quarter earnings release. The company beat expectations with record earnings, but scared investors away by lowering guidance for the rest of the year. The implication at the time was that Deere was expecting sales to slow down to a completely flat fourth quarter.
Well, last week Deere again offered mixed guidance with its third-quarter report. The company raised full-year net income estimates to $3.45 billion, from $3.30 billion, while at the same time lowering fourth-quarter guidance to a 5% drop in sales. Both can only happen together if the company's profit margin grows by almost a full percentage point in the final quarter, which isn't out of the question - in the recent quarter, net margin improved nearly two percentage points over last year.
There are two main reasons for sales falling in the fourth quarter. The first is sort of a good problem to have - last year's fourth quarter was very strong and makes for a tough act to follow. The other problem is that, while agriculture equipment sales account for the bulk of Deere's business, construction equipment still makes up about 20% of total sales, and the company is feeling cautious regarding government spending and its effect on construction.
What else is new?
Blaming slow sales on uncertainty surrounding government spending seems odd, given that that uncertainty has been hanging over the construction industry for several years, and yet Deere's construction and forestry segment has been growing rapidly until now. On the other hand, Deere isn't alone in its caution. I noted last quarter that Caterpillar had lowered its full-year sales guidance, and the company has done it again this quarter. The new estimate is now down to a range of $56 billion-$58 billion, and Cat also lowered earnings per share guidance to $6.50, from $7.00, implying a slight drop in profit margin.
Meanwhile, Deere's smaller competitors, CNH and AGCO are actually revising guidance higher. Both companies recently reported second-quarter earnings and are expecting full-year sales to be higher than they thought last quarter. CNH even raised estimates for its construction sales, while Deere had to lower its own.
Concerns that CNH and AGCO are stealing market share from Deere might be premature, though. On the conference call, management stated that market share in South America had grown "considerably", despite AGCO's efforts to spread its brand in the region.
The Foolish bottom line
While it's of concern that Deere's sales are slowing down, it's heartening that profit margins are expanding enough to compensate, but it's not a sustainable situation. The company already has a much higher operating margin than its competitors, so it's hard to say how much room for margin expansion there is before sales growth needs to take over. While I'm optimistic about the industry in general, Deere appears to be slowing down for the time being. Add the companies mentioned in this article to My Watchlist to keep an eye on the situation.
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The article Deere Is Still Slowing Down originally appeared on Fool.com.
Fool contributor Jacob Roche has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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