You Are Probably Missing the Big Opportunity in This Stock
Because companies sometimes fail to deliver despite tall claims and promises, I usually take management statements with a pinch of salt. So when Deere's deputy financial officer, Marie Ziegler, recently said that its management had intensified share repurchases during the last quarter because it feels the company's shares are trading "significantly below" their intrinsic value, it made me sit up.
Is Deere's stock really undervalued? At a P/E of less than 10, the stock does look cheap. But a buyback may push up share prices because it artificially increases earnings per share, thereby making the stock look cheap. That's not growth in real terms.
Deere needs to convince investors about its growth prospects in the near future and deliver strong growth on its top and bottom lines. From that standpoint, Deere's growth story looks intact, and the stock may have been punished unnecessarily. In other words, Deere's shares present a great opportunity for investors.
Consistency and resiliency
Despite sluggishness in its construction-equipment business, Deere delivered a record third quarter recently, with 26% improvement in net income year over year. Its top-line growth was comparatively smaller at 4%, but I think the fact that Deere churned such good profits from small incremental sales is notable. Investors should be happy to know that Deere now expects to end its fiscal year in October with record net income of $3.45 billion, which would be an impressive 13% jump over what it earned for 2012.
More importantly, looking beyond one quarter or even a single year, Deere's revenue and profits have risen consistently since 2010.
Investors should note that even in a challenging year like 2012, when the U.S. was hit by the worst-ever drought, Deere's profits hit a new high. That's resiliency at its best.
Even better, Deere's operating margin has had an equally good run-up in recent years, with margin in its agriculture and turf division hitting 17% in the last quarter. What's more, you may be surprised to know that Deere's margins are among the best in the industry.
For a fair comparison, since 80% of Deere's revenue comes from the sale of agriculture equipment and the remaining from its construction and forestry business, I have selected two competitors from the farm-equipment industry, AGCO and CNH Global , and one from the construction-equipment space, Caterpillar .
As you can see, while each of these companies has improved its operating margins since 2010, Deere's margin is more than twice that of AGCO's and a good 6 percentage points better than CNH's. Caterpillar's margin has grown at the fastest pace over the years, but maintaining it has become an uphill task for the company in the wake of the recent mining industry malaise. So despite facing similar headwinds as Caterpillar in its construction-equipment business, Deere is still better off.
Of security and support
Deere's growing operating margin further indicates its management's focus on and efficiency in cost control. As operating income improves, the company can also cover obligatory expenses like interest on debt better. Deere's interest coverage ratio is a healthy 7.6, which, again, is among the best in the industry. While AGCO has a great interest coverage ratio of 13.8, Caterpillar's and CNH's interest coverage ratios stand at 5.7 and 3.9, respectively.
In short, Deere has consistently delivered high revenue and profits and maintained healthy margins, and the company is set to end its financial year on a good note. Even better, recent fears about industry conditions may have been overblown.
The opportunity ahead
The markets have been wary that the recent plunge in crop prices could hurt farm receipts, which, in turn, could lower demand for Deere's farm equipment next year. While lower crop prices are a concern, projected bumper production (link opens as PDF) of essential crops like corn and soybeans this year would mean higher sales volumes for farmers, which could help offset lower selling prices. Last year, crop prices were at their peak, but the drought hurt crop yields significantly. Yet, U.S. farm cash receipts hit an all-time high, thanks largely to crop insurance claims filed by the farmers.
More importantly, international markets will play an increasingly important role for Deere in the future. The company aims to gets half of its revenue from markets outside the U.S. and Canada by 2018, up from 38% last year. The Brazilian markets, in particular, look promising -- tractor penetration there is still low despite a booming agriculture sector. Robust demand from South America helped Deere's international sales improve 9% year over year during the last quarter.
Deere's solid brand image makes it easier for the company to strengthen its foothold in the fast-growing markets like Brazil, China, and India. An increasing global presence should pay off handsomely in the future.
What you should plan next
I think Deere is a great company with a solid business line, efficient management, and strong financials. It is also committed to increasing shareholder value: It has a solid return on equity of 43%, has increased
its quarterly dividends by 82% since 2010, and has bought back shares every year since 2004. I'll give you a more detailed analysis of Deere's capital allocation strategies soon. Until then, I think long-term investors should plan to build a position in this stock.
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The article You Are Probably Missing the Big Opportunity in This Stock originally appeared on Fool.com.Fool contributor Neha Chamaria has no position in any stocks mentioned, and neither does The Motley Fool. 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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