Recommendation: Buy DE on a break above $83.50 or a bounce back up from support near $80 per share.
Deere (NYSE:DE) has consolidated between $73 and $83 a share, and the company is once again approaching a potential resistance breakout that could send prices to $90 or higher depending on how earnings season kicks off.
From a technical perspective, DE has resistance at $83.50, so we’re looking for a buy at or above $84. Our short-term target is at $90; the stock could run into some resistance as it approaches the yearly high from February. If earnings season – about to kick off in earnest — is better than expected, DE could break above $90 and potentially push through $100 per share. That is an ambitious price target, but it’s relatively moderate when you consider the 2007 and 2010 rallies.
Stocks like DE will generally have a fairly high positive correlation with rising agricultural prices, but the trends of food prices and DE sometimes diverge when investor stress is relatively high and risk-takers are less willing to buy stocks. Although the market has trended higher over the past few months, it has done so on very low volume. This lack of investor conviction has been a problem for cyclical companies like DE and has stunted their price growth.
As you can see in the chart above, DE has lagged the breakouts in corn and soybean futures, both of which above May lows. The pullback in commodity prices last month merely pushed them to support, where they are likely to break higher again as global stimulus drives prices. We would expect DE to perform much better when prices are higher and farmers have an opportunity to be more profitable.
But higher agricultural prices alone aren’t a guarantee of higher profits for farmers. Indeed, many pundits questioned the likelihood of ag profits, worrying that the higher prices were a function of lower supply. Their fears seem to have been unfounded, though — according to the U.S. Department of Agriculture, 2012 will be the most profitable year for American farmers on record. This bumper crop of cash certainly increases the probability that farmers will invest in new, efficient equipment from DE and other suppliers.
A big part of Deere’s underperformance relative to commodities and other manufacturing stocks stems from a surprisingly negative earnings report in August. At the time, management reduced the outlook for 2013 earnings by 2% due to higher materials costs and a slowing economy in Europe. That may not sound like much of a disappointment, but it’s a big deal for a stock that releases positive earnings surprises more than 80% of the time.
The moderate selling and stunted growth in August and September has been overblown. The company’s financials are strong, and central banks around the world seem determined to keep asset prices from falling in the short term. That may or may not be an effective strategy for long-term economic growth, but our projections for DE’s prices don’t extend much further than the first quarter of 2013. The tendency for DE to surprise during earnings means that prices should rise between now and the middle of November, when the company releases its fiscal fourth-quarter results. We recommend buying DE on a break above $83.50, or on a bounce off support near $80 per share.
