Should I Buy Deere Stock? 3 Pros, 3 Cons

by Dan Burrows | November 21, 2012 12:28 pm

Should I Buy Deere Stock? 3 Pros, 3 Cons

Farm- and construction-equipment maker Deere & Co. (NYSE:DE[1]) logged record quarterly earnings Wednesday — just days after Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A[2]) (NYSE:BRK.B[3]) disclosed a stake[4] in the company. But results missed Wall Street estimates.

Shares tumbled on the news, even as profits rose nearly 3% on a 14% gain in revenue, and Deere said upcoming fiscal year earnings would come in ahead of analysts’ average estimate.

Still, anytime the Oracle of Omaha initiates a new position, it’s worth paying attention. Buffett is a value hound with a preferred holding period of “forever.”

So, should you consider following the master into shares of Deere? To help decide, let’s take a look at the pros and cons:

Pros

Valuation. Buffett only buys things when they’re on sale, and that certainly looks to be the case with Deere’s stock. With a forward price-to-earnings ratio of 10, the shares trade at more than a 40% discount to their own five-year average, according to data from Thomson Reuters Stock Reports. They’re also cheaper than the S&P 500, despite having better long-term growth prospects.

More Mouths to Feed. Global population growth is accelerating rapidly and increasingly becoming urbanized. That means there’s a long-term need to produce more grain throughout the world. It all adds up to a massive secular tailwind for Deere, which makes the machines farmers need to sow and reap more food — especially in fast-growth developing countries like Brazil, India and China.

Berkshire Buyout? Buffett has made no secret that Berkshire’s $48 billion in cash is practically burning a whole in his pocket. He just hasn’t been able to find the right company at the right price. Deere is a play on the same secular economic trends that led Berkshire to buy railroad Burlington Northern Santa Fe, and with a market capitalization of $33 billion, the takeout price would be in the same ballpark.

Cons

European Weakness. As solid as the strategic thesis on Deere may be, in the short and medium term there’s no getting around the fact that global growth ain’t great. A recessionary Europe, in particular, is hurting results and is expected to be a drag going forward. For the upcoming year, management forecasts sales in Europe to be flat to down 5%.

Currency Headwinds. Companies with lots of overseas revenue have been getting hurt by foreign currency exchange, and Deere has been no exception. A strong dollar relative to euros and other currencies not only makes its products more expensive for foreign buyers, but the company also takes a hit when it converts those relatively cheaper foreign currencies back into stronger greenbacks. For the most recent quarter, unfavorable forex reduced Deere’s revenue by a painful 3%.

Poor Visibility. “Present global economic and fiscal concerns warrant continued caution,” CEO Samuel Allen said in a statement, and Wall Street should take that to heart. Both management and analysts have been too optimistic too much of the time when it comes to future sales and profits. Deere has now come up short on earnings for two consecutive quarters and, prior to Wednesday’s report, missed top-line estimates for three quarters in a row.

Verdict

Buy on weakness. Deere has had a choppy, disappointing 2012, lagging the broader market by more than 3 percentage points, and we wouldn’t be surprised to see more of the same until the global economic picture brightens considerably. But for long-term investors, the secular trend of worldwide population growth means great things for Deere’s growth prospects.

As of this writing, Dan Burrows did not hold any positions in the aforementioned securities.

Endnotes:
  1. DE: http://studio-5.financialcontent.com/investplace/quote?Symbol=DE
  2. BRK.A: http://studio-5.financialcontent.com/investplace/quote?Symbol=BRK.A
  3. BRK.B: http://studio-5.financialcontent.com/investplace/quote?Symbol=BRK.B
  4. disclosed a stake: http://investorplace.com/2012/11/what-is-warren-buffett-buying/

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