The long-term bull case for companies like Deere (DE) and Caterpillar (CAT) is so simple it’s almost silly, but slumping prices for everything from corn to coal make the near-term outlook for DE stock and CAT stock seriously challenging.
Deere is the biggest maker of giant farm machinery like harvesters and combines. Caterpillar is the largest maker of mining and construction equipment, like dump trucks and excavators. And they both benefit greatly just from global demographics.
After all, the world isn’t getting any smaller. Inexorable population growth means the planet needs more food and energy and metals and dwellings. Over a longer time frame, Deere and Caterpillar will only see more demand, so DE stock and CAT stock should benefit.
Of course, over a long enough time frame, we’re all dead. And for too long now, DE stock and CAT stock have been dead money.
After roaring out of the last bear-market bottom of March 2009, both DE stock and CAT stock have been disappointments. DE stock is off 5% over the last 52 weeks. CAT stock is roughly even. Work your way back a little bit and you’ll see that DE stock and CAT stock are trading at essentially the same levels they did at the end of 2010.
DE Stock, CAT Stock At the Mercy of Commodity Prices
There are different forces weighing on DE stock and CAT stock, but one thing they share are stagnant or lower commodity prices. Wheat, corn, copper and gold are all down sharply over the last year, and the weakness goes back farther than that. Indeed, a wide swath of hard and soft commodities are near or below prices that were also last seen at the end of 2010.
Part of that is due to China. The Middle Kingdom’s economy is slowing down dramatically, and at least some of that is on purpose. China isn’t spending on investment like it once was, so the feverish construction of things like highways and bridges and skyscrapers has cooled off. That’s one thing that has been hurting metals prices.
At the same time, the global economy has been sluggish, with giant areas of demand like the U.K and eurozone struggling to stay out of recession. They’re not investing like they once were, either. So that’s another knock on metals prices.
And metals prices are further hampered in some cases by too much production, as mining companies raced to produce more hard commodities when prices were rising years ago.
Mining companies are ratcheting back, which means CAT can’t sell as much equipment these days. (CAT stock does, however, have a saving grace in a resurgent U.S. construction industry, thanks to the housing market.)
As for agriculture, in some ways it’s worse. It’s the classic boom-and-bust cycle. Farmers harvested a record amount of corn in 2013. And now falling U.S. crop prices will cut yearly farm profits by 27% in 2014, according to the U.S. Department of Agriculture.
Rising prices a few years back seduced farmers into sowing more grains, especially corn. But after a couple of years, a glut of supply almost inevitably crashes into waning demand — and prices fall. Corn futures plunged 40% in 2013. Wheat dropped 22%. There’s no incentive for farmers to grow more of pretty much everything. They don’t need more machinery from Deere.
So get ready for another rough year. CAT stock got a lift from better-than-expected fourth-quarter results, and a fairly optimistic forecast. But it still sees revenue coming in flat for 2014.
Deere’s most recent results also pointed to a tough year ahead. The company expects 2014 sales and earnings to decline by mid-single-digit percents.
At some point, these cycles will turn. Some analysts see a trend pointing to recovery in the mining sector, albeit not until 2015. Deere’s outlook is perhaps more cloudy. Farmers hoard their crops when prices are low, waiting for a better time to sell. It’s going to take time to rebalance the supply and demand equation in this industry.
It’s true that Deere and Caterpillar are well-run companies and their stocks have many attractive attributes, like high returns on equity. But in the short haul, neither DE stock nor CAT stock looks good for sustained upside — not until the macro picture for commodities brightens.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.