Deere Could Get the Benefit of the Doubt

Deere & Co. (DE) investors will be looking for one thing from the company tomorrow morning: growth.

The agricultural equipment firm is scheduled to release its third-quarter earnings report before the bell Wednesday, and Wall Street is hopeful that the company has finally found some firmer ground.

The consensus is expecting Deere to post a profit of $2.17 per share on revenue of $9.28 billion. During the past four quarters, the company has seen revenue grow by 19% year-over-year, on average, but the numbers have been far from inspirational, as evidenced by DE’s lackluster price action during the past year.

Deere has struggled in 2013, as falling crop prices have resulted in lower equipment sales. The company is particularly sensitive to corn prices, which have seen quite a bit of pressure so far in 2013. However, a recent USDA forecast indicates that heavy rains in the U.S. could result in smaller harvests this month, sending corn prices broadly higher. The news has already provided some lift for DE shares, and could factor into the company’s revenue guidance.

On the sentiment front, neither investors nor analysts are showing a high degree of confidence in Deere heading into tonight’s report. There is a smattering of bullish sentiment in the brokerage community, with Deere’s third-quarter whisper number arriving at $2.19 per share — 2 cents higher than the consensus. But that is where the optimism ends.

Checking with Thomson/First Call, we find that Deere has attracted only 10 “buy” ratings, compared to eight “holds” and three outright “sell” ratings. Additionally, the stock’s consensus 12-month price target arrives at $90.61, representing a premium of only about 8.7%. In other words, a majority of analysts following DE shares expect them to add a mere 8.7% during the next year.

Elsewhere, short sellers have been loading up on DE shares. During the past four months, the number of Deere shares has surged 66% to roughly 16.2 million shares as of the most recent reporting period. As a result, some 4.2% of DE’s float is sold short and it would take more than five trading days at the stock’s average daily trading volume to cover these short positions.

If these short sellers are nervous about a potential DE rally in the wake of tonight’s earnings report, it isn’t showing up in the stock’s options activity. As I have noted before, short sellers are notorious for buying call options to hedge their positions. Because of the volatility surrounding an earnings report, stocks usually see heavier call open interest build ups heading into such events.

DE, however, has seen put open interest rise during the past several weeks. In fact, the stock’s August/September put/call open interest ratio is up from a reading of 0.95 during the first week in August to 1.04 as of the close yesterday. In other words, traders are adding bearish put options at a faster rate than call options.

The most popular put strike in the August/September series right now is the out-of-the-money Aug 82.50 strike, where 6,445 contracts reside. Following at a close second is the Sep 80 strike, with 6,217 contracts, while the Aug 80 strike is also notable with 5,328 contracts open.

On the call side, the out-of-the-money Sep 90 strike is king, sporting open interest of 6,798 contracts. In the August series, the 82.50 and 85 strikes are particularly notable, with open interest of 6,323 and 6,765 contracts, respectively.

Overall, options traders aren’t expecting much of a post-earnings move for DE. August implieds are pricing in a potential 2.4% move for DE shares in the wake of tonight’s report. This places the upper bound near $85.35, with a lower bound near $81.41.

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Looking at Deere’s technical chart, a rally to $85 could indicate a breakout for the stock. The shares have been pressured steadily lower since peaking near $94 in May, with resistance holding firm at DE’s 10-, 20- and 50-day moving averages. A move above $85 would place Deere stock above most of its short-term technical hurdles, potentially clearing the way for an extended run higher.

A move toward the lower bond near $81, meanwhile, would once again place DE in contention with support in the area. The shares have tested $81 as support numerous times in the past several weeks, and poor earnings guidance could call this key support region into question.

The good thing for Deere is the poor agricultural environment appears to have already been priced into the stock. In other words, inline to slightly weak earnings and revenue might not garner much of a reaction from investors. However, even a hint of optimistic guidance on revenue or a more positive outlook for the year could have a considerably bullish effect on the stock.

As such, traders looking to jump in ahead of Deere’s quarterly report might want to consider a September 82.50/85 bull call spread. This spread was offered at $1.33, or $133 per pair of contracts, at the close of trading on Monday.

Breakeven lies at $83.83, a 0.5% gain from yesterday’s close, while a maximum profit of $1.17 — or $117 per pair of contracts — is possible if DE closes at or above $85 when September options expire.

As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.

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