Deere & Company (
) is a well-known American manufacturer of agricultural machinery.
The company's success dates back to 1837 when John Deere introduced
the cast-steel plow from his workshop in Grand Detour, Illinois. It
has grown to be the biggest player in the agricultural machinery
industry world-wide with products on offer that include tractors,
harvesters, balers, planters, sprayers, diesel engines, drive
trains, lawn mowers, and snow throwers. The company also provides
financial and other related services.
DE is of course cyclical in nature, so if you believe the global
economy is in for a tough time in the coming years, you will want
to stay away. But the world's population needs to eat, and as new
members rapidly enter the global middle class pool, the demand for
quality and quantity of agricultural products will increase. DE has
been growing its business in developing countries at a decent rate,
and that trend is unlikely to reverse any time soon.
DE invests more in R&D than its competitors holding it in
good stead to maintain its dominant position globally moving
forward. It has long had a reputation for quality and management
places significant importance on maintaining that reputation.
DE has grown its EPS at a compounded rate of 26% over the past
10 years. This is an impressive growth rate for such a large
company. It should be pointed out though that EPS has grown at a
more modest 13% over the past 5 years - as with all cyclical
companies the GFC hit earnings of DE hard. DE's dividend per share
has grown at a 15% clip over the past 10 years. It is currently
offering a 2% yield.
We like to see companies generate about as much Free Cash Flow
as net earnings over a period of time. Over the last 10 years DE
has generated $8.3B of Free Cash Flow versus almost $15B of total
net earnings over that same period. Over the past 4 years DE has
generated $2.6B in Free Cash Flow versus total net earnings over
that same period of $7.6B. That is a concern. Delving deeper - Cash
from Operations over the last 10 years has totaled over $18B and
the figures have been reasonably consistent from year to year,
which is great to see. So DE has been spending a large amount on
capital expenditures each year - funding the expansion into
developing markets and keeping its manufacturing equipment up to
date. There is only one thing worse than a company spending lots of
cash on capital expenditures - and that's a company not spending
enough on capital expenditures - deferring the expenditures until
finally they have been deferred for too long. DE is a great
generator of cash from operations, but it happens to have a rather
large capital expenditure burden.
DE's net debt-to-equity ratio is too high. Over the past 10
years it has averaged almost 300% and it currently sits at 337%.
The company is spending a large amount of money on share
repurchases - a total of $7.6B over the past 10 years. This has 2
implications - it is not using that cash to pay down debt, and it
is keeping the equity base low. Shareholder equity in 2002 was
$3.2B and in October 2011 it stood at $6.8B, so though EPS has
grown at a great rate, shareholder equity has been kept low. The
major contributor to the high net debt to equity is the financing
division of DE, which operates like many other financing
organizations - with high amounts of debt. The company has operated
under high amounts of debt for a while so perhaps it is
sustainable? But its interest expense is over 23% of operating
income, which we view as too high. We would like to see net debt be
reduced in the coming years.
DE scores a rather sobering 50 / 100 for its Quality Rating. Its
Free Cash Flow as mentioned above is not great, its net debt to
equity is too high (albeit on an equity base that is kept low), and
though its EPS growth over a 10-year period has been great, it has
been inconsistent over that time, resulting in a low score. DE's
capital expenditure burden as mentioned above is significant, and
one that needs to be looked at.
Intrinsic Value is forecast to rise meaningfully in the coming
few years. This is based on the assumption that we will not enter a
global recession as a result of the European situation or any other
Looking at the graph - the share-price of DE is quite volatile
as can be expected of a cyclical stock. But even amidst the
volatility, buying opportunities have been rare.
Investment Grade Table
DE comes in at number 135 on the Investment Grade Table with a
low Investment Grade Score of 4. To put that in perspective, the
companies that inhabit the upper echelons of the Investment Grade
Table have an Investment Grade Score of over 60.
There is a lot to like about DE - it has an undeniable brand and
has positioned itself well to capitalize on growing demand from
developing countries. As such, some investors may see an
opportunity at current prices - DE is now in value. But some of
DE's metrics are concerning - the company has a significant capital
expenditure burden that it needs to get back under control, its net
debt to equity (and subsequently its interest expense) is too high,
and it is a deeply cyclical business. Management may well have
these items under control, but even so they can make for some
restless nights' sleep for some investors. DE is offering a small
Margin of Safety at the moment, and its Intrinsic Value is forecast
to rise in the coming years. But given the concerns, investors may
prefer to wait to see a much larger Margin of Safety prior to an
investment. In the meantime there are a number of more attractive
opportunities available in the market.
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours.
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