Industrial stocks by their nature are very cyclical. When the economy is performing well and demand for products is high, stocks in this sector often produce solid sales and earnings numbers. When the economy is soft and demand for products decreases, industrial companies often see sales and earnings decline, sometimes dramatically.
Agriculture stocks, a subsect within the industrial sector, are especially cyclical. When crop prices are increasing, farmers are flush with cash and often look to purchase new equipment to help increase their crop yield. When prices drop, sales often do as well as farmers begin to pinch every penny. One of the companies that often acts as a measuring stick for the entire agriculture industry is Deere & Company (DE).
Deere manufactures and sells agricultural equipment. The company consists of two divisions: Agriculture & Turf and Construction & Forestry. Nearly 80% of sales in 2017 came from the Agriculture & Turf division. The majority of sales come from large and small farms. Among the products that Deere offers are large agriculture and construction equipment, engines and lawn, garden and landscaping products. Deere has a current market cap of more than $50 billion.
Recent earnings release
Deere released third quarter earnings results for fiscal year 2018 on Aug. 17. The company earned $2.59 per share, missing estimates by 16 cents. This was an improvement of more than 30% from the second quarter of fiscal year 2017. Sales increased 36% to $9.29 billion, which was $80 million higher than what the market was looking for.
While the earnings miss initially caused the stock to dip, Deere's commentary helped the stock close higher on the trading day. Even with a possible trade war escalating with China, Deere saw demand worldwide for products increase. Deere's sales have increased 29% for the first three quarters of the company's fiscal year.
Crop values have largely been in decline since 2011 in places like the European Union and Brazil, but recent increases have resulted in higher sales volumes for Deere. U.S. farm cash receipts peaked in 2014 and have drifted lower the last few years, but they do appear to be stabilizing. In fact, due to the strength in crops like corn, wheat and cotton, demand for new farm equipment to replacing aging equipment is expected to pick up even more in 2019. Deere expects that food demand will double over the course of the first half of this century, offering the company a vast opportunity to continue growing.
Also helping sales increase are Deere's acquisitions. One such strategic acquisitions is Deere's 2017 purchase of German construction manufacture Wirtgen. Wirtgen added 17% to the company's sales increase.
Deere sees revenues growing 21% to $8.58 billion year over year during the fourth quarter, but this was slightly below the average analyst estimate. Still, 20% or higher growth is impressive, and the company expects sales in 2019 to be even better. Deere expects to earn $9.53 per share this year.
Dividend History and Valuation
Given the cyclical nature of its business, investors might not expect Deere to have an attractive dividend history. While the company did pause its dividend growth from 2016 to 2017, the dividend has increased by:
An average of 3.8% annually over the past three years.
An average of 8.5% annually over the past 10 years.
These average annual increases might disappoint certain dividend growth investors, but given the cyclical nature of Deere's business, I feel they shouldn't be discounted. Prior to the recent pause, the company had increased its dividend for each of the past twelve years. Most recently, Deere increased its dividend by 15% for the August 1st, 2018 payment. Given that the recent increases have generally been under 4%, this sizeable increase likely means that the company is bullish about future earnings growth.
Deere is expected to pay out $2.58 in dividends in 2018. Based off expected earnings per share of $9.53, the dividend payout ratio is just 27%. This is below the average dividend payout ratio of 31.1% that the company had between 2008 and 2017. This leaves the company plenty of room to maintain and raise its dividend even if earnings were to suffer a temporary decline. Investors should remember that Deere had increased its dividend for more than a decade before last year's freeze.
Deere's stock currently yields 1.76%, slightly below the yield of the S&P 500 (1.81%). While the extra income is nice, investors likely aren't investing in Deere solely for those purposes. Deere's stock has performed very well recently, rewarding shareholders with more than 20% returns over the last year.
Shares of Deere closed at $156.40 on Friday, giving the stock a price to earnings multiple of 16.4. According to Value Line, the stock has an average price-earnings ratio of 13.5 over the last ten years. Deere's stock is overvalued relative to its own history, but compared to price-earnings ratio of the S&P 500 (23.6), the stock is much more attractively valued.
Final Thoughts
Deere had a very strong third quarter, growing both revenues and earnings by more than 30%. While fourth quarter guidance was slightly below what the market was expecting, sales for next year are expected to grow as well. While Deere did freeze its dividend last year, the company issued a mid-double digit increase for the most recent payment. That should give investors comfort that the company expects future earnings growth. While shares are slightly above their historical valuation, Deere's stock could prove further gains given the demand for products. Investors looking to add a stock with a below market price earnings ratio and solid growth prospects should consider purchasing shares of Deere & Company.
Disclosure: I am not long any of the stocks mentioned in this article.
