Streetwise for Sunday, March 12, 2017
The Street’s recent volatility should not be an impediment to your search for investment bargains. Even with annually increased dividends, a stock can still be undervalued. Price is absolute, but value is relative.
Nonetheless, dividends continue to be an excellent indication of value, the premise being that rising dividends are a direct result of rising earnings, which in turn directly influences share price. Furthermore, any dividend yield above the 10-year Treasury rate, currently 2.57 percent, means that you are being well rewarded to wait for price appreciation.
A good example of a company whose shares are on sale, while at the same time having the honor of once being the central theme of a number one song on the country music charts, is none other than Deere & Company (DE). The song of course is “Big Green Tractor,” written by Jim Collins and David Lee Murphy and recorded by Jason Aldean.
Deere is the world’s largest manufacturer of farm machinery. And for the eleventh straight year, Deere is also among Ethisphere Institute’s list of most ethical companies.
When I wrote about the company a year ago, my 2016 earnings estimate for Deere was $4.25 with a projected 12-month share price of $89, yielding a capital gain of about 10 percent, plus an indicated dividend yield of 2.89 percent. So how did the company do? Earnings came in at $4.81 per share, while the shares recently closed at $110.84.
You must hand it to Deere’s management. Not much has gone right with farm receipts declining since 2014, meaning farmers are taking a pass on buying new equipment, particularly the high-margin large agricultural machinery that is Deere’s bread and butter. However, the company’s management continues to defy the doubters.
Nonetheless, Deere is rarely mentioned on any financial news network because farm machinery is boring; unlike electric cars or social media. However, boring can be lucrative.
Deere is a cyclical company driven in part by farm income. And in the past thirty-five years’ farm income has fallen on six separate occasions, with the average decline being 32 percent. However, in the past when farm income has fallen precipitously, it has snapped back the following year by an average of 51 percent.
Meanwhile, the recent pain in the agriculture sector is no secret. However, Deere has been reducing costs aggressively and that will make for a lean, mean fighting machine once agriculture’s fortunes turn around.
So, let’s see how successful Deere has been at tackling its marketplace. On Feb 17, Deere reported fiscal first quarter earnings of $0.61 per share, versus a Street consensus of $0.50. Despite the weakness in the agriculture sector, the company has not missed on delivering earnings since 2013. That’s an impressive streak.
Sales in the quarter fell 1 percent. However, equipment sales in the US and Canada decreased 8 percent. Outside of the US, sales rose 11 percent, with a favorable currency-translation effect of 1 percent.
For the year, Deere forecasts agriculture and turf equipment sales to rise by about 3 percent, while agriculture equipment in the US and Canada are forecast to be down 5 to 10 percent for the year as crop prices remain weak.
And it appears that 2017 could be the bottom of the current agricultural cycle. Meanwhile, construction & forestry is where optimism reigns. Deere sees worldwide sales up about 7 percent, reflecting moderate economic growth worldwide.
Deere’s intrinsic value, using the ValuePro.net discounted free cash flow to the firm model, after updating certain parameters such as revenues, shares outstanding, and operating profit margin, along with a risk-free rate of 4 percent, is $225.
My earnings estimate for Deere in FY 2017 is $5.20 with a projected 12-month share price of $121, yielding a capital gain of about 10 percent, plus the indicated dividend yield of 2.17 percent.
If you are looking for a play on the rebound in the agriculture sector, plus a play on the possible infrastructure build-out in the United States, Deere might be one to keep on the short list.
Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddReport.com.