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On May 31, we maintained our Neutral recommendation on agricultural and construction equipment producer Deere & Company (DE - Analyst Report). Our reiteration was primarily based on expected benefits from strong farm incomes, recovery in construction sector and strength in Brazil, offset by concerns regarding weakness in Europe, additional import duty imposed in Russia, Kazakhstan and Belarus, and volume and margin headwinds in the third quarter.

Why Reiterated?

Deere reported record second quarter 2013 earnings of $2.76 per share, up 6% year over year. Quarterly sales also increased 9% to $10.9 billion. Both were ahead of the respective Zacks Consensus Estimates.  

As per the U.S. Department of Agriculture, U.S. farm income will be a record $128.2 billion in 2013, up 14%. This will be driven by high market prices and crop insurance payments that will offset losses from the drought.

Prices for corn, wheat and soybeans are projected to remain historically high and above the pre-2007 levels. Relatively high commodity prices and strong farm incomes are expected to continue to sustain demand for farm machinery during the year.

Both the non-residential and residential construction sectors are showing signs of a much awaited turnaround. This, in addition to the new highway bill, will improve demand for Deere’s construction equipment in the U.S. market.

Deere is investing to increase its market share in Brazil. Value of agricultural production in Brazil is expected to rise 9% annually in 2013. Deere raised its agriculture and turf sales growth forecast for South America to 15% to 20% from previous expectation of 10% to 15%. This was driven by strong market conditions and growth in government subsidies in Brazil.

On the flipside, Deere expects agriculture and turf sales for Europe to be down 5%, due to weakness in the overall economy and poor harvest in the U.K last year. In the forestry sector, further weakness in the European markets is expected to offset higher demand in the U.S.

Effective Feb through Jul 2013, an additional 27.5% import duty has been placed on all imported combines going to Russia, Kazakhstan and Belarus, thus bringing the import duty to 32.5%. This is expected to have an adverse impact on sales of imported combines in these countries.

Furthermore, higher production costs associated with interim Tier 4 as well as global growth expenses will negatively impact margins in the next quarter.

Other Stocks to Consider

Deere currently retains a Zacks Rank #3 (Hold). Other stocks in the same industry with favorable Zacks ranks are Kubota Corporation with a Zacks Rank #1 (Strong Buy), while Alamo Group, Inc. (ALG - Snapshot Report), and CNH Global NV carry a Zacks Rank #2 (Buy).

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