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Deere (DE) Banks on Wirtgen Acquisition, Expenses Flare Up

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On Mar 24, we issued an updated research report on Deere & Company (DE - Free Report) . The company’s performance will be backed by strength in Brazil, higher housing starts, ease in tariff and the Wirtgen acquisition. However, its results might be marred by concerns in the agriculture business and elevated expenses.

Deere Rides on Wirtgen Acquisition

In December 2017, Deere acquired world’s leading road-construction equipment maker — Wirtgen — which significantly enhances the exposure of the former to global transportation infrastructure. Global transportation investment is expected to grow, driving increased demand for road construction equipment, such as milling machines, rollers and asphalt pavers. Those are all products in which Wirtgen maintains a market-leading position globally. Importantly, transportation spending remains strong in the United States and Europe, and continues to witness double-digit growth in China and India.

Notably, the Wirtgen integration is well underway, with the Deere-Wirtgen team working toward the synergy target of EUR 100 million by 2022. For fiscal 2018, Wirtgen is forecast to add $3.2 billion in revenues. Additionally, Deere now projects that Wirtgen will contribute $100 million in operating profit for the fiscal. Wirtgen is generating strong positive cash flow in the current fiscal. Deere expects that Wirtgen’s operating margins will be 13-14% beyond fiscal 2018.

Higher Housing Starts to Boost Revenues

Deere predicts global sales for Construction & Forestry equipment to be up 83% for fiscal 2018, including a positive currency-translation effect of about 1%. The outlook is based on global economic growth, including higher housing starts in the United States, and an improved oil and gas sector. Again, economic environment for the construction, forestry and road building industries bodes well, and it continues to support elevated demand for new and used equipment. For the fiscal, U.S. GDP is forecast to be up at 2.7%, which is above the 20-year average. Meanwhile, housing demand remains solid with housing starts expected to be 1.3 million units for the fiscal.

Ease in Tariff to Drive Top Line

Currently the United States has put hold on the tariffs on Chinese goods. Likewise the retaliatory tariffs by China on U.S. soybeans will no longer be imposed. This will drive Deere’s performance.

Strength in Brazil a Catalyst

In the EU28 region, sales are projected to be up about 5%, backed by improving conditions in the dairy and livestock sectors. In South America, industry sales of tractors and combines are estimated to be flat to up 5% for the fiscal, aided by strength in Brazil. In Brazil, the value of agricultural production is now expected to be about the same as last year, with a record soybean harvest. Furthermore, customers are anticipating lower rates for Moderfrota in July, and therefore, shifting purchases into the second half of the fiscal. This shift in sales is evident in a strong order book, which is up from last fiscal.

Concerns in Agriculture Business

Deere’s agriculture business will be affected in fiscal 2018 by the expectation of high global grain and oil seed stocks-to-use ratios. This is because abundant crops have offset strong demand around the world. In addition, corn, soybeans and stock-to-use ratios are expected to decline, in response to the increasing global demand and drought conditions in Argentina, which have lowered the country's corn and soybean production by roughly 25% and 33%, respectively.

Elevated Expenses to Mar Income

Deere will bear the brunt of elevated expenses in fiscal 2018. Its guidance for cost of sales as a percent of net sales is about 76% for the fiscal, up 1% from the previous guidance. The company believes an unfavorable product mix, elevated overhead spending and increased incentive compensation will escalate the cost of sales guidance. Deere also forecasts SA&G expense to be up about 18% for the fiscal. Further, unfavorable impact of acquisition cost and purchase accounting related to the Wirtgen buyout will dampen earnings.

Share Price Performance

Shares of the company have outperformed the industry in a year’s time. The stock has gained around 29% compared 24% growth recorded by the industry during the period.

Zacks Rank & Key Picks

Deere carries a Zacks Rank #3 (Hold).

Some better-ranked stocks in the same sector are Axon Enterprise, Inc (AAXN - Free Report) , Caterpillar Inc. (CAT - Free Report) and Terex Corporation (TEX - Free Report) . All three stocks sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Axon Enterprise has a long-term earnings growth rate of 25%. Its shares have appreciated 149%, over the past year.

Caterpillar has a long-term earnings growth rate of 13.3%. The company’s shares have been up 49% in the past year.

Terex has a long-term earnings growth rate of 20.2%. The stock has gained 27% in a year’s time.

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