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Farm equipment maker offers fertile ground for value investors

Deere & Co.'s stock has declined by 10 per cent in less than three months, and is now priced at a substantial discount

Toby Talbot/AP Photo

At a time when pockets of value are scarce in the stock market, Deere & Co. could be a bargain for investors with a longer-term horizon.

The world's largest farm equipment producer has been soundly punished by the price plunge in some agricultural commodities.

Deere's stock has declined by 10 per cent in less than three months, and is now priced at a substantial discount, said Bill Harris, partner and portfolio manager at Avenue Investment Management, which owns shares of Deere.

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"I don't need any more reasons than that," Mr. Harris said. "You've got a cheap stock. We don't even need the company to grow earnings. We think we can get to $110 or $120 just through multiple expansion."

But there are other reasons to buy Deere, including its substantial cash generation, decent yield and track record of dividend increases, its solid balance sheet, and its exposure to the rising demand for food required to sustain a growing global population.

Deere's earnings are largely driven by grain markets. High prices for grains translate into higher farmers' incomes, which in turn, fuel demand for agricultural equipment.

In recent years, changing appetites in China helped to lift demand for grain, supporting high agricultural commodity prices. On the force of that updraft, combined with economic growth, Deere's earnings per share nearly doubled between fiscal 2010 and 2013.

But the company's stock price didn't really follow suit. For more than three years now, Deere stock has been roughly flat.

One explanation is that much of the company's earnings growth was priced into the stock during its rebound from the financial crisis.

In the two years beginning with the 2009 bottom of the stock market, Deere stock quadrupled from just under $25 (U.S.) to just under $100.

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Since then, however, the company's earnings haven't commanded the same price on the market.

"The multiple has contracted, and I'd argue it's inefficiently priced," said Robert Gill, vice-president and portfolio manager at Lincluden Investment Management.

But he said he's holding off before taking a position in Deere.

"We felt like there was going to be more negative headline risk that would drag this thing down. We're trying to be patient. But we'll probably be buying fairly soon," Mr. Gill said.

Deere's share price has been driven down lately by a grain glut that has flooded markets and sunk prices.

Now at the end of an equipment replacement cycle, farmers facing income cuts will be doubly reluctant to invest in new machinery. "They won't be spending for a couple of years," Mr. Gill said.

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That restraint will put the squeeze on Deere's bottom line. A year-over-year earnings decline this year of 7.3 per cent will deteriorate further next year with an expected drop of 9.8 per cent, according to average analyst estimates compiled by Bloomberg.

Those projections clearly have not gone over well with investors, who may have overreacted to Deere's rough patch.

"We think expectations for declining agricultural equipment demand are largely reflected in Deere's share price, while the company's good execution and solid cash flow could help support more resilient EPS than some investors expect," said Andy Kaplowitz, an analyst at Barclays Capital.

Mr. Kaplowitz has an "overweight" rating and a $101 price target on the stock, which represents a 18-per-cent premium over Friday's closing price of $85.26.

But even with two years of declining earnings ahead, Deere stock is oversold, Mr. Gill said. It now trades at a trailing price-to-earnings ratio of just 9.1, compared to an average of 17.5 for the S&P 500 index.

There are very few companies trading at a single-digit multiple with Deere's credentials, Mr. Gill said. Deere has an average return on equity over the past few years of more than double the market average, a 2.8-per-cent dividend yield, compared with 2 per cent for the S&P 500, reputable management, and an iconic brand.

"It's a no-brainer for a buy-and-hold investor," Mr. Gill said.

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About the Author
Investing reporter

Tim Shufelt joined the Globe and Mail in August, 2013, primarily to cover investments for Report on Business. Prior to the Globe, he worked as a staff writer at Canadian Business magazine, a business reporter at the Financial Post, and covered city news and courts for the Ottawa Citizen. More


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