EUR 850.00 For Business Accounts Only

Morningstar | Global Ag Equipment Demand Remains Robust as Deere Integrates Wirtgen; Maintaining Our FVE

Deere grew equipment sales a strong 36% from the prior-year period, including acquisitions, and reached record fiscal third-quarter earnings per share of $2.78. Excluding U.S. tax reform effects, EPS was $2.59, a miss versus the consensus $2.75 estimate. Parsing out the equipment top-line expansion, Deere doubled sales in construction and forestry (including Wirtgen results) and increased agriculture and turf by 18% year over year. Clearly core demand is strong, but the market has not failed to notice. We maintain our wide-moat rating and our fair value estimate.

Deere is enjoying persistently strong demand in both ag and construction in most geographies, and reaping the operating leverage this affords, however, we think investors remain overly concerned about tariff effects. Amid these concerns, Deere expects U.S. farm cash receipts to be greater in fiscal 2019 than in 2018, and the crop value of production to be up in the EU, but flat in Brazil--pretty healthy. We consider tariffs to be a short-term headwind that will eventually wane, and that Deere will offset most of the impact via pricing by 2019. These have been common themes among industrials affected by tariff changes: Little impact thus far, and expectations that supply agreements and pricing power are likely to preserve margins pretty well.

Still, steel cost increases (around 50% so far) plus elevated U.S. trucking rates have compressed full-year operating margin guidance for the large agriculture and turf segment from the 13.5% level management indicated after the first fiscal quarter to the 12.5% level mentioned after the second quarter and affirmed in the third. Steel constitutes 10%-15% of material costs or about 5%-7.5% of net sales. More material is the impact on soybeans, but we think Chinese tariffs on U.S. beans will shift its imports to Brazil and U.S. beans will in part backfill the rest of the world demand that shifts to meet China’s needs.

We expect relaxed trade rhetoric, and certainly resolution of grade agreements would buoy shares.

This quarter, within net sales growth, a single percentage point of price improvement was roughly offset by a point of decline due to currency translation, and the Wirtgen acquisition in December added 17 points. For the full equipment segment, the firm expects 30% sales growth in fiscal 2018, including 12 points due to the Wirtgen acquisition. For its own agriculture revenue this fiscal year, Deere expects fiscal 2018 to grow about 10% in the U.S., 5%-10% in the EU 28, 0%-5% in South America, and 0% in Asia--all in, a healthy 15% improvement in net sales in ag and turf at about 12.5% operating margin.

Looking forward to fiscal 2019, management maintains its expectation that price actions for 2019 will offset materials inflation realized in 2018-19.

Early orders for 2019 show high take rates of precision agriculture features. Management continues to highlight acquisitions made to increase its precision ag portfolio, such as high-clearance sprayers, planters, and a carbon fiber manufacture. An example of its precision ag capabilities, the firm recently demonstrated a sprayer that targets weeds rather than applies a blanket of herbicide over the entire field. We expect such features will attract and retain customers in the Deere ecosphere of top-shelf high-tech products.