Deere – The Floor Looks Robust
In times when market momentum is very obviously directionally downward, certain stocks inevitably stick out as better insulated to the sell-off. With the S&P shedding more than 5% over the past week, DE has held firm around the $80 level and actually moved up as the market has moved steadily down – our prior work on the company and its historical valuation trends showed little room for further downside in the stock price.
Further downside to earnings remains likely, however, as certain tax incentives expire and farm incomes continue to be pressured by weak commodity pricing – but we retain our belief these effects are largely priced in, and DE’s recent performance offers some early support for this thesis. Notably, reports of bipartisan support for the reinstatement of a US farm equipment tax credit could be a source of marginal upside, though we note DE’s high non-US exposure, where agricultural industries will likely remain volatile but will also continue on the modernizing path that has driven growth for DE over the past decade.
In the more immediate term, history indicates we could see continued outperformance from DE in the fourth quarter – we modify an exhibit from our August report highlighting the company’s strong second half performances, noting that most of this outperformance tends to come in Q4. Additionally, valuation continues to be attractive, both relative to the broader Capital Goods sector and on an S&P relative P/E basis.
In short, farm economics remain a concern, but our belief that any weakness on this front is already priced into the stock has been confirmed by DE’s resilience in the face of the recent broad market sell-off. We believe considerable upside remains, with downside likely limited as demonstrated over the past few weeks, and our return on capital driven model shows a “normal value” of over $120 a share.