John Deere: A Potential Investment in Regenerative Agriculture

Regenerative agriculture is beneficial for the environment because it removes carbon from the atmosphere and sequesters it in the soil. Regenerative agriculture is helping to address the climate crisis, and companies are beginning to incorporate it into their supply chains for environmental, social, and governance (ESG) considerations. It is challenging to find companies that benefit from farmers transitioning from traditional farming to regenerative farming, but one potential candidate could be Deere & Company.

This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and briefly go through why the company has meaning to me. I have changed the format of the analysis a bit to try to make it shorter and with less numbers. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.

For full disclosure, I should mention that at the time of writing this analysis, I do not own any shares in Deere & Company. If you would like to replicate my portfolio or view the stocks in my portfolio, you can find instructions on how to do so here. I don't own shares in any of their competitors either. Deere & Company has been on my watchlist for years, but I haven't made a decision yet. In this analysis, I will investigate whether now is the right time to buy the shares. If you want to purchase shares or fractional shares in Deere & Company, you can do so through eToro. eToro is a highly user-friendly platform that allows you to start investing with as little as $50.

Deere & Company was founded in 1837 in Illinois, United States. The company is mainly recognized for producing agricultural machinery, heavy equipment, and forestry machinery. Their operations are divided into four business segments. The first segment is production and precision agriculture, which accounts for 45% of their revenue. This segment focuses on providing equipment and technology for grain, cotton, and sugar growers. The small agriculture and turf segment, which accounts for 23% of revenue, focuses on providing equipment and technology for dairy and livestock producers, as well as for lawn and property maintenance. The construction and forestry segment provides machinery and technology for earthmoving, forestry, and road building, contributing 24% of the total revenue. The financial services segment, which accounts for 8% of revenue, primarily provides financing for the sales and leases of equipment by John Deere dealers. Deere & Company's largest market is the United States, accounting for 54% of revenue, followed by Latin America contributing 14% of revenue, Western Europe with 13%, Asia, Africa, Australia, New Zealand, and the Middle East with 9% of revenue, Canada contributes 6% of revenue, and Central Europe & CIS accounts for 4%. Deere & Company is a long-standing company that has weathered various economic cycles, including civil wars, world wars, recessions, and pandemics. Deere & Company is a market leader, with a 25% share of the overall farming equipment market. Therefore, I believe that Deere & Company has a significant brand moat.

Their CEO is John C. May. He joined Deere & Company in 1997 and held various positions until he became the CEO in 2019. He was appointed Chairman of the board in 2020. He holds a bachelor's degree from the University of New Hampshire and an MBA from the University of Maine. In addition to serving as the CEO and Chairman of the board at Deere & Company, he also holds a position on the board of the Ford Motor Company. John C. May has delivered impressive results as a leader. The market capitalization of Deere & Company has doubled under his leadership, exceeding $100 billion for the first time. He has been recognized by Barron's as one of the top CEOs in 2022. John C. May has reorganized the company around specific crops and centralized its software, data, and analytics under a new technology leader. This indicates that Deere & Company has begun offering subscription services, leading to recurring revenue and higher margins. I believe that the reorganization of the company by John C. May will benefit Deere & Company in the long run. His results, combined with the acknowledgment from Barron's, give me confidence in John C. May leading Deere & Company moving forward.

I believe that Deere & Company has a strong brand moat. Furthermore, I am confident in the management. Now, let's analyze the numbers to determine if Deere & Company meets our criteria for a strong competitive advantage. If you need an explanation of the numbers, you can refer to "MY STRATEGY" on the website.

The first metric I will investigate is the return on invested capital, also known as ROIC. Ideally, you would like to see a return on invested capital (ROIC) above 10% in all years. The return on invested capital (ROIC) of Deere & Company is very underwhelming, to say the least, as they did not manage to deliver a ROIC above 10% from 2014 to 2020. It was somewhat surprising to see a return on invested capital (ROIC) like this, as high-moat companies typically deliver a high ROIC. However, it is a positive indication that the management has consistently achieved a Return on Invested Capital (ROIC) above 10% since 2021 and has increased it every year. An explanation for the historically low Return on Invested Capital (ROIC) is debt. Later in the analysis, I will share the return on equity (ROE), which does not take debt into account, and you will see much better numbers. Historically, the return on invested capital (ROIC) has been underwhelming. However, if you can tolerate the high debt, you will notice that the return on equity (ROE) is quite good.

The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most significant of the four growth rates I used in my previous format, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. While there have been periods of equity decrease, it is promising to see that equity has grown every year since 2016 and reached an all-time high in 2023. Therefore, I am confident in these numbers.

Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is worth noting that the free cash flow is not positive in all years. I believe that it reflects the cyclical nature of the industry in which Deere & Company operates. This means that there will be years with negative cash flow. You will need to be prepared to handle that if you invest in Deere & Company or other companies in the sector. Leveraged free cash flow was high in both 2020 and 2021 but has decreased significantly in 2022. Although it has increased in 2023, it has not yet reached the levels from 2020 and 2021. Furthermore, the low free cash flow yield suggests that the company is not currently undervalued. However, we will discuss this further in the analysis.

Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a 3-year period. This can be assessed by calculating the ratio of long-term debt to earnings. Based on my analysis of Deere & Company, it appears that the company has a debt-to-earnings ratio of 3,78 years, which exceeds the acceptable limit. Another important point to note is that Deere & Company reported record earnings in 2023, which may make the numbers seem more positive than they truly are. In the past decade, Deere & Company has accumulated more than 10 years' worth of earnings in debt in five out of ten years, which concerns me. If you are considering investing in Deere & Company, you should be prepared to accept the high level of debt. The high debt was evident in the return on invested capital (ROIC). As promised earlier, I will share the Return on Equity (ROE) for the last 10 years below. This is just to give you an idea of how debt is reflected in the numbers.

Like any other investment, there are risks associated with investing in Deere & Company. One obvious risk that we just mentioned is debt. The current level of debt is not alarming, but historically, Deere & Company has operated with high debt. In his book "Rule #1 Investing," Phil Town mentions the following about debt: "A business that is carrying a lot of debt relative to its income has an unpredictable financial future. If there are any problems with the economy, a business with a lot of loans might be in big trouble". As an investor, I dislike unpredictability. Although I do not believe that Deere & Company will go bankrupt, I am concerned about companies with substantial debt unless there is a justifiable reason, such as an acquisition. If you invest in Deere & Company, you will need to monitor its debt levels. Another risk is seasonality. Seasonal fluctuations in retail demand for agricultural equipment can lead to significant changes in the quantity and variety of products sold to retail customers throughout the year. Seasonal demand needs to be forecasted in advance, and equipment must be produced in anticipation of this demand to ensure efficient use of personnel and facilities throughout the year. This means that Deere & Company may experience significant seasonal fluctuations in cash flows. Furthermore, if Deere & Company makes incorrect estimates, they will have high inventory, which they may need to sell at a discount, thereby hurting profitability. Economic slowdown. In its annual report, Deere & Company explains that adverse economic conditions could reduce demand for their products and services. Their demand is closely tied to market fundamentals, and it can be significantly diminished in an economic environment marked by high unemployment, high interest rates, cautious consumer spending, inflation, lower corporate earnings, and reduced business investment. Negative or uncertain economic conditions that cause customers to lack confidence in the general economic outlook can significantly reduce the likelihood of purchasing equipment. These economic events have had a negative impact on Deere & Company's operations and may continue to do so.

There is also significant potential for Deere & Company in the future. One reason is if farmers face higher input costs. By "higher input costs," I am referring to expenses such as seeds and fertilizers, which have significantly increased in price in recent years. These increased input costs prompt farmers to consider alternative farming methods. Deere & Company offers products that help farmers reduce input waste without sacrificing yields. Deere & Company has introduced a product called ExactRate, which applies liquid nitrogen during planting. This indicates that farmers will be more precise in the use of fertilizer, and estimates suggest that farmers may end up using 70% less fertilizer than usual. Despite the high input costs, management mentioned that they continue to see strong demand for products like these. Recurring revenue. As mentioned previously, Deere & Company has restructured its operations to offer subscription services, including those for autonomous driving and precision technology. Deere & Company sells the hardware installation at a minimum cost, followed by a per-acre usage model that aligns Deere & Company's monetization with the value their customers receive. These technologies help farmers unlock significant productivity gains across their entire fleet of equipment. Management has mentioned that when a customer tries out new precision technology for the first time, they rarely revert to previous methods. These subscription services generate recurring revenue and have high profit margins. Management expects to grow enterprise recurring revenue to 10% by 2030. Regenerative agriculture. The reason I came across Deere & Company in the first place was that I was researching companies that could benefit from the transition to regenerative agriculture. This transition has received little attention in the media, but I believe it will have a significant impact in the future. Regenerative agriculture makes sense for farmers. A study found that farms using regenerative practices were up to 78% more profitable than conventional plots. It makes sense for companies to embrace regenerative agriculture for ESG (Environmental, Social, and Governance) considerations. Companies such as PepsiCo, Walmart, General Mills, Unilever, Danone, and Kellogg's have already transitioned some of their supply sources to regenerative agriculture, and this trend is expected to continue growing in the future. You might be wondering how it will affect Deere & Company. They already have products that can be used in regenerative farming, such as manure spreaders and no-till drills. And there will be more to come, as Deere & Company is focused on developing electric alternatives to its fuel-powered products.

Now it is time to calculate the share price of Deere & Company. I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 34,63, which is from the fiscal year 2023. I have selected a projected future EPS growth rate of 7% because the global agricultural machinery market is expected to grow at a 7,3% CAGR until 2023. Additionally, I have selected a projected future P/E ratio of 14, which is twice the growth rate. This decision is based on Deere & Company's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $235,74. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Deere & Company at a price of $117,87 (or lower, obviously) if we use the Margin of Safety price.

The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 7.177. The capital expenditures were 4.330. I attempted to review their annual report to determine the portion of the capital expenditures allocated to maintenance. I couldn't find it, so as a rule of thumb, you can expect that 70% of the capital expenditures will be used for maintenance. This means that we will use 3.031 in our further calculations. The tax provision was 2.871. We have 281,584 outstanding shares. Hence, the calculation will be as follows: (7.177- 3.031+ 2.871) / 281,584 x 10 = $249,20 in Ten Cap price.

The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Deere & Company's free cash flow per share at $14,31 and a growth rate of 7%, if you want to recoup your investment in 8 years, the Payback Time price is $157,10.

Deere & Company is an intriguing company. They are a company that has weathered all possible economic cycles. The company possesses a strong competitive advantage, and the management has performed well. Deere & Company is facing a short-term risk due to macroeconomic conditions that could lead to fewer product sales, but these conditions are expected to change in the future. Seasonality is a natural part of the cyclical nature of Deere & Company's business and something that any investor in Deere & Company should be prepared for, rather than something to worry about. The debt-to-earnings ratio is at its lowest point in ten years, primarily due to Deere & Company achieving record earnings in fiscal 2023. It is estimated that earnings will be lower in fiscal 2024 due to the cyclical nature of the industry. Consequently, the debt-to-earnings ratio is expected to be higher in fiscal 2024, and high debt is always a concern. I appreciate the shift in Deere & Company's business model to provide software as a service through subscription models. It should benefit the business moving forward, and we have already seen how the return on invested capital (ROIC) has increased since John C. May became CEO. I also believe that Deere & Company will benefit from transitioning to regenerative agriculture. Nonetheless, the high debt and cyclical nature of the business mean that I would require a significant discount if investing in Deere & Company. Thus, I will not consider purchasing shares in Deere & Company unless it reaches the Ten Cap price of $249,20.

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