John Deere: A potential bet on regenerative agriculture.
Opdateret: 24. dec. 2022
Regenerative agriculture is good for the environment as it removes carbon from the atmosphere and put it back in the soil. It helps solving the climate crises and companies are starting to support regenerative agriculture in their supply chains for ESG reasons. It is hard to find companies that benefits from farmers switching from traditional farming to regenerative farming, but one company 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 shares in Deere & Company. If you would like to copy my portfolio or see the stock in my portfolio, you can read about 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 pulled the trigger yet. In this analysis I will investigate if now is the time to buy the share.
Deere & Company was founded in 1837 in Illinois, United States. The company is mostly known for manufacturing agricultural machinery, heavy equipment, and forestry machinery. Their operations are categorized in four business segments: The production and precision agriculture segment (37 % of revenue), which delivers equipment and technology for growers of grains, cotton, and sugar. The small agriculture and turf segment (26 % of revenue), which delivers equipment and technology for dairy and livestock producers (26 % of revenue). The construction and forestry segment, which delivers machines and technology for earthmoving, forestry, and roadbuilding. The financial services segment (11 % of revenue), which mainly finance sales and leases of equipment by John Deere dealers. Deere & Company is an old company that has survived all sorts of economic cycles through civil wars, world wars, recessions, and pandemics. It is a market leader as Deere & Company has 18 % market share of the overall farming equipment market, where the four largest companies control 45 % of the market. Hence, I believe that Deere & Company has a large 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 and 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. Besides being the CEO and Chairman of the board in Deere & Company, he also sits on the board at the Ford Motor Company. John C. May has delivered some impressing results as a leader, as the market cap of Deere & Company has doubled under his leadership. He has been acknowledged by Barron's as ne of the top CEOs in 2022. I haven't been able to find much information about John C. May and he has only been CEO for a short time. However, his results and the acknowledgement from Barron's means that I feel confident in John C. May leading Deere & Company moving forward.
I believe that Deere & Company has a brand moat. Furthermore, I feel confident with the management. Now let us investigate the numbers to see if Deere & Company lives up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number I will investigate is the return on investment capital, also known as ROIC. Ideally, you would like to see a ROIC above 10 % in all years. The ROIC of Deere & Company is very underwhelming to say it the least. Except for the last year, they don't manage to top the 10 % in any of the years in the last 10 years . It was a bit surprising to see a ROIC like this, as high moat companies usually deliver a high ROIC. However, there is an explanation for the low ROIC and that is debt. Later in the analysis I will share the ROE, which doesn't consider debt and you will see other numbers. The ROIC is underwhelming but if you can stomach the high debt, you will see that ROE is quite good.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. While there have been periods where the equity has decreased, it is promising to see that equity has grown from 2016 and onwards and hit all-time high in 2022. I feel confident with these numbers.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. What springs to mind is that the free cash flow is not positive in all years. I believe that it reflects that cyclical nature of the industry that Deere & Company operates in, which means that there will be years with negative cash flow. You will need to be able to stomach that if you invest in Deere & Company or other companies in the sector. The free cash flow yield has been underwhelming in most years as well, and only topped 5 % twice.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years by calculation long-term debt to earnings. Doing the calculation on Deere & Company, I can see that Deere & Company has 4,71 years earnings in debt, which is above the limit. Another thing to be aware of is that Deere & Company had record earnings in 2022, which means the number may look more favorable than it is. In the three years prior to 2021, Deere & Company had more than 10 years earnings in debt, which I don't like. If you want to invest in Deere & Company, you will need to accept the high debt. The high debt was reflected in the ROIC. As promised earlier, I will share the ROE the last 10 years below. It is just to give you an idea on how debt is reflected in the numbers.
Like every other investment there are risks when investing in Deere & Company. One obvious risk that we just touched upon is debt. Over the last 8 years prior to 2021, Deere & Company had on average 10,8 years of earnings in debt. In his book Rule # 1 investing, Phil Town mentions the following on 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 don't like unpredictability, and while I don't think that Deere & Company will go bankrupt, I really don't like to see companies with such a large debt unless there is a reason to it, like an acquisition. If you invest in Deere & Company, it will be something that needs to be monitored. Another risk is supply chain shortages, commodity prices, and freight prices. It is something that management addressed extensively in their latest earnings call. Freight prices are elevated, which hurts margins. Supply chain shortages mean that Deere & Company cannot get all their parts, which results in them not being able to ship the finished product to its customers. And finally, high commodity prices have affected profits as well. Regarding commodity prices, management explained that they do not have fixed contracts on steel, which means they have seen progressively higher costs. Economic slowdown. In their annual report, Deere & Company explains that negative economic conditions could result in less demand for their products. To cite the annual report: "The demand for John Deere's products and services can be significantly reduced in an economic environment characterized by high unemployment, cautious consumer spending, lower corporate earnings, U.S. budget issues, and lower business investments". Many of these things are happening now and could result in some headwinds for Deere & Company.
There are also a lot of potential for Deere & Company moving forward. One is if farmers have higher input costs. By higher input costs I mean things like seed and fertilizers where the price has skyrocketed this year. These higher input costs make farmers look at alternative ways to farm. Deere & Company offers products that means that farmers can use less input without losing out on yields. One example is that Deere & Company has introduced a product called ExactRate, which applies liquid nitrogen at the time of planting. It means that farmers will be more precise with the use of fertilizer, and estimates are that farmers may end up using 70 % less fertilizer than usually. With the high input costs, management mentioned that they continue to see a strong demand for products like these. A much higher addressable market. In 2022 Deere & Company delivered a revenue of approximately $52,5 billion. However, management believes that their total addressable market is worth more than $150 billion. It means that there are plenty of room to grow as management believes that they only reached 35 % of their addressable market. Regenerative agriculture. The reason I came across Deere & Company is the first place was because I looked at companies that could benefit from the transition into regenerative agriculture. It is a transition that has gotten little attention in the media, but I believe it will be huge moving forward. Regenerative agriculture makes sense for the farmers as a study found that farms with regenerative practices were up to 78 % more profitable than conventional plots. It makes sense for companies too for ESG reasons and companies like Pepsico, Walmart, General Mills, Unilever, Danone, and Kellogg's have already switched some of their supplies to come from regenerative agriculture, and it will grow in the future. You might wonder how it will affect Deere & Company. They already have products that can be used in regenerative farming, such as manure spreaders and no drill tills. And there will be more to come as Deere & Company is focused on making electric alternatives to their products that run on fuel.
All right, we have gone through the numbers, potential and risk regarding Deere & Company, and now it is time for us to calculate a price for Deere & Company. To calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS at 20, which is a bit lower than the record 2022 but slightly higher than 2021. I chose an Estimated future EPS growth rate of 10 % (As the consensus the analysists expected growth rate is 10,7 %), Estimated future PE 20 (which the double of the growth rate, as the historically PE for Deere & Company has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY", we come up with the sticker price (some call it fair value or intrinsic value) of $256,45, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Deere & Company at price of $128,23 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The Operating Cash Flow last year was 4.699. The Capital Expenditures was 3.788. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 2.651,6 in our further calculations. The Tax Provision was 2.007. We have 298,772 outstanding shares. Hence, the calculation will be like this: (4.699- 2.651,6 + 2.007) / 298,772 x 10 = $135,70 in TEN CAP price.
The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With the Free Cash Flow Per Share at 7,15 and a growth rate of 10 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $37,99.
Deere & Company is an interesting company. They are a company that has survived all possible economic cycles. The company has a strong moat and while we only have little to judge management on, they have done a good job. I believe that most of the risk are short-term for Deere & Company. Supply chain will normalize, commodity prices are coming down a little as of lately, and freight prices has come down as well. There will be some economic headwinds to come but no one known how late these will last. I really like the potential for Deere & Company, and I think that regenerative agriculture has been ignored by the media and Deere & Company could benefit from the transition. Nevertheless, I cannot come to terms with the high debt, which is why I would need a large discount if I should invest in Deere & Company. Hence, I will not invest in Deere & Company unless it reaches the TEN CAP price at $135,70.
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