Deere & Company (NYSE:DE) is one of the largest lawn care and heavy equipment manufacturers in the world. The company has a valuation of almost $130 billion after it more than tripled from mid-2020 to mid-2021. That growth has put the company in an expensive position, and as we’ll see throughout this article, the company is now overvalued.
Deere Quarterly Financials
The company has managed to generate strong financial performance in recent quarters, but that also shows the volatility of its industry.
In fiscal Q2, the company’s revenue grew 30%, with sales up 34%. That resulted in net income going up 36% and diluted EPS going up 42% respectively. That comes from the company’s fixed costs being able to be distributed outwards more. The company’s EPS is almost $40 annualized, giving it a low double-digit P/E but its earnings are also in an up-cycle.
We do not expect that up-cycle to continue, especially in a rising interest rate environment, as that’ll affect demand for those expensive machines.
Deere Industry Outlook
The company expects the up-cycle to continue for 2023, but there are some signs of weakness.
The company’s U.S. and Canada Large AG is expected to grow by 10%, with Europe AG up 5%. However, the U.S. and Canada along with Asia are both expected to go down, and South America AG is expected to remain flat. There’s some foreshadowing that’s visible here in the numbers, despite a strong 2023 expected.
North America tends to have a stronger economy than Europe, and both tend to have a stronger economy than the remainder of the world. They’re both remaining strong as the rest of the world slows down. But they might be next in a rising interest rate environment. Even in the strong economies, this is perhaps visible as Large AG is much stronger in N.A. than Smaller AG.
That could show that smaller players are perhaps seeing some weakness.
The Deere Outlook
The company’s outlook involves reasonable strength in its portfolio, but shows its struggle to match up to its valuation.
The company expects $9.4 billion in net income at an effective tax rate of roughly 24%. The company expects net operating cash flow, before capital expenditures to be roughly $10.2 billion. From the company’s market cap, that means a P/E of roughly 14x, which does seem to be relatively low for investors.
That’s especially true versus the current market, where 14x is well below the P/E of the S&P 500 (SP500), for example. However, the company’s capital expenditures are substantial and don’t get cut randomly just because the market is down.
The impact on earnings in a downturn is visible above when the company faced a tough market in 2015-2016. During that time, the company’s TTM EPS dropped from a peak of almost $10 / share to a trough of less than $5 / share. That volatility in a tough market helps to indicate that the company deserves a lower multiple in good times.
The largest risk to our thesis is that Deere stock could grow into its valuation without its share price declining. That could make those who wait for lower prices to miss out, versus being able to invest now as the company’s growth slows down substantially but doesn’t stop. However, we are expecting a partial price collapse for the company.
Deere & Company is a great American institution. The company’s machines are revolutionary to the farming industry. Despite that, the company’s stock is overvalued. Its earnings have increased dramatically as the company has moved into a bull market, and that’s pushed it into a higher P/E level than it’s had historically.
The company has substantial risk for its earnings if the market drops. At current market prices, signs of weakness are starting to emerge in some markets, in our view. Putting all of this together, we recommend against investing in Deere & Company stock at this time, seeing it as an overvalued company and a poor investment.