Streetwise

Lauren Rudd

Sunday, March 30, 2014

An Investment With a Song

Few would be surprised if Webster’s added Wall Street to its definition of greed. Not to ruin your day but the financial markets have always been driven by greed. Furthermore, the wealthiest among Wall Street’s finest are often the greediest. This is no sudden epiphany; it has been so throughout history.

Yet, the Street’s antics should not be an impediment to your search for investment bargains. A good example of a company whose shares could be considered to be on sale, while at the same time having the honor of once being the central theme of a number one song on the country music charts, is none other than Deere (DE). The song of course is “Big Green Tractor,” written by Jim Collins and David Lee Murphy and recorded by Jason Aldean.

Deere is the world's largest manufacturer of farm machinery. It is also a company that I have received numerous inquiries about from both readers and students. When I wrote about the Company a year ago, my earnings estimate for FY 2013 was $8.76, with a 12-month target price on the shares of $98. While earnings were better than expected, coming in at $9.09, the shares once again did not reach my expectation with a recent close at $89.10, but more about that in a minute.

Unfortunately, shareholders have watched Deere trade in the $80's for much of this decade. Here it is teasing $90 for what seems like the 100th time. Will it finally move above $90? Who knows, but regardless this is a company that merits research.

Deere rarely gets mentioned on any financial news network. Why...because farm machinery is boring unlike electric cars or social media. However, boring can be lucrative. Deere has the potential to chalk up a 50 percent gain in share price over the next two to three years. The company also has a new dividend strategy that has taken the dividend from $1.20 in 2010 to $2.04 today, a 70 percent gain.

At the same time, Deere spent 5.5 percent of its 2013 net sales, or $1.5 billion, on research and development. Moreover, farm equity sits at an all-time high, meaning that the current debt-to-asset ratio for many farm owners suggests that now is a good time to buy new equipment.

The U.S. and Canada are Deere’s largest and most established markets, yet the compound annual rate growth is still only 8 percent, which means that at $89 per share the company trades at roughly 10 times earnings. However, the opportunity lies in markets such as Asia, Africa, the Middle East, Central and South America, where the company’s growth rate is close to 20 percent year-over-year.

Typically, Deere’s earnings surprise to the upside and the company’s shares trade higher before the conference call, after which management rains on the parade and the shares fall. That ended with the most recent earnings report.

Record earnings finally meant something, which means that Deere is ready to run....and nothing runs like a Deere. To that end, Deere remains well-positioned to earn solid profits despite a fragile world economy and will benefit longer term from the latest on-going trends in global farming.

The days when a farmer needed only a sickle and a strong back are long gone. The continually increasing demand for food requires that farmers plant, maintain, and harvest more efficiently. And there to help is Deere.

Despite a 175 year history, Deere can best be described as a new unfolding story of rapid growth. Perhaps its most exciting goal is to achieve sales of $50 billion by 2018. That would mean a near doubling in size over the next five years. An extraordinary feat no doubt, but it is one that fits neatly into the current trend of global growth in farming.

Looking at Deere’s intrinsic value, a discounted earnings model suggests an intrinsic value of $119 per share utilizing a 12 percent discount rate and a 9 percent growth rate. The more conservative free cash flow to the firm model returns an intrinsic value of $217 per share using a discount rate of 7.31 percent, which is the Company’s weighted cost of capital.

My earnings estimate for Deere in FY 2014 is $8.80 with a projected 12-month share price of $98, yielding a capital gain of 10.1 percent plus the 2.3 percent dividend yield.