With commodity prices falling and extremely volatile grain prices, farmers are holding back on their capital expenditures, and that means fewer tractor sales and bad news for Deere & Co. (DE.N), makers of the iconic John Deere farm, forestry and construction equipment. CEO Samuel Allen acknowledged on the last earnings release that 2014 was a tough year — and he expects 2015 to be even tougher. Is he sowing the seeds for possibly disappointing news on earnings?
Analysts have been busy lowering estimates for the company, and they may not have gone low enough. There is still a negative Star Mine Predicted Surprise of 5%, which leads us to believe that Deere may still miss even the lowered estimates. Let’s look at some of the reasons for the analyst pessimism.
Source: Eikon/StarMine
Surveying the fields
As you can see in the chart above, in 2014/15 there were 900 million tonnes of wheat produced, while only 712 million were used, and the ending balance was higher than in the previous period. So there may be an oversupply of wheat. We see similar trends for other grains, and that has kept prices depressed, which in turn keeps farmers on their toes. The largest revenue generator for Deere is large farming machines, which are likely to be affected the most by this downturn.
Source: Eikon/StarMine
Thin harvests
As you can see, it hasn’t been just 2014 that’s been a tough year — since 2011, Deere’s return on net operating assets has been falling and has reached a four year low of 12.7%, far below the industry median. Management has not been able effectively to generate returns from its assets, even in good times, and now that the environment has become challenging, we could see further deterioration in margins and operating efficiency.
Source: Eikon/StarMine
Sowing and reaping
Despite gross margins being slightly higher in the last quarter, it looks like operating and net margins are close to the lowest levels seen in five years. That tells us the costs of doing business may have increased, and as tractor sales fall in 2015, which is what the CEO expects, it may lead to cost cutting and gross margin reduction, and have an even more severe impact on margins.
Source : Eikon/StarMine
Watching the weather
Analysts seem to have taken note of this and have lowered estimates for Deere in the past 90 days. The I/B/E/S consensus estimate is now 84 cents per share compared to $1.15 just three months ago. The SmartEstimate is even lower at 80 cents per share and five of the six 5-star rated analysts (these are our top rated analysts) are below the consensus. Predicting an earnings miss is indeed a bold call by us given that in the last eight consecutive quarters, the company has handily beaten estimates, so keep an eye out for this one to see if Deere can make hay while the sun shines.
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