Tuesday, October 13, 2015

Analysis of Deere

Deere, an American outdoor machine producer

Company: Deere

ISIN US2441991054 | WKN 850866

Business: An American outdoor machine producer. They have eight different product categories: Residential (lawn mowers), Agriculture (tractors etc.), Construction (Trucks and Loaders), Landscaping & Grounds Care (commercial lawn mowers), Golf & Sports (fairway mowers etc.), Forestry (harvesters and dozers), Engines & Drivetrain (diesel engines and generators), Specialized (military and rental). Their largest is however Agriculture and most people in countries conducting modern agriculture will have have seen the beautiful Deere logo.

Active: 30 countries world wide. Focus on US, Canada, Europe, Brazil, Russia, India and China. I was surprised to see that they did not mentioned Africa but maybe the infrastructure need to improve much more before Deere can establish themselves stronger there.

P /E: 9.1

contrarian values of P/E, P/B, ROE as well as dividend for Deere

The P/E for Deere is excellent with 9.1 but the P/B is a bit high with 3.2 and this then gives us a no go from Graham. The earnings to sales are ok with 9% and the ROE is excellent with 35% but that most likely comes from debt leverage since they have a book to debt ratio of 0.2 which I do not like.
In the last five years they have had an excellent yearly revenue growth rate of 6.8% which then gives us a motivated P/E of 19 to 22 which means that Deere is today undervalued by the market.
Deere want to stay on top of things and are therefore spending 46% of their earnings on R&D. I find this value to be high but acceptable.
They pay an ok dividend of 2.8% which only correspond to 26% of their earnings so there is still room for improvements.
As an additional comment I want to add that 2015 is not working out so well for Deere which means that the running P/E is up around 12 or so. They also have a massive share buyback program and what I do not like so much is that they keep the shares in the books.

Conclusion: Graham says no to this company but I, Warren Buffett and Charlie Munger says yes to it. the P/E is excellent, the P/B is so, so and the ROE spectacular and the dividend is ok. Personally I always want companies to destroy shares they buy back to guarantee that the managers to not come up with too silly ways of giving them to themselves. I would also not very much like to see a company selling those shares on the market of which they would then make a profit but the share price would probably also drop when such quantities of shares comes out again. Nah, I like when companies have share buyback, burn the shares and if things go very well then make a share split. On the other hand one will never get all and I am happy enough with Deere as it is.

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Anonymous said...

The reason for the high debt levels is due to the fact that they have a financing service where their customers can borrow money to buy their equipment. Deere then loans an equal amount of money to a löser interest rate due to their strong credit rating. At least thatis hos i understood it. So maybe deere should be valued as an investment company owning one manufacturing company and one bank?

Anonymous said...

P/E is 9.1 BUT P/FCF is 45.5!!! I would not touch DE.

Anonymous said...

@Ano 2
I do not know what it means when you say that price to free cash flow is 45. I mean price to earnings means that if nothing else changes then in 9 years my investment will be paid back. Easy things like that I can understand. But P/FCF 45? What do one need to be scared of and why?

Fredrik von Oberhausen said...

Yes, today many of the large automotive, machine and IT-service companies for that matter have their own financial services so you are probably correct in that one should look at the two parts individually. There I am however stubbornly (probably also stupidly) looking at all companies the same way.

To my knowledge it makes little sense to look at banks with the P/FCF and if you look back at what @1 wrote then the high P/FCF could be explained by the two parts.

Here is a link to P/FCF from Investopedia that might help you but I hope that @2 will respond to the question.

Anonymous said...

P/FCF is stock price divided by free cash flow per share. Lets for simplicity's sake assume that FCF equals owner earnings in Deere's case. Owner earnings is simply cash from operating activities subtracted by capes and excluding investments for future growth. Owner earnings as a measure is by far superior compared to net income as the latter one can easily be manipulated. Cash flow is a much better measure because a) it can not be manipulated for a long period of time, b) dividends are paid from cash flow not from net income and c) cash flow statement reveals the true state of the underlying company. Warren Buffet introduced the term 'Owner Earnings' and uses it as a basis for his investments. Whenever you are making any investment decisions, replace the net income by owner earnings. However, as the author already stated, cash flow statements do not work with financial companies. Deere is sort of a combination of an equipment manufacturer and bank which makes it very difficult to analyse the company. But I would still say that cash flow statement gives a quite good picture of Deere. The cash flow from operating activities is slightly above net income as it should be with good companies BUT the capex has historically been 2/3rds from operating cash flow. Great companies have low capex leaving much more cash for future investments, dividends and debt repayments. Look f.e. at KO.

Fredrik von Oberhausen said...

Thank you for the excellent explanation!