Shares of Deere (DE) have been sinking lower in recent weeks, thanks in part to a poorly received (but still quite solid) fiscal third-quarter earnings report.
Undoubtedly, Deere has been quite the industrial laggard, with shares down 6% year-to-date in a big up year for broader markets.
Though Deere's latest quarter was met with considerable negativity by investors, I do think the numbers were decent enough to justify a sustained rally. The company beat on earnings, while raising its fiscal year guidance. It was a classic beat and raise, but one that wasn't appreciated in the slightest. Why?
There's a general feeling of unease when it comes to agricultural machinery plays these days. Nobody wants to be caught in them once the next machinery spending drought hits. The optimal time to upgrade the tractor or combine was back in 2021, when elevated crop prices provided farmers with ample spending power.
And yes, the boom days may be over - but that doesn't necessarily mean a bust will be coming shortly after.
Peak Demand has Passed, but is a Downturn Ahead?
Investor fears seem to be brewing over a potential downturn in farming. Such fears seem to be overtaking what was a relatively decent quarter for Deere, as earnings per share (EPS) hit $10.20 - well ahead of the $8.20 estimate - on revenue of $14.3 billion. Management also hiked its full-year guidance to a range between $9.75 billion and $10 billion, about $500 million higher than the initial guidance.
Personally, I thought there was a lot to like in the quarter. I found the weak post-earnings reaction to be quite surprising, and think investors are essentially getting the quarter for free, courtesy of Mr. Market. Peak demand for Deere equipment certainly seems to be in the rear-view mirror - but just because the best days are done does not mean there's going to be a great deal of pain ahead for Deere shareholders who are hanging on, especially not at today's depressed valuations.
Investors seem to be treating shares of Deere as a hot potato, looking to sell now with the intention of asking questions later. There's no question that it can really hurt to hang onto shares of a cyclical stock right before the downswing hits. But with so much negativity surrounding the name right now, DE may already have some chance of a downturn partially priced in.
Sure, crop prices aren't as high as they were more than a year ago. And the agricultural cycle may be getting just a tad long in the tooth. That said, business cycles don't tend to die by old age alone. It is possible for the current cycle to lengthen by a few more years. And if this happens, those who ditched the stock may find themselves missing out on robust gains in a well-run industrial that's starting to look like one the cheapest stocks in the market.
What About Valuation?
Last Friday, shares of DE dipped nearly 3% (and for no real good reason), bringing the stock down just north of 10% from its all-time high of $445 and change. It's a typical correction and one that could reverse, even without help from the broader S&P 500 Index ($SPX), as we head into the fourth quarter of 2023.
At the time of writing, Deere stock trades at 11.82 times trailing price-to-earnings (P/E). That's a considerable discount to the stock's five-year historical average of 19.73. Further, shares also trade at a discount to the farm & heavy construction machinery industry average of 13.76 times.
For one of the best-in-breed firms in the agri-equipment industry, I find the discount to be completely unwarranted. Deere's latest quarter showed management's devotion to trimming costs while continuing to stay on the cutting edge of innovation.
In recent years, Deere has introduced impressive new tech into its latest tractors. Such tech can help beef up productivity over time. While autonomous tractors may be many years away, it's only a matter of time before the farming scene embraces greater autonomy.
Given this, investors should appreciate Deere stock for its tech savvy. At these depths, it seems like nobody on the Street seems to be able to think long-term - at least, not with fears of a farming downturn.
Bottom Line
Deere stock looks like a deep value play right here. Too many investors are dismissing the shares because they expect a bust, just because a recent demand boom has concluded.
On the date of publication, Joey Frenette did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
