Friday, August 21, 2009

Volume 3, Issue #80

Also in Today's Issue...

Wall Street just doesn't understand Deere & Co. (NYSE: DE).

No surprise there: There's a Rolls-Royce dealer a few minutes from the stock exchange, but the nearest John Deere dealer is more than 50 miles away, and it mostly sells lawn tractors. The massive heavy-duty agricultural equipment, the large tractors and combines that are Deere's main source of revenue is used in the area of the country that Wall Street tends to fly over.

This goes a long way toward explaining why Wall Street tends to get it wrong when it comes to Deere. It has no frame of reference for the company, which began manufacturing farm equipment in Illinois in 1837.

In the 172 years since, the company has built a unparalleled reputation for quality: Loyal customers have rewarded the company with a 50% market share. My dad still has my great-grandfather's 1941 Model A John Deere in the shop at his farm. Grandpa Ted used it for 30 years, and it still runs perfectly today. That's on par with the aforementioned Rolls-Royce.

So when Deere reported earnings, it came as no surprise to me that Wall Street focused on the wrong things:

* Revenue was down, mostly on a -47% drop in construction sales.

* Deere's outlook for 2009 suggests the worst sales downturn in 50 years.

* Net earnings slipped -27% in the third quarter.

This news caused a predictable result. Shares fell. But that's wrong, wrong, wrong.

What these pin-striped finance geeks need isn't a weekend in the Hamptons, they need to get on their jets and head to Kansas, Indiana or Iowa. A few hours swathing hay or planting wheat would do them a lot of good.

When they've breathed enough fresh air to clear their heads, they'll realize the truth about Deere. They'll learn to focus on the right things when they value the company. When that happens, the shares will be poised to deliver serious gains.

Here are six things to help them get started:

1. Deere has an unconquerable moat.
A farmer would rather keep a older piece of Deere equipment running than to buy from another manufacturer. Deere's "green iron" is not only extremely well made, but the company continually advances agricultural technology. Better technology means more efficiency and greater production, and that puts money in farmer's pockets. These purchases are supported by the best dealer network in the business. Excellent service minimizes downtime during critical harvesting and planting seasons.

2. Deere's Farm Business is Key, Not Construction.
Deere's most critical business segment isn't the construction equipment that hurt it in this quarter -- it's the agricultural equipment that powers its results every other quarter. Agricultural equipment makes up 59.2% of revenue. Ag and credit together make up 79.3% of operating profits.

3. Deere has a strong financial footing.
Assets outweigh debt nearly three to one. It has plenty of cash on hand and no short-term debt. Deere has more than enough resources to take care of the portion of its $13.9 billion in debt that's coming due. No one needed to bail out Deere when times got tough.

4. Deere's performance has exceeded expectations.
And not just by a little. The 17 analysts Bloomberg polled expected Deere to turn in earnings of 56 cents a share. It earned 99 cents a share. As I said, this is a hard company for Wall Street to understand. Deere has exceeded expectations in 13 of the past 18 quarters.

5. Deere has managed well during the downturn.
Let's make sure we're clear: Deere didn't lose any money. The company earned $420 million in its third-quarter. Its net margin was 7.1%, a level of profitability that exceeds 260 out of the 500 companies that make up the S&P. Among the most promising signs: Margins on ag equipment came in at 10.3%, a clear sign that Deere doesn't have to cut prices to move equipment.

6. Deere has a bright, "green" future.
Emerging markets, where Deere's ag sales dropped, will rebound with the global economy. So will the U.S. construction-equipment market. And the biofuel boom will cause greater demand for the crops that can be used for biodiesel and cellulosic ethanol, which could move unproductive acres into production, sparking a demand for more tractors, swathers, balers and planters.

The key to looking at Deere is to take the long view, not to overreact to short-term results. Don't worry about what happened, or even about what's happening. Focus on the future, not on the crop you just cut, but on the one you just planted. Deere has $3 billion in inventory ready to meet the demand that the recovery will bring.

With all that in mind, the inevitable conclusion is that Deere, at current prices, is a steal of a buy for long-term investors who are willing to bet that the world will continue to need the food farmers grow.

Many Happy Returns,

-- Andy Obermueller
Chief Investment Strategist
Government-Driven Investing