Wirtgen Buyout To Aid Deere Amid Dismal Agriculture Business

On Feb 19, we issued an updated research report on Deere & Company DE. The company is poised to gain from the Wirtgen acquisition, higher housing starts, and improving oil and gas sector. However, the company’s lackluster agriculture business and elevated expenses are expected to dent its performance in the near future.  

Let’s illustrate the factors in detail.

Wirtgen Acquisition to Boost Deere’s Construction Business

In December 2017, Deere acquired world’s leading road-construction equipment maker — Wirtgen — for $5.2 billion in cash and debt. This buyout will aid Deere’s North America-centric construction business expand to a global scale and also catapult it to the position of an industry leader in global road construction. The transaction is also anticipated to add about 56% of its Construction & Forestry segment’s sales in fiscal 2018.

Higher Housing Starts a Boon for Deere

Deere projects global sales for the Construction & Forestry equipment to be up a massive 80% in fiscal 2018, driven by higher housing starts in the United States. Single-family housing starts are strong across all regions in the nation. Further, increasing wages and job growth reinforce the outlook for growing housing starts.

Per the latest report of the U.S. Census Bureau, housing starts in January 2018 came in 9.7% higher than the December tally and are up 7.3% year over year. This January, U.S. new-home construction grew to the highest level since October 2016. It is expected that this momentum in the housing market will continue through the year.

Stabilizing Oil Prices to Fuel Growth

Deere estimates that its construction investment will be up 2.2% in fiscal 2018, higher than the previous forecast of 1.4%. The increase is primarily being led by oil and gas, and residential activity. Oil prices are estimated to average above $58 a barrel for the fiscal. In addition, machinery rental utilization rates continue to improve and rental pricing continues to gain positive traction.

Agriculture Business a Concern for Deere

Deere’s agriculture business will be affected in fiscal 2018 by the expectation of high global grain and oil seed stocks-to-use ratios. This is because abundant crops have offset strong demand around the world. Further, the U.S. farm cash receipts are estimated to be $372 billion, approximately 1% lower than fiscal 2017, as gains from oil crops are offset by declines in feed crops.

Adverse Impact of Tax Reform

Deere’s earnings will be hurt by the impact of the tax reform in fiscal 2018. The company recorded equipment operations tax rate of 422% in first-quarter fiscal 2018, primarily due to the impact of the tax reform. For the remainder of the fiscal, the effective tax rate is projected in the range of 25-27%, which implies an effective tax rate of approximately 62% for fiscal 2018.

Escalating Expenses to Impede Deere’s Profit

In addition, Deere will be affected by elevated expenses in the current fiscal. Its guidance for cost of sales as a percent of net sales is about 75% for the fiscal. The company believes an unfavorable product mix, elevated overhead spending and increased incentive compensation will drive the cost of sales guidance. Deere also forecasts SA&G expense to flare up nearly 23% in the fiscal. These expenses will dampen earnings.

Share Price Performance

Deere has outperformed its industry with respect to price performance in a year’s time. The stock has appreciated around 54.5%, while the industry has recorded growth of 44.8% during the same time frame.

Zacks Rank & Stocks to Consider

Deere currently carries a Zacks Rank #3 (Hold).

Some better-ranked stocks in the same sector are Dover Corporation DOV, W.W. Grainger, Inc. GWW and H&E Equipment Services, Inc. HEES. All three stocks sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Dover has a long-term earnings growth rate of 13%. Its shares have rallied 20.9%, over the past six months.

Grainger has a long-term earnings growth rate of 9.7%. The company’s shares have been up 68.3% during the same time frame.

H&E Equipment Services has a long-term earnings growth rate of 18.6%. The stock has gained 77.8% in six months’ time.

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