Agriculture’s Wild Ride: John Deere Is Cheap But Risky

Source: iStock

John Deere (NYSE:DE) is a leading global manufacturer of agricultural machinery. It is a well-recognized and respected brand that in many ways is synonymous with quality American manufacturing. Considering that the global population is growing, which means that there should be an increase in global demand for food and agricultural commodities, investors might consider taking a position in John Deere, whose products aid farmers and allow them to produce more food at a lower price.

If you look at John Deere stock, it appears to be relatively inexpensive at less than 10 times earnings. Furthermore, a long-term chart reveals that the company has done an excellent job of creating shareholder value over the years. Management has increased the company’s dividend payout fairly regularly, and it has retired a lot of the outstanding shares so that each shares represents a bigger piece of the company.

For those looking to buy a position in an agricultural machinery company, Deere seems like the way to go. But for now, at least, I would be cautious, and I cite the following reasons as why.

First, the market more broadly appears to be pulling back. Deere is considered by many to be a cyclical stock, especially given that it has a construction machinery division, as well as a financing division. In a down market, Deere shares can underperform, especially if short sellers target industrial companies. Deere shares are also vulnerable because the company has a lot of debt. If there are fears of a recession, then industrial companies with a lot of debt can get hit pretty hard.

Second, while I am bullish on agricultural commodities longer term, they have underperformed over the past few years. As a result, farmers have less money with which to buy agricultural machinery, and if they do, it may not make sense for them to replace old tractors if they are working well when they can use the old ones for another year or two. As a result, John Deere’s sales and earnings will suffer. We have already seen a decline in the company’s sales, and management even put off a dividend hike for a quarter because of it.

I suspect that this trend will continue for a couple of quarters. Keep in mind that farmers will design next year’s budgets using this year’s prices unless there is some sort of exogenous event that drives prices substantially higher or lower in the near term (e.g., a draught or a blight). So even if you expct that agricultural commodity prices will rise in the coming months and years, this will not immediately translate into profit growth for Deere and its peers.

Declining profits make for declining stock prices, and Deere should be no exception. While this can create a great opportunity for long-term investors, I would wait for a better entry point.

Third, the stock has hit significant resistance in the mid-$90 per share to the $100 per share range multiple times in the past several years. Earlier this year, we saw the stock get to nearly $95 per share before pulling back, indicating that this resistance is still intact. Shorter-term traders will look at this and decide to put off taking positions, and more aggressive traders may even consider taking short positions, especially now that we are seeing short-term weakness in the stock market.

For investors who like the idea of owning a leading agricultural machinery company such as Deere, there seems to be strong support in the high $70 to low $80 range. Investors should keep in mind, though, that in a volatile market, Deere shares can fall especially hard, and it wouldn’t surprise me if we saw an even steeper correction even if there is relatively good value at a 10 percent to 15 percent discount to the current share price.

Disclosure: Ben Kramer-Miller has no position in John Deere.

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