What John Deere’s Fiscal Conservatism Means for Investors

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Recently, John Deere (NYSE:DE) declared its quarterly dividend of $0.51/share. What was somewhat unusual is that the company was scheduled to raise its dividend as so many blue chip companies do on an annual basis. Deere didn’t. Nevertheless, since this decision was made, the shares are up from below $85/share to above $88/share on above average volume, and so it seems that investors are applauding this move. What does it mean for shareholders both in the short and long term?

Materially, it makes very little difference. A $0.05/share dividend raise (9.8 percent) per quarter would mean an additional expenditure of about $75 million. This isn’t much considering that the company had well over $3 billion in profits over the past 12 months. It does, however, speak to management’s priorities and to its agenda and outlook.

As we saw in the company’s latest earnings release, management’s outlook is relatively cautious. It expects that sales in its agriculture division will be slightly down year-over-year given that the prices of agricultural commodities are down. This latter fact implies that farmers will have less capital available to upgrade their equipment, and so there is nothing surprising about this negativity. Furthermore, even though the prices of agricultural commodities have begun to rise this will likely not impact farmers’ decisions for the upcoming planting season unless we see an unusually large price spike.

In addition to this conservative outlook, investors need to realize that Deere is a highly leveraged company with $34 billion in debt and a debt/equity ratio of 3.6. As a non-financial company this is high, and it borders on excessive. If Deere’s business performs well then it will pay off, but if we see a recession and/or lower agricultural commodity prices Deere shares are particularly vulnerable, and in a panic it may be forced into a panic selling scenario that would be horrific for shareholders.

While this isn’t the most likely scenario by any means, it is a worst-case scenario, and I think Deere’s management — with its conservative outlook — wants to strengthen its capital position. While this is a good thing, I think it ultimately sheds light on Deere’s relatively precarious financial position.

Investors looking for a leveraged play on agricultural commodities should definitely consider buying shares in John Deere. I think the relative strength in the shares over the past several days is a response to strong price action in the grain market. At the same time, John Deere’s “best in breed” brand may not be enough to make it the steady blue-chip agriculture stock that more conservative investors might be looking for.

Investors looking for exposure to the agricultural machinery sector should definitely consider John Deere, but there are other options. The most obvious is Kubota (OTCMKTS:KUBTY), which is a Japanese company. Kubota products are not nearly as well-known as John Deere products but they are not inferior. The stock trades with a higher valuation than Deere, but in return, investors are getting relative balance sheet safety. Furthermore, Kubota shares will benefit assuming that the Yen weakens further.

Investors who are willing to consider a small-cap alternative should take a look at Lindsay Corp. (NYSE:LNN). Lindsay is unique in that it makes irrigation systems, which allow farmers to manage water as well as the resources needed to distribute it among a field of crops. This makes farming more efficient. Furthermore, while Deere’s agricultural machinery is relatively ubiquitous electronic and computerized irrigation systems are not, meaning that assuming agricultural commodity prices rise more and more. farmers will utilize them, and the installation of an irrigation system will likely come before a tractor upgrade assuming the tractor still works. Lindsay trades at a higher price to earnings multiple than Deere but it is growing faster and it has no debt. The one concern is that it is hanging on to its road barrier infrastructure business which is losing money.

Ultimately, Deere is a great company, but we have seen how its stretched balance sheet has reached a point where management doesn’t want to stretch it further by raising the dividend. While it is still a great company, investors may want to broaden their horizons to Kubota and Lindsay. Keep in mind that this is not an “either/or” situation and a reasonable approach for agriculture bulls might be to own two of these stocks or even all three.

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