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John Deere -- attractive and expensive [ClearOnMoney]
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John Deere -- attractive and expensive

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Commentary

John Deere -- attractive and expensive

16 Jan 2013 by Jim Fickett.

John Deere, the world's largest manufacturer of farming equipment, caught my eye for several reasons:

  • Production of food will likely continue to rise, and Deere will benefit.
  • Deere has a water division, focusing on high performance irrigation products; I think irrigation efficiency is likely to continue to advance, and Deere will benefit.
  • In Q3 Berkshire Hathaway bought stock in Deere; this suggests that Deere is a well-run company.

Note that Deere should not be thought of as primarily a water investment. Deere does not break out results for its water division, so it is difficult to know how big it is, but irrigation is not featured in annual reports or presentations, so the water division is probably not a large fraction of the company. Still, water scarcity will provide a tailwind.

Over the last 13 years, Deere has normally been profitable on both an accrual- and cash-accounting basis:

To smooth out the volatility, the dashed lines in the graph above show the 5-year moving averages of net income (blue) and free cash flow (red). These suggest that profits are growing over the long term, and that sustainable free cash flow and net income are both towards the upper end of those ranges, say in the neighborhood of $1.5 billion.

The company is delivering a large amount of cash to shareholders, while at the same time successfully building equity:

This suggests that shareholders will do well over the long haul. (Note: I have not yet looked into share option plans for employees, and the extent to which buybacks really benefit investors.)

With a conservative estimate of $1.5 billion for sustainable earnings, and a market cap of $34.8 billion, a cyclically adjusted P/E comes out at about 23. That is rather high. All we know about Berkshire Hathaway's purchase is that it occurred during the third quarter. At one point in late September Deere's stock price was about 28% lower. It is probably worth waiting for a better entry point.