Deere & Company

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 3/5

Deere & Company is a global leader in the production of agricultural equipment, construction, forestry, and other related products.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Deere & Company operates through three main segments: Production & Precision Agriculture, Small Agriculture & Turf, and Construction & Forestry.

  • Production & Precision Agriculture: This segment focuses on large-scale farming operations and is responsible for manufacturing and distributing a wide range of equipment, from large tractors to combines, and implements. It’s where Deere’s cutting-edge technologies, such as precision farming equipment and automation systems, are primarily deployed.
  • Small Agriculture & Turf: This segment concentrates on the production and sale of smaller tractors and related equipment for tasks such as landscaping, and hay management, along with equipment for large-area mowing and turf care.
  • Construction & Forestry: This segment produces and sells equipment for construction, earthmoving, and forestry operations, including loaders, excavators, and various forestry equipment.

Deere’s Financial Services segment also warrants attention, providing retail financing for the company’s products to dealers and customers, as well as offering wholesale financing to their dealers.

Deeres’ global reach has made it a key player in global food production, and it is also working to provide solutions to climate change.

Industry Landscape & Trends

  • Agriculture: The agricultural sector is subject to volatility in crop prices, commodity prices, tariffs, trade agreements, government policies, and various local regulations, which can heavily influence demand for DE’s products. Rising input prices, especially for fertilizers, are a big concern for farmers. Increased usage of technology in farming is pushing demand for precision technologies, and the use of tech to reduce carbon footprint is a growing trend that could impact the industry going forward.
  • Construction and Forestry: This industry depends on infrastructure investment, housing starts, and commodity prices. Infrastructure spending is expected to grow due to global trends such as electrification and urban development. This segment also requires companies to adapt to increasingly stringent environmental regulations, which is another trend affecting this industry.

Financials Analysis

  • Profitability and Margins: As a manufacturer of heavy equipment, Deere’s operating margins are quite sensitive to manufacturing costs and inflation. This means that DE needs to consistently improve production, supply chains and management practices to be able to maintain profitability. Despite the sensitivity, DE has maintained a remarkable net margin, which has been improving YoY as we can see in the 2023 consolidated results. Looking at profitability by segments, we have a mixed picture with the agriculture divisions showing some nice YoY upticks, but the financial division’s profits being hampered by increasing borrowing costs.
  • Revenue Distribution: Deeres’ biggest revenue generator is still “Production and Precision Agriculture”, but they also generate a significant amount of revenue from the other divisions, highlighting the diversity of the portfolio. A major trend in terms of sales is that “Equipment operations sales” are going up YoY.
  • Cash flows and Investments: As we will see in the latest report, Cash from Operations, while a great number has been severely impacted by an increase in working capital needs. Management seems to see it as a temporary impact and predicts that things are likely to normalize by the end of fiscal year 2023. Investments are generally in manufacturing, automation, and tech development.
  • Capital Structure and Debt: DE has a fair amount of debt which is used for financing, research and development. It seems that the company is taking advantage of lower interest rates to lock in long term debt. While a good strategy, this makes it more sensitive to sudden spikes in the interest rates.
  • Share Repurchases and Dividends During the recent financial results, management announced that they are buying back stocks and increasing dividends. This clearly signals a long-term focus from the management to maintain investor confidence.
  • Key metrics: The company’s key metrics are: Net income attributable to Deere & Company, which was $7.1 Billion for the fiscal year 2023 which was a YoY increase. Diluted Earnings Per Share, which was $26.10 for fiscal year 2023, a significant YoY improvement. ROE for FY 2023 was also great, at almost 30%.

High debt, combined with cyclicality of the industry makes DE vulnerable to certain economic downturns, as well as a hike in interest rates.

Competitive Landscape

  • Agriculture: DE faces competition from other major agriculture companies, including CNH Industrial and AGCO Corporation. Competition among these giants typically revolves around pricing, technology, and features of their equipment, as well as distribution network strength, customer service, brand recognition and innovative R&D.
  • Construction and Forestry: Competitors in this space include Caterpillar, Komatsu, and Volvo Construction Equipment. Price, reliability, availability, and service are the major differentiating factors for this segment.

It is important to note that DE has a presence in both developed and developing countries, and their diverse portfolio exposes them to different economic dynamics around the world.

Moat Analysis

Based on my research and data provided, I would give DE a moat rating of 3/5. Here is my reasoning.

  • Brand Loyalty: DE’s history and brand reputation for high-quality, reliable, and innovative equipment are unparalleled in the agricultural sector, giving it a significant competitive advantage over its peers. Farmers often prefer sticking with the company that they know, trust, and have used for years and have built personal relationships with. This creates a customer lock-in and increases the likelihood of repeat purchases.
  • Distribution Network: DE possesses an incredibly extensive network of dealers across various regions which allows it to provide quick parts and repair services to customers, minimizing downtime. This creates a competitive advantage because a competitor is less likely to be able to create the same network, as its a slow and expensive process.
  • Technological Superiority: DE has invested heavily in precision farming technology, digital solutions, and autonomous machinery. These solutions provide increased value to their clients, and make it hard for competitors to match DE’s technological edge.

  • Switching Costs: Because the company has built deep business relationships with customers that require constant interaction with the dealer network, it makes it harder to switch providers. The reliance that farmers place on the company means that a new competitor has a lot of hurdles to cross before it can reach to the customers of DE.

  • Lack of Scalable Manufacturing and Competition: Although DE is a large company, it doesn’t seem like scale plays an outsized role in its moat, as many smaller players can compete, as there is a substantial difference in the products. It operates in a competitive environment where any company with a superior technology might disrupt others.

Legitimate Risks to the Moat and Business Resilience

  • Cyclicality: The cyclicality of agriculture and construction industries means DE is exposed to volatility, and a slowdown in the global economy can cause significant damage.
  • Commodity Prices: Fluctuations in commodity prices can dramatically affect the affordability of DE’s products to its customers.
  • Technological Disruption: New technologies can be a risk to DE if its current offerings become obsolete. It’s difficult to predict how fast technological changes will come, and if the company will be able to innovate quickly enough to stay relevant.
  • Geopolitical Events Geopolitical turmoil, wars, and climate change can disrupt supply chains, production and markets. This will have a substantial effect on Deeres’ business.
  • Rising costs and input prices: Costs for raw materials, fuel, labor, and transport can put a dent in the overall profitability of the company and is a key area of concern for management.
  • Dependence on Financing: A large portion of the sales are from financing through their financial division. A hike in borrowing costs or bad credit decisions can have an adverse effect on the company’s bottom line.

Despite all these risks, DE shows decent resilience because of its long history and deep relationships.

Understandability

I would rate this a 2/5 for understandability. The equipment-manufacturing businesses are not too complex to grasp on their own, but DE has also integrated the more difficult financial division in their business. The way all parts work together requires some knowledge of finance and complex business operations, reducing understandability of the business. However, this company is also considered a part of old economy and not the glamorous new tech space, which could be easier for many to understand than say, a technology company.

Balance Sheet Health

I would rate this as a 3/5 for balance sheet health.

  • While DE’s revenues and profits have been increasing, its debt levels have gone up too. Given the cyclicality of the industry and the sensitivity of their finance business to interest rates, this should be viewed with some caution.
  • A lot of capital seems to be flowing towards investments and shareholder returns. While this signals positive intent, we should keep in mind that it might not be a signal of good financial discipline.
  • Deere has seen large inventory accumulation due to supply chain issues and slowing demand. While inventories are useful, too much inventory can lead to losses if those goods have to be sold for a lower price than they were bought for. Management has expressed confidence in inventory management in the coming quarters, but still needs to be watched.

While the balance sheet isn’t in a terrible position, it isn’t the best either. The company needs to take steps to address rising debt and inventory levels.

Recent Concerns, Controversies, and Management’s Perspective

One of the biggest challenges DE has faced recently is the supply chain disruption, which has affected the company in a multitude of ways.

They have addressed it by:

  • Securing multiple suppliers of the same products.
  • Building a larger inventory of components.
  • Investing in technology to improve supply-chain monitoring.

Management has also said they are constantly working on their supply chain and are seeing encouraging signs of recovery from the supply chain woes.

They also have noted that Inflation is also a major headwind for them, impacting their costs and margins and that they have been constantly adapting pricing accordingly to minimize its impact.

Management remains optimistic about its growth and is confident of weathering the economic uncertainties and challenges ahead of them, and have stated they will focus on what is in their control like increasing efficiency and market share. They have also stated they will use their flexibility to adjust their output according to changes in demand.