Deere (DE) in the Headlights

Agriculture stocks have taken a late summer beating as commodity prices deflate across the board. The group that had previously been on the offensive has now become quite defensive as investors question the longevity of the recent rally.

Longs have a right to be skeptical. We have seen any number of impressive bubbles ultimately end very badly. Will the same happen in agriculture?

Given that much of the basis for the rise in food stocks was anticipation for ethanol demand, it is certainly possible that the bubble may very well pop. In addition, demand from emerging economies like China and India appears to be slowing.

The same perfect confluence of events that resulted in unprecedented gains may now flip entirely to be the perfect storm for losses.

Coming along for the ride in agriculture was truck and tractor maker Deere & Co. (DE). Since last summer when food prices started to rise, investors speculated that high prices would translate into equipment purchases by farmers.

DE moved impressively higher as a result. The stock increased in price from a low in the $50's to a high of near $100. That is an impressive move for a very large and normally stable growth company.

Unfortunately the move was just a mirage. Recently the company announced that it had grown its profits by 7% in the most recent quarter, but they missed expectations due to higher raw material costs and cut-backs in U.S. spending.

Investors scurried sending DE shares back to the mid $60's. Does such a state represent a buying opportunity?

Find out Jamie's opinion, as well as what some of our top bloggers think about Deere when you read the rest of this week's Bull/Bear Report.

I think so. Indeed DE benefited from the "everything agriculture" trade, but the company was positioned to do well with or without large gains in commodity prices. The selling due to an earnings disappointment does not make Rational sense.

DE is still growing and that growth can be expected to continue in the near and far term. Feeding the world will require investment in equipment that DE provides. To wit, DE announced that it was increasing its manufacturing capacity to keep up with demand for its products.

Forget the gyrations of the last 12 months. DE should do well over the long haul and buying at a discounted price is a good opportunity to establish a position.

Here are your thoughts:

Bull Case - Don Barrett

I watched as a weak dollar seemed to keep the U.S. afloat with a strong rise in exports. And now as the dollar strengthens the economy is rising and anything with a hint of being commodity related is getting slammed. I am happy to see corn, wheat, and other commodities drop in price, but I never expected to see farm implement manufacturers, coal, and some of the other backlash from the rising dollar. As I said last week, coal companies such as Arch have already inked contracts at set prices on out to 2010 and the prices Arch and the others are going to receive is already set and won't drop. The farm implement manufacturers such as Deere and ArtsWay are getting hammered. ArtsWay was up 30% last week and a day or two later dropped by 20%.

A lot of times I am guilty of looking at individual stocks and not looking at the big picture. I spent the weekend looking at some charts and I was shocked at some of the pullback some stocks have suffered. And the main damage seems to have been in the Ag industry. Most of the experts say that investors were locking into commodities which trade in dollars to try and beat the inflation we are facing. If you look at this angle and in oil especially you have speculators, which by definition are buying contracts but will never take possession of the commodity. I heard the other day that about 50% of all the contracts on oil were speculators. Again, by definition a speculator is someone who will never take delivery of the commodity. Southwest Airlines controls jet fuel prices by buying options and they were very successful at doing this. But, if I buy options on jet fuel, I'm a speculator as I don't have a plane and will never take delivery of the jet fuel. So, we had a huge bubble in commodities and it has imploded and this will ease the inflation problem worldwide soon.

At this time as I said I wouldn't buy anything Ag related. Deere's last 2 quarters were great and although they met their projections, a couple of brokers' sales earnings didn't meet their expectations and Deere has dropped by about 30%. If you are a long term investor and can wait this correction out, you should do real well. Companies like Deere are doing just fine, I just don't know when this phase will be over.

The Bear Case - Russ of RD's Picks

In addition to serving as inspiration for one of the greatest country songs ever, you may be aware that Deere & Co. (DE) makes farm and construction machinery. Over the past two years, the stock has run from about 37 to over 90 earlier this year. It's now pulled back to 65 and change, about where it was one-year ago.

The company looks cheap, trading at 13.5 times ttm earnings and 11 times estimated 2009 earnings. Early in the first round of the Strategy Lab Open, Ken Kam asked us to explain why conventional wisdom about a stock's price is wrong in our blogs. In this case, I wasn't able to turn up a reason why the market pricing on DE is wrong.

The stock is trading at a substantial discount to the overall market, but there are several risks to explain the discount and little good news that isn't already well known.

The bull case is that the strong agricultural business will continue to translate into higher tractor and machinery sales and there is evidence to support that. In the 13 Aug conference call, DE management stated that the 8000 and 9000 series tractors have orders extending through July and Sep '09 respectively and that 70% of next year's expected combine sales have orders. The company also has invested in production capabilities and will have increased capacity for combines coming on line in 2009 and tractors in 2010. Deere's other big machinery segments, forestry and construction, are weak but profitable.

Currency translation is expected to add about $150 million, or about 7%, to '08 earnings. With the dollar strengthening, currency translation may very well turn from a positive to a negative. At a minimum, DE will be hard pressed to duplicate this year's currency gains going forward.

A stronger dollar will also benefit foreign competitors. The 19 August Wall St. Journal included an article on a joint venture between Mahindra & Mahindra of India and China's Jiangsu Yuenda Yancheng Tractor to produce tractors. Japan's Kubota (KUB) and Europe's CNH Global (CNH) would also benefit from a stronger dollar.

If US politicians end mandates and subsidies pushing ethanol, corn prices would drop as corn based ethanol production falls.

Input cost inflation will put pressure on margins. During the conference call, several analysts asked about costs and management indicated they've been able to pass most of the higher input costs along to customers.

I don't have a good handle on the farm equipment replacement cycle, but I doubt farmers rush out and buy new tractors and equipment every time there's a great year. A logical cycle would something like a big sales gain in a boom year with smaller gains in subsequent strong years. That may not be the case, but if it is, Deere has probably already seen the biggest chunk of growth in this cycle.

DE is a strong company that's been executing well. The stock seems to be fairly valued at 65 and change, but it's tough to call it a 'buy' with some of the potential headwinds on the horizon.

I normally prefer trying to pick out the best stocks in a sector rather than using an ETF, but since the driving factor behind the bull scenario is a strong and growing agricultural business, the Market Vectors Agribusiness ETF (MOO) might make more sense for an investor considering DE. Since DE makes up nearly 8% of the ETF, you still get some John Deere power in the mix.

---

The bear case is more of a neutral case. That is understandable given the nature of the agricultural trade today. It very well may be the next bubble to pop with disastrous consequences.

I do not think that is the case here. Even in that scenario, DE should do well regardless. The company is leveraged to provide equipment to farmers and steady growth can be expected no matter where commodity prices go.

I'd be a buyer of DE at these levels.

Jamie Dlugosch
Executive Editor, InvestorPlaceBlogs

by The Freshman |  08/29/08  |  Stocks: ARTW, CNH, DE, KUB, MOO,