John Deere and Co - Stock analysis

It's time to get on this again.  Next week is going to be busy as there will be 3 earnings reports I need to watch and I haven't documented my prep for 2 of them.  Today I want to talk about John Deere and Company.  Those of you that have read my blatherings before will know that this stock is a link to my heritage and is an industry I understand quite well from a customer's point of view.  My thesis for this company is simple, but two-fold.  First, the population is growing, the farmers have less land to grow food on, and there are less farmers.  So there's a need for better equipment to more efficiently do the work and produce stronger crop outputs.  When it comes to equipment, John Deere is the best there is in the market.  The second is a replacement cycle of old equipment.  I have a very strong US focus with John Deere despite about half of their income coming from outside the US in many of the latest reports.  And that's because there's an invisible growth engine in the US that no one seems to consider.  That engine is crop prices.  Crop prices greatly accelerated due to high oil prices and high demand from China for crops.  When those prices jumped, farmers in the US were finally flushed with enough cash to replace troubled equipment and make repairs they had to try to avoid in the past.  Since then, prices have remained relatively strong compared to prices of a decade ago.  This will increase the amount of sales in the US and I suspect the potential that the US could turn to be a higher portion of sales for a period of time and if not, it's because the other economies of the world are also taking off - which is nothing but a positive for DE.

I want to start with the negatives this time around.  I need to closely analyze the risks to owning this stock at this time and be able to assess reasons to sell.  The fist risk I recognize is the fact that this stock has been on an absolute tear since September.  Since then, the stock has risen nearly 25% to it's highs around $95 which it hit about a week ago.  That's a hot stock and it's been gradually pulling back since.  If I was a larger operation, I'd be foolish not to sell some anticipating a pullback for a little while as things readjust.  And that goes along with the next risk.  DE is a serial poor earnings reporter.  It's not that they report bad results.  No, that's not it at all.  The problem is that they're TOO conservative when they report.  Their projections and guidance have a bad habit of putting fear into people that it sells off pretty sharply just after earnings before it goes and starts putting in gains again.  Last time the company reported, the stock pulled back roughly 6% over a 2-3 week period before it started on it's next ascent.  This has been a pattern of almost clock work.  The final thing I think we should be aware of, but isn't completely a risk is the charts.  Now I'll admit I'm not a great chartist.  That being said, even I can recognize some simple patterns in the current chart.  When I pull a 9 month weekly chart for DE, It's very easy to see that the stock has been trading in a rather consistent upward channel since last July.

As you can see in this chart I've put together, it wasn't very surprising that the stock took a turn to the negative at 95.  In fact, it's almost uncanny how this stock has slowly bounced from floor to ceiling along the way.  The fact that recently it's been accelerating the rate could be a little bit of a concern, though as it may indicate more volatility in the stock price that could break the trend.  At this point I think the floor stock could meet the floor at the $89-91 range and it could be a key point to watch - especially with that earnings pattern risk in front of us.  if the stock is around the $90 price next week at earnings, I could see the stock pull back as far as 86.  Part of me is tempted to sell a portion of my gains right now if I get an up day in the next few days and save that money for what seems to be an obvious pullback coming our way.  However only a part of me is saying that and it's basing those thoughts on the concept of having larger positions that create less impact of trading fees.  The final risk is this is a cyclical stock.  If something in the market changes and people become fearful and want to sell - this has to go and go quick!  This stock could drop 10-20% easily with how it's grown and how people will become fearful of cyclical stocks.

Now for the good parts.  First, I think DE is going to post sales numbers that are higher than they were anticipating.  If you follow this stock and the various company and analyst comments, I bet you're wondering why I feel that way, right?  Well, here's why.  Yes, there was a devastating drought that hit major crop regions of the US last year.  It caused crop prices to rise due to a reduction of supply.  But there's something else that people don't seem to take into consideration - crop insurance.  I'm not sure if people have paid attention to various articles around how Crop insurance needs to be reformed to help with US budget issues and how payouts this year have had the highest impact to the US budget ever, but that is something people really need to take note of here - people have protect their risk against crop losses.  This means that despite there being no crop, farmers walked away with a check in their hands to compensate a very large portion of what they could've lost - and at the prices they could've sold at based upon current market prices!  This means that not only did they get paid for most of their losses, but they were also paid at a higher crop price because prices were up due to the drought!  That means come the end of the year farmers had money burning a hole in their pockets and they had to spend it to try to reduce tax implications.  From the little bit of access I have to "Farmer Joe" resources, John Deere sales reps were quite the happy bunch last fall.  I think this will show in sales numbers.  The next reason why I think this stock has room to run is its value.  This stock is currently trading around 12 times last years earnings and closer to 10 times next year's earnings.  Last year EPS grew at a 13% clip and even if that clip isn't maintained, I don't see EPS getting cut in half this year.  That means the stock is trading only about 1x it's growth rate - which is absolutely cheap!  Not 4 years ago DE traded at 26 times earnings.  And although I don't expect us to get near that again anytime soon, considering 14 times earnings, as we see multiple expansion begin to happen with economies steadily becoming stronger, isn't really out of the question at all.  That puts a price target for the company out at $120.  Yep, you read me right.  I think it's perfectly conceivable to have a $120 price target for this stock over the next 12-18 months in the current environment - and that's conservative for that long of a timeline.  Another item sure to help this company is the fact that construction is again on the rise too, so when Ag used to carry the load as construction waned due to economic uncertainties, I foresee additional headwinds at this time.

Taking into account a risk/reward analysis, I see the risk to be a maximum of 20% and reward of 30% from current price levels.  Given current economic conditions, I consider it to be more of a 10% downside risk at this time.  All that said, I don't have my position filled on this stock.  Although my cost basis is much lower, I think this stock is a buy if it really does pull back some more going into and/or because of the earnings and forward guidance reports.  At this stage, it's best to await earnings.  I will buy into any pullback based on earnings fears if the facts do not change.  If earnings breaks my theories or macro issues arise and strike fear in the markets, I'm pulling out a good chunk of my portion to lock in gains and reuse later.  Even if the channel trend I showed is broken (not due to fundamental changes), I don't think it'll be the end of the world.  It just may mean that my buying opportunity will be closer to the $86 range as that's where I see the next line of support being from the technicals.  If the stock wants to go on sale like that, I'll be happy to take advantage of that and I hope you are too!