MOLINE, Ill.Deere & Co. has replaced Caterpillar Inc. as the industrial stock that keeps investors up at night.
The Moline-based farm equipment manufacturer rattled Wall Street with a Nov. 26 prediction that sales would fall 15 percent in fiscal 2015, which began Nov. 1. That's a lot worse than the 5-percent decline it reported for fiscal 2014. Deere shares then fell almost 1 percent on the news and were down 4.7 percent for the year through the end of November.
The cause is familiar to anyone who has followed Deere for a while: Lower commodity prices and falling farm incomes are putting pressure on demand for agricultural machinery, especially for larger models, Deere said in its earnings report.
Deere's sales have risen and fallen with farm incomes since the company's founding in 1837 by an entrepreneurial blacksmith. In the most recent upcycle, sales surged 45 percent between 2010 and 2013 as global demand lifted prices for corn and other crops. With prices cycling down again, Deere's sales naturally are heading lower, too.
A sharp sales drop like the one the company is expecting in 2015 can divert attention from the longer-term trend, which matters most for a company like Deere. Even if sales do fall to about $30 billion, they'd still be 50 percent above the $20 billion Deere posted 10 years ago.
Deere has done well by investors willing to ride out cyclical ups and downs. While its stock trailed the Standard & Poor's 500 Index over the past one-, three- and five-year periods, its 10-year rise of 139 percent is nearly double the S&P's.
What's more, Deere has learned to manage expenses during downturns, ensuring strong returns. According to analysis from Chicago-based Morningstar Inc., Deere's return on invested capital for the past five years is 20 percent, well above its 9.2 percent cost of capital.
As the world's largest maker of agricultural equipment, Deere has a strong brand rooted in an extensive dealer network that provides farmers with service levels few competitors can match.
Hand-wringers also overlook the powerful economic trends supporting Deere. As middle classes expand around the world, demand for basic food products steadily rises. Nobody benefits from that trend more than Deere, which supplies equipment needed to meet that demand.
Some see parallels between Deere's nose-dive and a recent sales plunge at nearby Peoria, Ill.-based Caterpillar. It's true the construction equipment manufacturer has been going through a similar cyclical decline, but declines have moderated at Cat and its stock has been climbing again.
Also, Cat's woes were exacerbated by an ill-advised buyout of a mining equipment manufacturer just before prices for mined commodities plummeted. Deere has hitched itself to no such millstone.
Deere's real challenge isn't the latest agricultural downturn. To sustain long-term growth, Deere must keep giving farmers reasons to buy new equipment and claim its share of emerging-growth markets overseas.
Innovation will be critical, as it has been since Deere's eponymous founder devised a better plow for 19th-century sodbusters. If the company can't keep introducing features that boost farmers' productivity, lower-priced offerings from competitors and used-equipment dealers will look more attractive.
It's probably unrealistic to expect Deere to dominate abroad as it does in North America, where it controls nearly half the agricultural equipment market. But the company must position itself to capitalize on these growing markets.
Deere is moving forward on both fronts, rolling out a range of digitally enhanced products and building factories around the world. Investors concerned about Deere's long-term growth prospects should keep an eye on these efforts.
Columnist Joe Cahill wrote this blog late last year for Crain's Chicago Business magazine, a sister publication of Tire Business.