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John Deere

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may have fallen into one of the oldest traps in the business.

Industry data for the U.S. tractor market this week suggest that Deere, of Moline, Ill., may be pushing too much product onto the dealerships that sell farm machines to the end user. If this is happening, it may mean past earnings have been artificially inflated and that future ones could sag below expectations.

A recent Detox

examined numbers that indicated the practice of overselling to dealers -- often called channel-stuffing -- is taking place. For a time, dealers might be willing to take the new inventory because Deere's finance arm, John Deere Capital, might be lending them money to buy the extra gear. Deere's representative didn't return a call seeking comment on the channel-stuffing theory.

The stakes are high for the big tractor seller, whose richly priced stock suggests investors are expecting a strong performance in the coming year. Deere recently affirmed fiscal 2003 earnings guidance of $2.05 to $2.50 per share; analysts surveyed by Thomson Financial/First Call expect the company to make $2.43. Deere trades at 19 times that analyst consensus number, which is high for a manufacturer in an old industry. As a result, if channel-stuffing is taking place and 2003 earnings suffer as a result, Deere stock could tank. Deere fell 39 cents Thursday to $45.90.

Tractor Beam

The numbers that are currently creating a buzz are the industrywide U.S. sales and inventory numbers that are released monthly by the Association of Equipment Manufacturers. Because Deere has such a large share of the U.S. market, the monthly numbers are seen as quite representative of Deere's performance. Deere provides on its

Web site a monthly sales commentary in which it compares its performance with that of the industry. But it doesn't give precise numbers, typically restricting its comments to whether it did better or worse than the AEM trends.

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The industry's November numbers were weak. For example, Deere said that North American sales to end users of four-wheel-drive tractors and combines -- both high-margin machines -- fell 48% and 35%, respectively, from their year-ago levels. In both cases, Deere said its own sales "were down more than the industry." The company commented that last year's November sales were strong because of some close-out sales, implying that the year-ago figure was going to be a tough base to improve on.

However, sales figures alone cannot indicate if channel-stuffing is taking place. One way to check that is to get a number for sales to dealers and compare it with retail sales. If the ratio rises, then inventories could become overstocked.

Industry retail sales figures and dealer inventory levels are given by the AEM. To get the number for sales to dealers, Deere watchers take the most recent month's inventory, add it to retail sales and then subtract the beginning-month inventory. (Say dealers had 110 tractors in inventory at the end of September, sold 20 tractors in October and ended October with 100 tractors in inventory. Manufacturers would've had to sell another 10 to the dealers for there to be 100 in dealer inventory.)

Venison on the Grill?

Calculations using AEM data show that in the period equivalent with Deere's fourth quarter (August through October), sales to dealers of four-wheel-drive tractors were 1.09 times retail sales this year, compared with 0.7 times last year. In 2002, 100-horsepower-plus tractors and combines also showed significantly higher ratios compared with 2001.

Another much-watched indicator is the ratio of dealer inventories to sales. This figure is reached by dividing one month's sales into the previous month's inventory. This calculation also shows that inventories are building for the industry, and probably for Deere as well.

Four-wheel-drive tractor inventories in October were 10.3 times November sales, compared with 3.7 times for last year and 7.8 times in 2000. For combines and 100-horsepower-plus tractors, the sales-to-inventory ratios this year were 3.9 and 8.5, respectively, both up from the 2.8 and 5 in the year-ago periods.

Let's be clear, there's no way of telling whether these numbers reflect what's really been going on at Deere specifically. And the company may have had low inventory numbers last year as it cleared out old models. But if these numbers do turn out to be a good proxy, the market will make venison out of a slow-footed Deere.

In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback and invites you to send any to