NEW YORK (TheStreet) -- The decision by Warren Buffett's Berkshire Hathaway to sell its entire position in Deere & Company (DE) earlier this year didn't exactly provide a vote of confidence for the manufacturer of John Deere tractors. At around $90, shares are down 1.2% for the year to date.
Indeed, the company has several weaknesses that could impede the progress of its stock. But recent developments also provide reasons for cautious optimism. Let's examine the issues.
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The company released its outlook for fiscal 2015, with Deere's management expecting sales in the agriculture and turf segment to drop by 20%, while its construction and forestry segment will rise slightly by 5%. Since the agriculture and turf segment accounts for roughly 80% of Deere's equipment sales, this outlook doesn't bode well for the company. Most of this drop is related to the U.S., European Union and South America including Brazil. The International Monetary Fund also revised down its outlook for growth rate in economies sincluding China, Brazil and EU. This is another negative indication for Deere.
Based on these changes, the construction and forestry segment is likely to account for a bigger share in the Deere's total equipment sales -- from 19% in fiscal 2014 to 25% in fiscal 2015.
In the past year, the company also saw a drop in profitability mainly due to a drop in profit margins in the agriculture and turf segment. Nonetheless, this segment's operating profitability was still higher than its construction and forestry segment. Therefore, we are likely to see even lower earnings next year.
The company also expects to spend a lower amount of its capital expenses in FY2015 than in FY2014, a drop from $1 billion to $875 million.
But there are also some positive signs: With respect to the agriculture and turf segment, the progress in demand for grains, wheat and corn could provide an indication for the changes in demand for Deere's equipment.
The recent U.S. Department of Agriculture forecast for grains, wheat and corn showed a slight rise in supplies for 2014-2015. The outlook for wheat prices was revised up a bit, while corn prices remained unchanged. Next year's projected prices are still well below 2014's levels. But if prices keep slowly climbing up, this suggests U.S. farmers may eventually increase their spending on heavy machinery compared to previous estimates.
In the meantime, Deere offers a reasonable dividend yield of 2.7%, roughly in line with other heavy machinery companies' dividend yield such as Caterpillar (CAT) , which is currently at 3%. Joy Global (JOY) pays an annual dividend yield of 1.7%.
Deere's shares repurchase program also provided additional yield for its investors. The company's total dividends and buybacks reached $3.5 billion in the past year. At the current stock price this annual yield comes to almost 4%. Over the past several years, the fall in its earnings didn't hold back the company from raising its dividend payment or continuing to repurchase its stocks. This also bodes well for the company to keep doing so next year as well.
In terms of valuation, Deere is relatively high with a forward P/E of 16.5. In comparison, Caterpillar's forward P/E is 13.3 and Joy Global's ratio is 12.5.
Even though Deere has some strong points, including its growing construction and forestry business and reasonable dividend, the company still has more than a few weaknesses. Considering its current high price compared to its peers, Deere could be an interesting opportunity if its price comes down to the mid-$80s price range.
TheStreet Ratings team rates DEERE & CO as a Buy with a ratings score of A-. TheStreet Ratings Team has this to say about their recommendation:
"We rate DEERE & CO (DE) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its notable return on equity, good cash flow from operations and increase in stock price during the past year. We feel these strengths outweigh the fact that the company has had somewhat weak growth in earnings per share."
You can view the full analysis from the report here: DE Ratings Report