After a 2x rise since the March 23 lows of this year, at the current price of around $235 per share we believe Deere & Company’s stock (NYSE: DE) has reached its near-term potential. Deere’s stock has rallied from $111 to $235 off the recent bottom compared to the S&P which moved 55%, with the resumption of economic activities as lockdowns are gradually lifted. DE stock is also up 58% from levels seen in early 2018, two years ago.
DE stock is now up 42% from the levels it was at before the drop in February due to the coronavirus outbreak becoming a pandemic. This seems to make it fully valued as, in reality, demand and revenues will likely be lower this year than last year.
Some of the 58% rise of the last 2 years is justified by the roughly 32% growth seen in Deere’s revenues from 2017 to 2019. Also, the company managed to expand its Net Margins by 14% from 7.3% to 8.3%, which translated into a 52% growth in earnings. While its P/E Multiple contracted between 2017 and 2019, it has expanded thus far in 2020. We believe the stock is likely to see downside despite the recent uptick and the potential weakness from a recession-driven by the Covid outbreak. Our dashboard, ‘What Factors Drove 58% Change in Deere Stock between 2017 and now?‘, has the underlying numbers.
Deere’s P/E multiple changed from 22x in 2017 to 17x in 2019. While the company’s P/E is 23x now, there is a potential downside risk when the current P/E is compared to levels seen in the past years, P/E of 20x at the end of 2018, and P/E of 17x as recent as late 2019.
So what’s the likely trigger and timing for downside?
The global spread of Coronavirus has meant a decline in economic growth, and the construction sector in particular has been one of the worst-hit. Deere’s equipment is designed to cater to two primary sectors – Agriculture and Construction. Given the decline in overall construction, the company saw a 27% plunge in segment sales, while Agriculture & Turf segment fared better with a sales decline of a mere 4% in Q3 fiscal 2020 (fiscal ends in October). The company’s management in its latest quarterly earnings conference call provided guidance of a 10% decline in Agriculture & Turf and a 25% decline for the Construction & Forestry segment in the current fiscal year.
The actual recovery and its timing hinge on the broader containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. Following the Fed stimulus — which set a floor on fear — the market has been willing to “look through” the current weak period and take a longer-term view. With investors focusing their attention on 2021 results, the valuations become important in finding value. Though market sentiment can be fickle, and evidence of an uptick in new cases could spook investors once again. DE stock at $235 is trading at 23x its expected 2021 earnings, which is higher than levels of under 20x seen over the recent years.
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