Deere Stock is Soaring, But is it Time to Pump the Brakes?

Deere & Company (NYSE:DE) was surging on February 21 after an earnings report that crushed expectations on the top and bottom lines. DE stock was up over 9% and trading at over $181 per share. The rally has pushed the stock into positive territory in 2020 for the first time since early January.

Positive earnings reports can be a catalyst for stocks and DE is no different. For the company’s first-quarter of fiscal 2020, Deere reported sales of $6.53 billion. While this was substantially higher than the FactSet estimate of $6.22 billion, it was 6% less than the same quarter in 2018.

However, the story was better when it came to the company’s profit. Deere reported net income of $517 million which comes out to $1.63 per share. This was higher than the FactSet estimate for $1.27 per share. And it also was higher on a year-over-year basis. In the same quarter for fiscal 2019, the company posted a $1.54 EPS on net income of $498 million.

Investors are encouraged for a couple of reasons. First, as Deere CEO John C. May echoed in his remarks this could be a sign of U.S. farmers having renewed confidence as the U.S. and China have come to a Phase One deal in trade talks. The second reason for investor optimism is that Deere’s first fiscal quarter is typically its worst of the year.

Deere did not increase its full-year guidance

One cause for concern is that Deere management is continuing to forecast a decline in net sales for its agriculture and turf sector as well as its construction sector. In the earnings report, agriculture and turf net sales were down 4% YoY and the company expects a 5%-10% decline in 2020.

The situation is similar in the construction sector. Sales were down 10% YoY and Deere is projecting a 10%-15% decline in net sales for fiscal 2020.

China continues to project uncertainty

As 2019 was coming to a close, the optimism for stocks like Deere and Caterpillar (NYSE:CAT) was palpable. The conventional wisdom was that the Chinese were looking for a deal just as badly as U.S. farmers. While that may be true, China still is presenting uncertainty for farmers who already deal with enough uncertainty as it is.

Yes, the outbreak and subsequent quarantines resulting from the coronavirus is a headwind on many U.S. companies. While it appears Caterpillar may be ready to reopen its Chinese manufacturing facilities, it’s much too early to know what the capacity restraints will be due to the virus.

However, as it relates specifically to DE stock, a more pressing concern may be a different virus. China has been dealing with a severe outbreak of African Swine Flu (ASF) since August 2019. The country has cut roughly 25% of its pork production. For a country that is the largest consumer of pork, this may be good news for U.S. pork producers but may be not as much for farmers.

China is diversifying

And that’s because an unintended consequence of the trademark, according to Fortune magazine, is that China is discovering that diversification of sources is the key to its food security. Darin Friedrichs, senior Asia commodity analyst at INTL FCSTONE in Shanghai states, “Agriculture is one of those things that the U.S. side really has to address…basically over the past year and a half, China has been really aggressive in trying to diversify where (it’s) buying from.”

This is being reflected most acutely in the country’s soybean crop. Farmers that were expecting a huge tailwind from the Phase One deal are finding that China is less dependent on the United States for that commodity. And, with the outbreak of ASF, they have less need for soybeans to feed pigs.

Deere Stock May be Overvalued

DE stock posted a positive gain of over 15% in 2019. However, the stock lagged behind the S&P 500 index. Investors are watching closely for any signs of a rebound in the segment.

In January, an analyst from Forbes projected a $168 price target for DE stock. That was based on the lower projections for revenue in the company’s various segments. Since the company has not changed that outlook, a question will be if analysts change their outlook on earnings. Prior to earnings, analysts were forecasting a full-year EPS of $11.02, which would be a 27% increase from 2019. Deere was holding a conference call to review the earnings report at 10:00 a.m. on February 21.

Although uncertainty in China may scare off growth investors, income investors can still look at Deere for its dividend. The yield is currently around 1.68%, but the company has a low payout ratio and with increased earnings, a dividend increase may be in the offing.