Looking at a Deere cycle

The company beats estimates in its fourth quarter, but projections for next year are disappointing.

By Jim J. Jubak Nov 24, 2010 2:36PM
Jim JubakValuing a cyclical stock such as Deere (DE) -- which reported fiscal-fourth-quarter earnings today -- is always difficult. 

You have to figure out where the company is in the revenue cycle from peak to trough and back again. And you have to figure out how long the cycle will last.

In Deere's case, the Wall Street projection is that the company is about to hit the top of the cycle.

Earnings growth, according to Wall Street, will soar in the fiscal year that ended in October 2010 and then head downward as the cycle peaks to 35% in the quarter that ends in January 2011 on its way to just 16% growth for the fiscal year that ends in October 2011. Post continues after video:
That projected peak seems early to me, considering that the company's business really bottomed only in late 2008 through late 2009 and considering that farm prices seem to be headed higher, not lower, for the foreseeable future. According to the Association of Equipment Manufacturers, sales of four-wheel-drive tractors were up 83% in October 2010 from October 2009 and sales of large row-crop tractors climbed by 54%.

That sounds like acceleration rather than a peak to me. 

Deere beat expectations on earnings and revenue in the fourth quarter, with profits of $457.2 million, or $1.07 a share, up from a loss of $222.8 million, or 53 cents a share, a year ago. Revenue was up 35% to $7.2 billion.

And that surprise is likely to be just the first of a string of three or four.

Standard & Poor's estimates calendar-year earnings at $5.12 for 2011. That puts the stock at 14.9 times projected calendar-year earnings at the open Tuesday, when shares traded for $76.22. Shares were trading at $76.18 Wednesday.

That makes the stock undervalued, in S&P's opinion, since normally Deere trades for at least 16 times earnings at this point in its recovery cycle. That gives S&P a 12-month target price for Deere of $82 a share.

(Deere disappointed analysts Wednesday, however, by forecasting about $2.1 billion in profit for the next fiscal year. That's about $4.92 a share, Bloomberg reported.)

If like me you think Deere is about to deliver a series of earnings surprises -- because the cycle is stronger than currently expected -- then that $5.12 is low. Last quarter Deere delivered a 15% earnings surprise. If the company matches that for the next calendar year, then earnings for calendar 2011 add up to $5.89 a share, and the 16 times target price comes to $94 a share.

That's my logic, anyway. Deere is a member of my Jubak Picks 50 portfolio.

At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. As of the end of the most recent complete quarter on September 30, 
the fund owned shares of Deere. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here. 

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