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Construction Demand to Buoy Deere Till Agriculture Picks Up

Zacks Equity Research

Deere & Company’s DE Construction & Forestry sales rose 1% year over year to $3.02 billion in the third quarter of fiscal 2019 (ended Jul 28, 2019). In the first three quarters of fiscal 2019, the segment’s sales improved 11% from the prior-year comparable period.

This was driven by the Wirtgen acquisition, higher shipment volume and price realization, somewhat offset by unfavorable foreign exchange. The segment reported operating profit of $378 million, marking an improvement of 35% from the prior-year quarter figure of $281 million. So far in the fiscal year, the segment’s operating profit improved 66% year over year to $954 million.

The Wirtgen acquisition contributed $158 million to operating profit in the third quarter of fiscal 2019 and $275 million so far in the fiscal year. Apart from this, price realization and higher shipment volume, partially offset by higher production costs and unfavorable effects of currency exchange, drove profits. Operating margin in the quarter was 12.5% compared with 9.4% in the previous fiscal year, marking an expansion of 310 basis points year over year.

Wirtgen Buyout to Drive Construction & Forestry Segment

Deere projects global sales for the Construction & Forestry segment to rise 10% in fiscal 2019. This will be backed by the Wirtgen acquisition as well as strong demand for equipment. With order books extending into the fourth quarter, the segment seems on track to witness improved results in the second half of the fiscal year.

In forestry, global industry sales are expected to be flat to up 5%, primarily driven by higher demand in EU28 countries and Russia. The segment’s operating margin is projected to be about 11%. The economic environment for the construction, forestry and road-building industries holds promise and continues to support elevated demand for new and used equipment.

For fiscal 2019, U.S. GDP, total construction investments, housing starts and oil activity remain at supportive levels for equipment demand. Equipment rental utilization remains high and rental rates will continue to improve in 2019. Global transportation investment in this calendar year is anticipated to be up about 5%, spurring demand for road construction equipment such as milling machines, rollers and asphalt pavers, which are all important product lines for Wirtgen.

As a reminder, Deere acquired the world’s leading road-construction equipment maker, Wirtgen, for $5.2 billion in cash and debt in December 2017. The buyout significantly enhanced Deere's exposure to global transportation infrastructure. The company updated its synergy target to 125 million euro by 2022.

This upbeat performance helped offset the impact of the ongoing weakness in the agricultural sector on Deere’s sales. The Agriculture & Turf segment’s sales were down 6% year over year to $5.9 billion in the third quarter of fiscal 2019 while operating profit at the segment declined 24% year over year to $612 million.  Prevalent concerns over export-market access, near-term demand for commodities such as soybeans, and overall crop conditions resulted in farmer’s getting cautious about their equipment purchases. Nevertheless, backed by the Construction & Forestry segment’s performance, Deere reported third-quarter fiscal 2019 adjusted earnings of $2.71 per share, an improvement of 5% from the prior-year quarter.

Deere lowered expectation of year-over-year equipment sales growth to 4% from the previously mentioned 5%. The expectation for net income for the fiscal year is now at about $3.2 billion compared with $3.3 billion stated previously. For the Agriculture & Turf segment, Deere projects industry sales of agricultural equipment in the United States and Canada to be flat in fiscal 2019 compared with the prior fiscal year. The segment’s overall fiscal 2019 sales are expected to be up 2% year over year.

Further, Deere’s results continue to bear the brunt of higher costs of raw materials on the implementation of tariffs and logistics. It will likely continue to hinder the company’s margins until a resolution is reached.

Nevertheless, there hope for Deere as well as other stocks — including AGCO Corporation, Lindsay Corporation and Titan International, which have exposure to the agricultural sector. Per the USDA’s latest available projections, net farm is anticipated to rise 10% year over year in 2019 to $69.4 billion, after a decline of 16% in 2018. Further, the USDA announced a $16-billion aid program for American farmers, who have been hurt by the U.S. trade war with China. This is likely to improve farmer sentiment and bolster equipment sales.

Shares of Deere have gained around 10.1% over the past year compared with the industry’s growth of 8.0%.

Zacks Rank & Stocks to Consider

Deere currently carries a Zacks Rank #3 (Hold).

A few better-ranked stocks in the Industrial Products sector are Zebra Technologies Corporation ZBRA, Cintas Corporation CTAS and Tetra Tech, Inc. TTEK. While Zebra Technologies presently sports a Zacks Rank #1 (Strong Buy), Cintas and Tetra Tech carry a Zacks Rank of 2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Zebra Technologies has a projected earnings growth rate of 16.71% for the current year. The stock has gained 21% in a year.

Cintas has an estimated earnings growth rate of 11.15% for 2019. The company’s shares have gained 25% in the past year.

Tetra Tech has an expected earnings growth rate of 15.97% for the ongoing year. The stock has appreciated 15% over the past year.

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