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Deere to Bank on Construction Demand Till Agriculture Picks Up

Zacks Equity Research

Deere & Company’s DE Construction & Forestry sales increased 11% year over year to $2.99 billion in the second quarter of fiscal 2019 (ended Apr 28, 2019). The segment reported highest second-quarter revenues.

This was driven by Wirtgen acquisition, higher shipment volumes and price realization, somewhat offset by unfavorable foreign exchange. This segment reported operating profit of $347 million, an improvement of 34% from the prior-year quarter figure of $259 million. The Wirtgen acquisition contributed operating profit of $102 million in the reported quarter. Apart from it, price realization and higher shipment volumes partially offset by higher production costs and less favorable product mix drove profits. Operating margin in the quarter was 11.6% compared with 9.6% in the previous year – a 200 basis points expansion year over year.

Wirtgen Buyout: A Key Catalyst for Construction & Forestry

Deere projects global sales for Construction & Forestry equipment to rise 11% in fiscal 2019. This will be backed by strong demand for equipment and the Wirtgen acquisition. With order books extending into the fourth quarter, the segment seems on track for improved results in the back half of the fiscal.

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 11.5%. 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 remains at supportive levels for equipment demand. Equipment rental utilization remains high and rental rates will continue to improve in 2019. Global transportation investment this calendar year is anticipated to be up about 4%, 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 enhances Deere's exposure to global transportation infrastructure. The company has updated its synergy target to 125 million euro by 2022.

This upbeat performance helped offset the impact of the ongoing weakness in agricultural sector on Deere’s sales. The Agriculture & Turf segment’s sales were up 3% year over year to $7.3 billion in the second quarter of fiscal 2019, while operating profit at the segment declined 4% year over year to $1,019 million.  Backed by the Construction & Forestry segment’s performance, Deere reported second-quarter fiscal 2019 adjusted earnings of $3.52 per share, an improvement of 12% from the prior-year quarter.

Citing ongoing concerns over the impact of the escalating trade war between the United States and China, weakening agricultural market for fiscal 2019, Deere lowered expectation of equipment sales year-over-year growth to 5% from the prior expectation of 7%. For the fiscal, the company anticipates net sales to increase about 5% year over year, down from previously guided growth of 7%. The expectation for net income for the fiscal is now at about $3.3 billion compared with its earlier expectation of $3.6 billion. For the Agriculture & Turf segment, Deere projects industry sales of agricultural equipment in the United States and Canada to be flat to up 5% in fiscal 2019.

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

Nevertheless, there is a ray of hope for Deere as well as other stocks like with exposure to the agricultural sector like AGCO Corporation AGCO, Lindsay Corporation LNN and Titan International TWI. Per the USDA’s latest available projections, net farm is anticipated to increase 10% year over year in 2019 to $69.4 billion after a decline of 16% in 2018. Further, the USDA has announced a $16 billion aid program for American farmers who have been hurt by the U.S. trade war with China. Payments will be made in up to three tranches, with the second and third tranches evaluated as market conditions and trade opportunities dictate. The first tranche will begin in late July or early August, and the second and third tranches will be made in November and early January, respectively. This is likely to improve farmer sentiment and bolster equipment sales.

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