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Deere's Q1 earnings hurt by higher costs, trade war

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(Adds comments from earnings call, updates shares price)

By Rajesh Kumar Singh

CHICAGO, Feb 15 (Reuters) - Deere & Co's first-quarter earnings on Friday missed Wall Street's estimates, hurt by higher raw materials and logistics costs as well as by slowing trade between the United States and its partners, particularly China, sending its shares lower.

The world's largest tractor manufacturer retained its 2019 earnings guidance - full-year net income is expected to be $3.6 billion with a 7 percent annual growth in equipment sales.

But whether the company would beat or miss the guidance depends on the outcome of Washington's ongoing trade talks with China, which is one of the biggest export markets for U.S. agricultural products.

Deere's shares were down more than 2 percent at $159.01 in midday trade. The stock has gained over 9 percent this year, after falling about 6 percent in 2018, on hopes of a deal with Beijing.

Hoping that the trade issue would be resolved soon, Deere built up roughly $1.3 billion in inventory in the first quarter from the previous quarter.

Stephen Volkmann, a machinery analyst at Jefferies, says the inventory could weigh on the company's profits if the trade standoff prolongs and may force it to resort to cost cuts.

"If we settle the trade issue in a meaningful way, then this (earnings) forecast is conservative," he said. "But if it continues to drag on, you are going to see some risk."

The trade war is further squeezing American farmers whose incomes have been under pressure amid a global grain glut.

China bought about $12 billion worth of U.S. soy in 2017, but mostly shifted purchases to Brazil last year because of the trade fight.

While China has recently returned to buy U.S. soy, the purchases have been too small to make up for the lost sales. With supplies swelling in the domestic market, prices plunged to near decade lows last autumn.

Deere said the trade war has made farmers more cautious in making major purchases. However, it downplayed risks to the 2019 sales forecast, saying replacement demand for aging fleet was still "very healthy".

"We anticipate a resumed recovery in equipment volumes as new trade routes mature or U.S.-China trade contingencies abate," Brent Norwood, investor communications manager, said on an earnings call.

The company expects industry sales of farm and turf equipment in North America - its biggest market - to be flat to up 5 percent this year. But it trimmed the profit estimates for its agriculture and turf division, citing the slowdown in replacement demand for large farm equipment amid persistent trade uncertainties.

Not only has U.S. President Donald Trump's tariff war clouded the outlook for farm equipment demand, but it has also inflated the domestic prices for steel and aluminum used by the company in making its products.

Freight and raw materials costs are expected to remain elevated in the coming quarter. The tariffs on Chinese imports are projected to cost $100 million this year.

Deere's production costs in the first quarter shot up by 2 percentage points from last quarter. Higher manufacturing costs along with a rise in warranty-related expenses led to a 10 percent annual fall in operating profit in the first quarter at its agriculture and turf division.

Sales at its construction and forestry division were up 31 percent year on year in the latest quarter. But the company downgraded the 2019 sales growth forecast for the unit to 13 percent from 15 percent estimated earlier.

For the quarter ended Jan. 28, the company reported an adjusted profit of $1.54 per share, up 14 percent from a year earlier, but below analysts estimates of $1.76 per share, according to Refinitiv Eikon data. (Reporting by Rajesh Kumar Singh; Editing by Mark Potter, Phil Berlowitz and Susan Thomas)