In the latest edition of Good Buy or Goodbye, Barron's Senior Writer Al Root joins Yahoo Finance Live to analyze cyclical stocks Deere & Co. (DE) and Caterpillar (CAT).
Root names Deere a buy though "farmers are not doing as well as they were," with total income down $70 billion from it's peak. Despite "less spending on farm equipment," Root stresses being near a trough favors cyclicals. Root acknowledges Deere plans to invest in precision farming, including "self-driving tractors" and "computers planting seeds" for cost savings, and that the company hopes to eventually reach 10% it's of sales from software sales, up from 1% currently. With an attractive valuation, Root sees positives in this stock for investors.
However, he says avoid Caterpillar amid "new equipment erosion," nothing that the "slowing of orders" at one dealer "indicates that maybe the cycle is turning for them." Already "operating right at the peak" for non-residential construction, Root expects a downturn to a come.
For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.
Editor's note: This article was written by Angel Smith
Video Transcript
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JULIE HYMAN: It's a big noisy universe of stocks out there. Welcome to "Good Buy or Goodbye," our goal to help cut through that noise to navigate the best moves for your portfolio. Today we're taking a look at two major American machine makers. Joining me here with how to play these cyclical stocks is Al Root, Barron's Senior Writer. Good to see you. Thanks for coming in.
AL ROOT: Thanks, Julie.
JULIE HYMAN: So let's get to your buy stock, first of all. And it is Deere, the farm equipment giant. Of course, when you're talking about Deere, a lot of what you talk about has to do with the farming cycle, right, and the income that farmers are bringing in and how much they're willing to spend. So where are we in that cycle? You think close to a bottom maybe.
AL ROOT: Well, you hit on it. These are two cyclical companies. And at this point, farmers are not doing as well as they were. Corn prices are down about 35% to 40% year-over-year. Farm income is projected in 24 by our great USDA to be about $115 billion. That's down from two years ago from a peak of about $185 billion. So that means less spending on farm equipment and things like that. But when you're getting close to a trough, that, of course, is a good thing for cyclical stocks.
JULIE HYMAN: One of the interesting things that's been happening in farming, too, is a lot of technology being brought into the industry with what's called precision farming. How is Deere sort benefiting from that?
AL ROOT: So this is things like self-driving tractors, computers, planting seeds at a perfect depth, better, more targeted applications of pesticides and fertilizers. So you use less, that's a cost savings, it's a better for the environment. If you remember, CNH, Deere peer, bought Raven. AGCO just did a joint venture with Trimble. This is sort of a big deal with the industry. This is about partly about selling recurring revenue subscriptions for these types of services.
Deere, eventually, wants us to represent about 10% of their sales. It's probably about 1% of their sales now. So that secular trend is just starting. And we'll carry on sort of higher highs and higher lows throughout the various cycles that'll happen between now and 2030.
JULIE HYMAN: And by the way, those self-driving tractors and such tend to be a lot more expensive. So--
AL ROOT: Yeah. That's exactly right. It's all a price bump on the original equipment.
JULIE HYMAN: Yeah, it's interesting stuff. Then let's talk about valuation here, Deere versus its historical valuation, how is it stacking up?
AL ROOT: So cyclical 101, I am a great lover of cyclical stocks and industrials. You typically trade at a low valuation of peak earnings, high valuation of trough earnings, that's just the way things go. Right now, Deere is trading at about 13 times, 2024 calendar year or fiscal year, depending on how you want to look at it. That's actually-- and earnings are expected to be down, so you're getting sort of a low multiple, below average, on lower earnings, which is a pretty good setup for the stock.
JULIE HYMAN: Interesting. OK, we always like to talk about what could be the downside risk in a situation like this. And in this case, it could be that we don't see a rebound in farm income, right?
AL ROOT: So farming, it's the weather, right? So it really depends on US weather, global weather, crop yields, things like this. So knee-high by the 4th of July, that's what the saying is for corn. So it really depends on the weather. So another bad year in '25 delays this sort of upside that people might see.
Industrial investors never like to buy things when earnings estimates are going lower. But eventually, you get to the bottom. But when that bottom is is sort of the big risk here.
JULIE HYMAN: OK, good to know. And then let's talk about your one that you don't like. And you sort of alluded to it. It is Caterpillar. Now the stock has done pretty well over the past year. And people don't know the company as well, might think it's in farming equipment. It really isn't. It mostly is digging mines and other industrial uses, right? But you say the orders are eroding. They're not doing as well.
AL ROOT: So if you take a look at the starting points of both stocks, right, Cat is up about very roughly 30% over the last 12 months, Deere is down about 20% over the last 12 months. So this is a point in the cycle like it's been tremendous. Construction spending in the US, tremendous.
And right now, backlogs are starting to slip. A Cat dealer Finning, it's a Canadian publicly listed company. It's a dealer, right? So you have this insight into retail orders for Cat machines. Their backlog in Q3 was about 2.3 billion. Their backlog in Q4 was about 2 billion. So this slight erosion, this slowing of orders indicates that maybe the cycle is turning for them.
JULIE HYMAN: Interesting. Let's also talk about the construction cycle, which you mentioned, non-residential construction in particular. We're seeing a peak.
AL ROOT: So it is a technical term on fire. So about $1.2 trillion in annualized non-residential commercial construction in the US right now, all time high. It's the IRA. It's reshoring of manufacturing. All of those things and themes that we hear about and talk about all the time, that's having a real positive impact on construction activity in the US. Infrastructure and Jobs Act, right, all of that stuff.
And that's great. It's great for Cat. And they had a wonderful year in 2023. But you always worry about when that's going to turn over and how much better it can get. So when we talked about Deere, we've had a couple of down years. Deere is operating-- Cat is operating right at the peak right now.
JULIE HYMAN: Interesting. And then finally, let's talk about valuation for this one, too, and what sort of being priced in.
AL ROOT: Right. So if I ran the universe, I would like to see Cat trade at a 13 time multiple on its 24 earnings estimates. It's trading at about 15 times. So there just isn't as much caution or cycle thought among investors right now. They're basically saying, hey, the good times are here for Cat, and they'll stay. That's a little risky for me. I would prefer it to be trading more like Deere and Deere to be trading more like Cat essentially.
JULIE HYMAN: Yeah. And then let's talk about the upside risk for this one is that if interest rates do start to roll over more meaningfully, you could see an uptick in construction.
AL ROOT: Yeah. So it's rates, it's China. As things recover, that's good for Cat. It should be good for Deere as well to some extent, but that's good for Cat so. The risk is really things turn out better than feared and that the cycle is longer. And that the normalization from COVID, right, it isn't that severe and we just keep building things like crazy for the next few years.
JULIE HYMAN: Well, I guess we'll see. And just quickly, disclosure-wise, do you have a position in either of these stocks?
AL ROOT: No. Barron's doesn't trade individual stocks. And I don't own anything.
JULIE HYMAN: OK. Good to know. So let's summarize what you're telling people here. Basically, buy Deere based on that attractive valuation, benefits from precision farming, and maybe a bottoming of the farming cycle. On the other side, you're saying avoid Caterpillar, it faces peaking US non-residential construction and erosion of new equipment orders. Thanks so much, Al Root. Really appreciate it.
AL ROOT: Both great companies, but sometimes the cycle--
JULIE HYMAN: Yeah. All right, the latest installment-- thanks for watching the latest installment of "Good Buy or Goodbye." Look out for new episodes three times a week at 3:30 PM Eastern. We'll be right back.
