Will Warren Buffett’s John Deere Investment Pay Off?

There is arguably no investor more famous than Warren Buffett, chairman of investment conglomerate Berkshire Hathaway (NYSE: BRK-B). Buffett is so famous and widely followed that each time Berkshire buys or sells a stock, it’s huge news.
One of Buffett’s stock holdings, John Deere (NYSE: DE), is under pressure. The company has been besieged by the collapse in agricultural commodities over the past two years, which is weighing on sales of its tractors and combines.
Nevertheless, Buffett recently increased his stake in the heavy machinery maker, and Berkshire now owns 22.8 million shares. That comes out to a $1.8 billion investment, which makes Berkshire the largest shareholder of Deere with approximately 7% ownership of the company.
Given all that’s going wrong for Deere, is Buffett making a mistake? Or does he see a recovery as imminent?

Boom and Bust

Agricultural commodities saw a notable boom in prices in the years following the financial crisis and recession of 2008. But in the past two years, that momentum completely reversed. Agricultural commodities like corn have seen prices collapse. This has reduced farm incomes, which in turn results in lower spending on Deere’s farm equipment.
Not only that, but the strengthening U.S. dollar is reducing demand in overseas markets. These forces are having a pronounced effect on Deere’s international business. Deere caters heavily to emerging markets like Brazil, where its performance has collapsed.
Deere’s net equipment sales fell 22% last year, and unfortunately 2016 has not gotten off to a better start. Deere’s earnings per share fell 28% in the first quarter of fiscal 2016, year over year.
Weakness was widespread across geographic markets. In the U.S. and Canada, sales fell 18%. Outside the U.S. and Canada, sales fell 9%. The company expects 2016 to be another challenging year. Sales are expected to decline 10% for the full year.
There are several problems in each of Deere’s main operating segments. Sales of agriculture equipment are expected to decline 15% to 20% in 2016 in the U.S. and Canada.
In the European Union, Deere has seen economic conditions improve modestly, but poor conditions in pork and dairy is weighing on sales in those markets. The company expects a 5% drop in agricultural and turn retail sales in the EU this year.
In emerging markets China and Brazil, while economic growth is strong, it is slowing. And, the value of agricultural production in those countries is expected to be flat at best this year.

Catalysts for Deere

It’s easy to dismiss Deere based on the contraction in the farming industry. But this could be a short-term dip amid a longer-term boom. The major catalyst for Deere’s recovery could be the rise in global populations and the ensuing demand for food.
The global agriculture industry faces an unprecedented challenge due to rising populations. The global population recently passed 7 billion, and is projected to reach 9 billion by 2050. As populations and economies expand, nations around the globe are about to see millions of new entrants into the middle class.
As middle classes expand and consumers emerge with greater spending power, eating habits typically shift upward to more protein-based diets. This could result in an unprecedented strain on global food production, and agriculture companies are hard-pressed to meet the constantly increasing demand for food. Combine this with the fact that land available for food production is a finite resource, and it’s clear that there is an immense challenge facing the agriculture industry in the years ahead.

Few Competitors

It’s not hard to see why Buffett is a fan of Deere. The company is a strong brand and a leader in its industry. There are not many existing competitive threats to Deere, which gives it a wide economic “moat” as Buffett calls it. And, Deere is a cheap stock; shares trade for 14 times earnings and the stock pays a solid 3.1% dividend.
Buffett is a long-term investor, and that is exactly the mindset one must have to invest in Deere. The long term picture looks bright due to the immense future demand for food, and in the meantime, the stock at least pays investors well to wait for the turnaround.

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