Some of us have a somewhat idealised view of farming. Hay wains, Clydesdales and milkmaids characterise the popular imagination, but the reality is that gene sequencing, advanced hydrology and global positioning systems are more in keeping with modern agricultural practice.
That’s to say nothing of the link between farming and the oil & gas industry. Food supply in industrialised countries still relies heavily on fossil fuels, both in terms of the use of hydrocarbons as a key feedstock in the manufacture of fertilisers and pesticides, but also as a cheap energy source at all stages of food production.
Farming remains one of the biggest consumers of fossil fuels, but as concerns over soil degradation, water shortages and climate change increasingly inform rural policymaking, the switch to tech-driven solutions is gathering momentum, an ideal scenario for the likes of Deere & Co (NYSE: DE), perhaps the world’s best-known manufacturer of advanced agricultural equipment.
The Illinois-based group recently paid $250m (£182m) to acquire a Silicon Valley start-up – Bear Flag Robotics. As the name implies, it feeds into Deere’s ambition to address many of the challenges faced by farmers through increased automation and autonomy. It follows on from the 2017 deal to acquire Blue River Technology for $305m and is a sure pointer to the direction of travel.
Artificial intelligence and machine learning are increasingly to the fore, but the digital transformation comes at a cost, increasingly so ever since the initial roll-out of harvesters with guidance systems and auto steering at the turn of the millennium. Deere & Co registered year-on-year capex growth of 22.4 per cent through the third quarter, an above-average rate driven – at least in part – by food inflation brought about by logistical problems exacerbated by poor harvests in many producing regions.
That may be bad news for cash-strapped households, but rather better so for specialist manufacturers such as Deere & Co. In general, rising agricultural commodity prices tend to spur agricultural equipment demand, while the concurrent improvement in the construction sector, together with an intensifying focus on precision agriculture, will continue to drive sales growth over the long run.
Although Deere & Co had to tailor its manufacturing operations in the face of the pandemic, the group’s recent Q3 update reflects broadly favourable market conditions. Sales were well ahead of the consensus forecast, enabling the group to book net income of $1.67bn for the quarter ended 1 August, or $5.32 a share, which meant that earnings were 135 per cent in advance of where they were nine months into the last financial year.
Obviously, the relative improvement was partly down to the disruption brought about by the pandemic in the early part of 2020, but with grain and oilseed consumption forecast to outstrip supply through 2021, there is evidence to suggest that farmers are looking to secure new equipment while prices are moving in their favour. Deere’s chairman and chief executive, John C May, said that he anticipates “demand for farm and construction equipment to continue benefiting from favourable fundamentals”, while highlighting “the growing engagement with [Deere’s] digital platform”.
For an established blue-chip with market fundamentals apparently working in its favour, the asking price doesn’t seem prohibitive; 21 times forecast earnings represents good value when set against the historical average. Cash profits have delivered a 10.5 per cent compound annual growth rate over the past five years, with a steady underlying margin of 18.9 per cent. And the forecast return on equity for 2021 is 13 percentage points in advance of the average rate of 24.8 per cent. Those are decent growth rates for a market leader in a mature industry, although perhaps analysts might be more inclined to frame it along the lines of a tech valuation nowadays – who knows?
The current quick ratio of 0.5 suggests that Deere would be able to settle only half of its current liabilities instantaneously, but it’s a capital-intensive affair by definition and its inventory and prepaid expenses are not considered in the equation. At any rate, the market would have red-flagged the group’s latest foray into Silicon Valley if it thought liquidity was a genuine cause for concern (unless they are indeed viewing it as a technology play).
Even if Deere & Co is not to your taste, it's worth remembering that its investment case should be supported by demographic trends for the foreseeable future. Increased urbanisation is leading to agricultural labour shortages in rural areas, as workers decamp to the cities. The problem has become acute in some countries in the Asia-Pacific region, providing fertile ground for the group’s next-generation farming kit.
