Industrials

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Deere & Co. investors bought the rumor. Now they're buying the news, too. 

The maker of tractors, planters and other agricultural equipment reported fourth-quarter earnings per share on Wednesday that soundly beat analysts' expectations, thanks largely to cost cuts. Deere also said 2017 sales and net income won't drop quite as much as had been feared. It was a solid showing all around --  but was it really spectacular enough to justify a spike of as much as 11 percent in the stock? 

Leaping Deere
Deere shares spiked to a record after the company reported earnings that weren't as awful as expected
Source: Bloomberg

Years of surplus harvests have pressured crop prices and forced farmers to cut back their budgets, spurring three straight years of sales declines at Deere -- the longest slump since at least the 1980s. The $32 billion company's better-than-expected outlook for 2017 signals that the agricultural equipment market is starting to stabilize and that perhaps the worst of the revenue rout is over.

But here's the thing: Deere was already trading as if a recovery was nigh. At the start of the week, the stock traded at about $92 a share, its highest price since August 2015 and about 7 percent higher than analysts' average 12-month price target. After Wednesday's gains, it's now trading at a record. The negative spread between the stock price and analysts' average price target hasn't been this wide in at least a decade.  

Who's Wrong Here?
Deere's surge has left anlaysts' average price target in the dust
Source: Bloomberg

"Starting to stabilize" also isn't the same thing as "starting to grow." Revenue is still expected to decline next year, with Deere calling for a 1 percent drop in the farm-tools business that makes up the bulk of its sales. Keep in mind that Deere originally called for equipment revenue in fiscal 2016 to be down about 7 percent, then widened out that call to a drop of as much as 10 percent before ending up with a decline of about 9 percent. Point being, it's difficult to predict the recovery path for commodity prices, whether that's crops or oil.

And yet, Deere's enterprise value is now 1.5 times its projected revenue for fiscal 2017 -- the highest multiple since 2011, a year in which the company went on to post a 23 percent surge in total revenue. Deere does have things going for it -- the company has shown a knack for finding ways to prop up profit even without sales growth. But without clear signs of a turnaround in its underlying markets, it's an expensive-looking stock.

Slow Clap
Analysts are projecting Deere's revenue will start to pick up in 2018, but the growth isn't back yet
Source: Bloomberg

While many struggling industrial companies have been riding high lately on the prospect of huge infrastructure investment under a Donald Trump administration, Deere doesn't stand to benefit quite as much as some of its peers. The company does sell construction equipment such as excavators and dump trucks, but that accounts for less than a quarter of its overall revenue.

In fact, Deere's dependence on agricultural markets could be a liability should Trump follow through on threats to impose big tariffs on goods from Mexico and China. U.S. farm exports are going to be a possible counter-target for tariffs, Howard Ward, chief investment officer of growth equities at Gamco Investors Inc., said on "Bloomberg Surveillance" Wednesday morning, noting ``it's a tit-for-tat world if we go down that path."

Trump isn't necessarily going to stick with his hard-line tack on trade, but even if he bends Deere's turnaround prospects won't be any more of a sure thing. Either way, if you ask me, the latest leg up in Deere's shares may be a leap too far. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net