Deere's stock soared 2.5% on Friday as reports came in of crop prices gaining upward momentum. Weak crop prices had been hurting the company, as they resulted in declines in farmers’ income which in turn led to a drop in demand for agriculture equipment. While this rebound is certainly good news for Deere, we do not believe that this is indicative of a near-term turnaround for Deere. Below we explain why.
We have a $92 price estimate for Deere, which is slightly below the current market price.
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Agriculture Equipment Demand Tanked On Lower Crop Prices
In 2013, favorable weather conditions drove up corn output by 30% year-on-year and soybean output by 8%. Harvest levels remained elevated in 2014 as well, driving prices of these crops to four year lows. The decline in crop and soybean prices negatively impacted farmers' income, since receipts from these commodities alone account for around 50% of crop receipts, or 28% of overall commodity receipts.
As their income declined, farmers were forced to put off or cancel purchases or maintenance of equipment, leading to a significant decline in sales of agricultural equipment and spare parts. This severely hurt Deere's Agriculture & Turf division revenue, which fell 9% in the fiscal year 2014. In fiscal 2015, the segment's revenue declined 27% and 25% in the first and second quarters, respectively.
Earlier in the year, the U.S. Department of Agriculture forecast a 32% year-on-year drop in U.S. farm income for 2015, to $73.6 billion, the lowest since 2009. This was primarily due to the falling prices of crops such as corn and soybean. Per the USDA's estimates, corn prices will decline to $3.55-3.75 per bushel in marketing year 2015, compared to $4.46 in 2014. Soybean prices are expected to decline from an average of $13.00 per bushel in marketing year 2014 to $10.00 in 2015. Looking at the decline in U.S. and global farm income, Deere forecast a decline of 24% in its fiscal 2015 net sales.
Crop Prices Have Picked Up But Not Enough To Benefit Deere
The prices of corn and soybean have surpassed the average price forecast by the USDA, while the price of wheat is moving closer to its forecast. Corn prices rose to a one-month high of $4.06 per bushel, soybean price increased to a three month high of $10.02 per bushel and wheat rose to a five-month high at $5.66 per bushel. The increase in prices of these crops is primarily the result of unfavorable growing conditions, which will likely impact supply. Wet conditions are discouraging farmers from planting corn and soybean, while seedlings struggle to mature, threatening yields for these crops. The conditions will also delay wheat harvests.
The continued upwards movement of crop prices is indeed good news for Deere, as it means that the worst should be over for the company. However, it is important to note that crop prices are still very low compared to what they were in 2012. Additionally, current prices are very close to their average price estimate, which means that the USDA's forecast still looks realistic for the time being. Therefore, even if the unfavorable weather conditions do impact yields, farm income is still likely to decline by double digits. This should continue to impact demand for agriculture equipment, and in turn, Deere's revenues.
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