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Deere: Profits seen under pressure in face of ag downturn

Even with crop prices trending higher, the worst of the agricultural downturn may be far from over for Deere.

Continued weakness in the domestic market along with softness in South America are affecting the company's farm machinery business. The slump is being felt hard, particularly on high-horsepower tractors and combines.

"Our 34 contacts across four different countries reported sequentially lower demand and steep year-over-year double-digit declines across all markets." -Eli Lustgarten, analyst, Longbow Research

"Global demand for farm equipment remains steeply depressed," Longbow Research analyst Eli Lustgarten said in a note Friday. "Our 34 contacts across four different countries reported sequentially lower demand and steep year-over-year double-digit declines across all markets. North American and international markets seem to be worsening as crop prices stay low and farmers struggle to break even."

One area that appears to be holding up better is Deere's North American turf and utility equipment business, which includes riding lawn equipment, mowers, golf course equipment and utility vehicles. Historically, about 60 percent of Deere's overall sales come from the United States and Canada.

Deere releases its fiscal second-quarter results on Friday before New York markets open. Analysts will be looking to see if the company updates its guidance and discusses the impact of farm commodity prices, given that soybeans and corn have turned higher in the past month.

Non-GMO corn is harvested with a John Deere & Co. 9670 STS combine harvester in this aerial photograph taken above Malden, Illinois.
Daniel Acker | Bloomberg | Getty Images
Non-GMO corn is harvested with a John Deere & Co. 9670 STS combine harvester in this aerial photograph taken above Malden, Illinois.

"North American large ag equipment is still the primary driver," said UBS analyst Steven Fisher. "Construction is the other key area, and that has been weak for them in the fiscal first quarter, and I think that will be another area of softness in the fiscal second quarter, both from a volume and pricing perspective."

In the Europe region, Germany is lagging, but Fisher said there are markets with "relative strength," such as France, due to tax incentives. "It may not have fully extended out the whole quarter and could be offset by other parts of weakness in Europe."

Warren Buffett's Berkshire Hathaway recently disclosed an increased stake in Deere worth nearly $1.7 billion. Through Wednesday's close, Deere stock is up 8 percent year-to-date, outperforming the broad market as well as Apple stock — another Berkshire holding.

Asked for comment this week about the bigger Buffett stake, a Deere spokesman said, "We don't comment on stock transactions and do not make market-related media comments before earnings during the quiet period."

Consensus estimates from equity analysts are for Deere to show earnings of $1.48 per share in the most recent quarter, a decline of 27 percent from $2.03 per share reported a year ago, according to Thomson Reuters. Worldwide revenue is forecast to decline 9 percent to $6.7 billion.

The Moline, Illinois–based company's largest segment, ag and turf, is forecast by analysts to show an April quarter sales decline of 9 percent, according to FactSet. The construction and forestry segment's revenue is projected to fall nearly 12 percent. The three previous quarters have seen both segments posting even bigger declines, but analysts say the comparisons are getting easier.

In North America, a glut of used farm equipment that's available remains a challenge for Deere as it looks to sell new machinery. Macquarie Capital recently looked at the pricing of older farm machinery sold at auction and found "prices for Deere tractors remain negative, falling approximately 11 percent year-over-year in April." Also, the investment firm predicts the used market will "see [price] declines continuing through 2016."

During its earnings conference call in February, Deere provided a full-year 2016 forecast calling for a 10 percent sales decline. It forecast full-year 2016 earnings of $1.3 billion back in February, a downward revision from its earlier forecast calling for earnings of $1.4 billion. Deere reported net income of $1.94 billion in fiscal 2015 ending Oct. 31.

"Overall, we think the buy-side is anticipating a reduction to fiscal year 2016 guidance, which is not our baseline view," Citi analyst Timothy Thein said in a Deere preview note Monday. Also, the analyst doesn't expect Deere's management to make changes to its U.S./Canada ag and turf or construction and forestry segment outlooks. However, he sees "risk" on the South America front with the political changes in Brazil, including a new ag minister potentially making farm policy changes.

Some of the headwinds Deere may discuss during its earnings call were already highlighted by its farm machinery competitor AGCO, which last month reported first-quarter earnings that exceeded analysts' estimates. In discussing Brazil, AGCO said demand for farm machinery in that market is challenging, given "political instability, economic weakness and uncertainty on the funding levels of the government-subsidized financing programs in Brazil."