Buffett, Gates trim Deere stock as farm sector recovery slow to materialize

Soft red winter wheat is harvested with a John Deere & Co. combine harvester in aerial photograph taken over Kirkland, Illinois.
Daniel Acker | Bloomberg | Getty Images

Some investors may see dashed hopes of a recovery anytime soon for Deere, based on two billionaires — Warren Buffett and Bill Gates — reducing their stock holdings in the farm machinery giant.

The disclosure was made this week in regulatory filings by Buffett's holding conglomerate Berkshire Hathaway and Gates' Cascade Investment, a Washington-based investment vehicle controlled by Gates.

"It probably says they don't have a whole lot of near-term optimism either on the appreciation of Deere stock or the improvements in their end markets," said Kwame Webb, an equity analyst at Morningstar.

Deere's top shareholder

Berkshire's regulatory filing Monday revealed the sale of 1.32 million shares of Deere, or a nearly 6 percent cut in the holding, lowering the stake in the company to about 21.96 million shares. That's a roughly 1.4 percent stake in Deere, worth $1.7 billion based on current prices.

Though Deere is a small part of Gates' fortune, he remains the industrial company's top shareholder with Cascade holding 31.42 million shares, a roughly 10 percent stake valued at $2.43 billion. Cascade reported the sale of 85,000 shares in open market transactions, according to a filing made Wednesday with the U.S. Securities and Exchange Commission.

"We do not make public comments concerning the activities of investors related to their ownership of Deere stock," a Deere spokesman said when emailed for comment.

Moody's negative outlook

At the same time, Deere is facing scrutiny from at least one major credit rating agency. On Monday, Moody's Investors Service cut Deere's ratings outlook to negative from stable, saying the manufacturer's "operating performance could remain under pressure for another year." Moody's affirmed Deere's A2 long-term and Prime-1 short-term ratings.

In the note, Moody's stated that the "the negative outlook reflects the challenges Deere is facing as the result of the broad and lengthy weakness in farm equipment demand, which is contributing to low profits and cash flow, and unusually low margins. The weak equipment demand is unprecedented in its severity and length, but is driven by an unusually strong string of crop harvests, which led to excess grain supplies and pushed down commodity prices."

Deere is scheduled to report its fiscal third-quarter results on Friday before the bell.

Deere lags broad market

The Moline, Illinois-based company's stock has fallen nearly 18 percent in the past year, trailing the broad market and Caterpillar, another major industrial name. For U.S. farmers — Deere's key customer — analysts estimate that cash corn prices in parts of the Corn Belt are below the cost of production.

"A better-than-expected growing season in North America and falling crop prices points to additional declines in farmer profitability, which likely makes the company a bit cautious on the rest of fiscal 2016, and possibly setting up 2017 as another soft year for equipment," said BMO Capital Markets analyst Joel Tiss in a research note Wednesday. "However, with the shares underperforming since mid-2011, investors' expectations appear very low."

Last week, the Association of Equipment Manufacturers reported industry-wide unit sales for ag equipment in North America fell by 26 percent in July for the larger tractor segments (100 horsepower and above) when compared with the year-ago period. Four-wheel-drive tractor unit sales sank by 43 percent from a year ago and represented the worst tally since late 2006, and even combines were down double digits.

Demand-side weakness

"Low commodity prices, stagnant farm incomes and elevated used equipment levels in the U.S. and Canada are continuing to pressure demand for farm equipment," said Joshua Jepsen, a Deere spokesman, during a conference call in May with analysts. "The decline is most pronounced in the sale of high horsepower models."

Due to intense competition between Deere and ag machinery competitors such as AGCO and CNH Industrial, there's been a trend of more aggressive leasing terms on equipment as companies struggle to maintain market share.

Short-term leasing has been a popular option for farmers but the downside for dealers and manufacturers is they have been reducing the glut of used equipment and adding additional product coming off leases can depress prices.

Right-sizing production

"Management did an excellent job preparing the company from 2010 through 2013 for an eventual downturn by optimizing manufacturing facilities, hiring temporary workers for cyclical-peak-production capacity, improving purchasing, and a host of efficiency measures," said Tiss. "That preparation has come in handy by allowing the company to stay profitable during a significant downturn."

Meantime, analysts are forecasting Deere's earnings per share in the July quarter will decline by 38 percent and revenues will fall 11 percent, according to Thomson Reuters.

"If they were to say anything positive about North American ag or South American ag, I think that would be received very, very positively," said Morningstar's Webb.

Despite a poor corn crop, Brazil's ag market has been showing some promising signs and is one of the bright spots in the economy. Significant investment from the government is helping the farm sector grow and contributing to customer order activity for ag machinery such as tractors and combines.