U.S. tractor maker Deere & Co. is set for upside as rising grain prices spur a cycle of equipment replacement across the globe, according to UBS.
Analyst Steven Fisher, who upgraded the stock to buy from neutral, also told clients that a potential dividend increase and a strong earnings performance this summer could prove lucrative for shareholders.
"We think the slow recovery in Deere's large agricultural business could accelerate in fiscal year 2019 with higher grain prices, which have a favorable set-up entering the growing season," Fisher said in a note Thursday. "We think higher grain prices would stimulate a recovery in North American high-horsepower tractors, which have been declining for five years."
In addition to the burgeoning demand for tractor equipment, UBS believes Deere will raise its dividend 21 percent in fiscal 2018 to a 30 percent payout ratio.
Assuming the company continues to return 50 percent to 60 percent of its operating cash to shareholders, Fisher said, Deere will have $1.25 billion in cash flow left over to buy back shares.
The equipment maker upgraded its sales outlook earlier in the year, citing stronger conditions in its agricultural and construction markets. For the past four years, Deere has been struggling against weaker demand for farm equipment as global oversupplies kept a lid on prices.
"Given the recovery ongoing in 2018 and management's expectation that operating cash flow will grow 56 percent year over year, we think it is very likely that Deere could raise its dividend and continue to buy back shares," Fisher said.
The expectation of shareholder-friendly activity prompted Fisher to increase his 12-month price target on Deere's stock to $185 from $175, implying 18 percent upside over the next year.
Shares of the Moline, Illinois-based company are largely unchanged since January, though they're up more than 13 percent in the past month and are 2 percent higher in early trading Thursday.