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The success of Deere is now on hold until the U.S. and China resolve their trade dispute and relieve the swelling soybean inventory, according to Bank of America Merrill Lynch.
The brokerage on Wednesday downgraded the tractor supplier to a neutral rating from a buy rating, two days before the company's first-quarter profit and sales report. Analyst Ross Gilardi wrote in a note to clients that the decision to cut Deere's rating was based on the lack of apparent progress between Washington and Beijing and weaker demand for construction equipment.
Those two factors make it unlikely Deere will raise its fiscal 2019 outlook and maintain its current premium to rival machinery maker Caterpillar, Gilardi told clients. The analyst also lowered his 12-month price target on Deere stock to $170 and trimmed his fiscal year 2019 earnings per share estimate to $11.25.
"Judging by Deere's dramatic outperformance, investors seem complacent that China will lift their retaliatory soybean tariffs on the U.S.," Gilardi wrote. "If the tariffs aren't lifted, and China continues to shun U.S. soybean imports, U.S. farmers will face rising uncertainty into spring planting as U.S. soybean inventories are already soaring. In our view, this is a real risk to farm equipment demand in the second half of 2019."
Deere stock fell 1.5 percent Wednesday following the downgrade.
As one of the world's largest manufacturers of farming machinery, Deere could take a hit if U.S.-China trade negotiations don't improve. Soybean shipments offloaded in China in the first two weeks of 2019 were down about 37 percent from the first two weeks of 2018, according to tanker-tracking firm ClipperData. Soybeans account for 40 percent of area harvested for the U.S. farmer, according to Bank of America.
China, the world's latest soybean consumer, has pivoted to Brazil and other exporters for its supplies since slapping tariffs on U.S.-based soybeans.
Beijing imposed levies of 5 to 10 percent on $60 billion worth of U.S. products effective Sept. 24 in response to the Trump administration's tariffs of 10 percent on $200 billion of Chinese goods. If the two economic powerhouses fail to reach an agreement by March 2, those U.S. levies could increase to 25 percent.
"It's remarkable to us that Caterpillar is viewed by many as the poster child of the U.S.-China trade war, while Deere is viewed by many to be far less vulnerable," Gilardi added. "In reality, Deere is as embroiled to the U.S.-China trade war as any company we follow due to China's retaliatory tariffs on U.S. soybeans."
Soybean stocks to use have jumped to 22.2 percent, "materially above" long-term averages, the analyst wrote. The historic oversupply hasn't had too much of a negative impact on equipment demand as U.S. farmers have been able to monetize a significant portion of last year's crop at a decent price and have been compensated by the federal government.
However, if the trade dispute isn't resolved by the onset of the planting season, farmers could shift growing to corn en masse, creating another commodity glut.
The "soybean tariffs need to disappear," Gilardi wrote.