What Will It Take for Deere to Recover?

Now that the dust has settled on Deere & Company's earnings, it's time to take a closer look at the ongoing trends in its business. The stock has, superficially at least, some very attractive qualities.

The food industry is relatively noncyclically aligned and offers investors the potential to generate positive returns irrespective of where the economy is headed. Meanwhile, Deere investors will be hoping that 2015 sees a trough in its earnings. With that said, the company's third-quarter earnings and guidance were disappointing, and there is no sign that Deere's difficult end markets are picking up just yet.

So where does this leave the case for buying stock in Deere?

Deere is struggling with large machinery sales. Source: Deere & Co.

Deere takes it backLast time around, Deere's management cheered investors by raising its full-year net income forecast to $1.9 billion from $1.8 billion. However, as I wrote at the time, the increase was largely due to increased cost-cutting. In fact, full-year sales expectations were decreased on a reported and constant-currency basis.

Fast-forward to the third quarter, and Deere promptly cut its full-year net income forecast back to $1.8 billion and reduced full-year sales expectations for a decline of 21% compared to a previous estimate of a fall of 19%.

Moreover, excluding currency movements, management now expects sales to decline by 17% rather than a previous estimate of 15%. A quick look at how guidance has shifted throughout the year demonstrates a lot about Deere's trends. As you can see in the table below, guidance for sales growth (excluding currency effects) was reduced in both equipment divisions in the third quarter.

Data source: Company presentations. All sales growth figures are currency adjusted.

Cash flow, pricing, used equipmentEssentially, lower commodity crop prices and reduced farmers' income are continuing to pressure demand for Deere's large agricultural equipment. Moreover, economic weakness in growth markets like Brazil and China is weakening Deere's growth prospects. For example, the company now sees South America agriculture and turf retail sales down 20%-25% from a previous forecast of a reduction of 15%-20%.

However, the real surprise was in the downward shift in expectations for construction and forestry equipment. Despite citing some positive construction indicators -- such as an increase in forecast total construction investment growth to 2.3% from 0.3% previously -- Deere's management disclosed on the earnings call that it was "seeing weakening in our order books"and Manager of Investor Communications Susan Karlix went on to cite a number of responsible factors, including the slowdown in the energy sector, wet weather, and "sluggish economic growth outside of the United States."

All of which is taking its toll on other key metrics for the company. For example, Deere reduced its expectations for cash flow from operations to $3.2 billion from $3.4 billion previously. In addition, Deere is seeing some increased pricing pressure from competitors that Director of Investor Relations Tony Huegel described as being "very aggressive on pricing right now."

In fact, the company now expects price realization for the full year to be 1% from a previous estimate of 2%. Huegel spoke on the matter and outlined that there was a "fair amount of rounding to get to that whole number" and that there hadn't been "a substantial change in the pricing environment since last quarter."

Nevertheless, it's still a reduction in pricing expectations, and despite Deere's inventory situation being better than its rivals, if they are likely to aggressively reduce inventory by cutting prices, then Deere will surely suffer, too.

The takeawayAll told, current market conditions are weak for Deere, and it is suffering some of the fallout from weakening economic growth in emerging markets as well as ongoing weakness in crop prices and farmers' income. Furthermore, pricing pressures could get stronger in future quarters as competitors try to reduce their inventory levels.

All of which doesn't make happy reading for Deere investors. In truth, the bullish investment case for the stock really lies in the idea that crop prices could trough in 2015, leading to increased cash receipts for farmers in future years -- usually good news for Deere's agricultural machinery sales. Deere needs higher crop prices, because the economy isn't helping much and the case for the stock rests on the assumption that prices for crops like corn, wheat, soybean, and cotton will move higher in the coming years.

The article What Will It Take for Deere to Recover? originally appeared on Fool.com.

Lee Samaha has no position in any stocks mentioned, and neither does The Motley Fool. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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