Deere & Co. (DE): The best-kept secret in AI & Autonomy

This 180-year-old company has a new trick up its sleeve.

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Deere & Co. (DE)

Highlights

• Deere has quietly become a data, AI, and autonomous driving powerhouse.

• Deere is entangled in a class-action lawsuit regarding right-to-repair.

• Dividend growth was put on hold for a while but looks to be back with a vengeance.

Thesis

Deere & Co. (DE), a manufacturer of heavy earthmoving and agricultural machinery, has benefited from diversified revenue streams and technological advancements and has shown its commitment to shareholders through dividends and buybacks. DE is poised to be the main player in the AgTech space and provides the machinery and data necessary for cultivating land and gathering crops.

Recent News

• On July 7, 2022, the United States Consumer Product Safety Commission issued a recall alert on John Deere X380 & X390 lawn tractors. The wheel hubs were not manufactured to specifications and can fail, causing the tractor to lose braking and propulsion, posing crash and injury hazards.

• John Deere has suspended all shipments to Russia.

• Deere reported a second-quarter net income of $2.098 billion.

• The John Deere Foundation announced a $1 million donation to World Food Program USA to combat global food insecurity and address the staggering rise of acute hunger exacerbated by the crisis in Ukraine.

• Deere & Co. has formed a joint venture with GUSS Automation, LLC, in Kingsburg, California. GUSS (Global Unmanned Spray System) is a pioneer in semi-autonomous orchard and vineyard sprayers.

Positives

Deere & Co. has many positives to their business, and the first of which I'll talk about is their diversified revenue streams. DE operates in 3 major segments: Production & Precision Ag, Small Ag & Turf, and Construction & Forestry. These 3 segments account for 89% of revenues, and the other 11% come from Financing of Machinery and Other.

Production & Precision Ag is comprised of machines that serve in the production of corn, soy, grains, sugar cane & cotton. It's worth noting that the price of these commodities has skyrocketed in 2022, potentially incentivizing farmers to produce more and purchase more machinery to do so.

Small Ag & Turf is comprised of machines that serve in the production of dairy, livestock, and high-value crops such as fruits. Turf/Compact machinery is also looped into this category and contains products such as tractors.

Construction & Forestry is where the heavy machinery lives. Machines like excavators, logging machines, and bulldozers are sold to fulfill earthmoving, roadbuilding, and forestry industry needs. These machines are incredibly expensive, but it offers DE another revenue stream opportunity through financing.

The next positive I'd like to talk about is DE's technological advancements. Deere & Co. has become a quiet leader in autonomous driving and has been able to do so due to the nature of the farmland. There are no pedestrians, crosswalks, or other cars to deal with and tractors just go in straight lines for the majority of the time. Deere even has satellite technology that feeds info to autonomous tractors to adjust them in real-time. Really cutting-edge stuff!

Deere has also made incredible strides in data collection, and this is what gives them such a moat in my opinion. They're amassing climate data from farms around the world and using it to make predictions and forecasts about microclimates. This information tells farmers the optimal time to plant and how historical climate events have affected crops.

Deere is also aggregating data from over 250 sources about precise seed, nutrient, and pesticide placement. Farmers can see anonymous (anonymous to protect competition) data to see how/when to plant particular crops, optimal seed depth, and how to use pesticides most efficiently. Data like this can save inches in each row, in turn squeezing much more production from each acre of farmland. A growing population needs a sustainable food strategy behind it and Deere's data will help us do just that.

The last positive I’d like to talk about is their cash returned to shareholders. Since 2004, Deere & Co. has returned about 55% of cash from operations to shareholders by way of dividends and stock buybacks. I’ll talk more about the dividends later but as far as stock repurchases, Deere & Co. has executed them spectacularly. In 2021 alone, Deere & Co. repurchased 6.22 million shares, decreasing its shares outstanding to 308,200,000 as of January 1st, 2022. While I prefer companies to reward shareholders through dividends, I do appreciate buybacks if done wisely. Buybacks make existing shareholders own more of the company, thus making your shares more valuable.

Negatives

I do see a few negatives on the horizon for DE, but they are mainly short-term concerns in my opinion. The first concern I have is higher interest rates. Higher interest rates make borrowing money for big equipment harder and more expensive. DE already has a high debt-to-equity ratio of 2.67 and is in a business where a lot of its products are very costly to make. A rising rates environment is especially not conducive to Deere and will only make the cost of doing business higher the longer rates keep rising.

Rates aren't the only thing that's been rising. The price of steel, a critical component in the vast majority of DE's products, has already flirted with previous all-time highs in 2022. 2 of the top 5 steel producers are China and Russia, very unfavorable due to their respective lockdowns and current wars. Rising steel prices will eat into profits and pose unfavorable margins for the company, either forcing Deere to just suck it up or pass on the inflationary costs to its customers on their already-high prices.

The last negative I see is the ongoing class action lawsuit that's been presented to Deere about the right to repair. This is not a short-term headwind and is a cause for concern as a potential DE shareholder. Deere is being sued for violating the Sherman Anti-Trust Act, and disgruntled farmers have a bone to pick with them. Older tractors with minor issues were able to oftentimes be fixed by farmers while right on the farm. With today's tractors being built more high-tech, proprietary software is needed to diagnose and repair problems with equipment, no matter how minor the problem is. Deere is accused of monopolizing repairs because only their dealerships have the software necessary to fix problems. One farmer detailed how it costs him $1,000 each way to load his tractor on a trailer and transport it to and from a dealer, and that's not including the cost to fix the problem. Deere is facing a farmer revolt and a potential lawsuit payout that could affect the company's bottom line.

The Dividend Breakdown

For those that don’t know, I mainly use 3 metrics to assess the quality of a company’s dividend. The first is the Dividend Growth Rate, which I use to assess the company’s ability to raise dividends and combat inflation. When assessing the Dividend Growth Rate, I look at the 10 Year Compound Annual Growth Rate (CAGR) because it’s usually the longest-term data readily available and more indicative of long-term company trends. The second metric I use is the Dividend Payout Ratio, which tells me how much of the company’s profits are going to shareholders. The Dividend Payout Ratio also shows me how much room a company has to grow its dividend before it becomes unstable. The last dividend metric I use is Dividend Yield. Dividend Yield tells me how much “bang for my buck” I get as a shareholder. Yield isn’t everything, but it’s nice to see how much money I’ll get back as an investor in the next quarter.

With that being said, I’ve developed a scoring method for rating a company’s dividends. It consists of the previously mentioned metrics scored out of 5 and each score is multiplied and weighted by importance. The highest possible score a company can receive is a 31, and members of the Dividend Aristocrats club will receive an extra point for their long-standing history of reliable dividend raises. Each metric has its own criteria which I’ll share below:

• Dividend Growth Ratio is the most important metric for me, so scores will be multiplied by x3

• Dividend Growth Ratio of 0%-5% is a 1, 5%-7% is a 2, 7%-9% is a 3, 9%-12% is a 4 and a rate of more than 12% is a 5

• Dividend Payout Ratio is the second most important metric, so scores will be multiplied by x2

• Dividend Payout Ratio of 95% or more is a 1, 75%-95% is a 2, 55%-75% is a 3, 35%-55% is a 4 and a rate of less than 35% is a 5

• Dividend Yield is the least important metric of the 3, so scores will be multiplied x1

• Dividend Yield of 0%-1.5% is a 1, 1.5%-2.5% is a 2, 2.5%-3.5% is a 3, 3.5%-4.5% is a 4 and a rate of more than 4.5% is a 5

DE scores are shown below:

DE's 10-year Dividend Growth Rate (CAGR) is 9.42%, beating the Industrials sector median of 7.65%. Their Dividend Payout Ratio is 21%, well within the margin of safety with room to comfortably grow their dividend over time. Their dividend yield is 1.52%, right around its 4-year average yield of 1.47%. Compared to the median yield of 1.66% in the Industrials sector, DE’s 4-year yield is a little low. Lastly, DE has been paying a dividend for 9 years but has only raised it consecutively for the last 2 years. This is definitely a cause for concern because I do not want to park my money in a company that doesn’t consistently raise its dividend. The dividend needs to outpace inflation otherwise I’m losing income. Overall, Deere & Co. scored 24/31 points, proving that the company has a decent dividend, but I am concerned with its shaky history of inconsistent dividend raises. It is worth mentioning that DE raised its dividend by 38% in 2021, and I'm optimistic that this will be the start of a good track record of healthy increases.

Final Thoughts

After weighing the positives and negatives, I’ve decided that I would like to initiate a small position in DE, and increase it after the litigation is settled. They currently trade at a P/E of 15.53x which is right around the market average of 16.43x. Deere is also trading under its 5-year average P/E of 21x.

My biggest concern with Deere is the class-action lawsuit. I don't know if they'll be required to pay damages, and I don't know how much those damages will be. We're moving into a period of tighter monetary policy and it's critical to make every dollar count. The cost of borrowing capital is rising and Deere exists in an industry that is very capital and debt intensive.

I do love that Deere is an under-the-radar tech company. The data they've amassed is astonishing, cutting-edge, and crucial to the development of our farmland for years to come. We all need to eat!

The last thing I'll mention about Deere is that it gives you indirect exposure to investing in farmland. Farmland is a highly sought-after asset class that's pretty unattainable to non-accredited investors like me. You get exposure to farmland, as well as tech, data & heavy machinery when you buy DE stock. I'm looking to initiate a starter position soon.

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