Why We're Not Overly Concerned About Tariffs and Deere
Core demand remains strong, and tariffs are a short-term headwind that will eventually wane.
Deere (DE) grew equipment sales a strong 36% from the prior-year period, including acquisitions, and reached record fiscal third-quarter earnings per share of $2.78. Excluding U.S. tax reform effects, EPS was $2.59, a miss versus the consensus $2.75 estimate. Parsing out the equipment top-line expansion, Deere doubled sales in construction and forestry (including Wirtgen results) and increased agriculture and turf by 18% year over year. Clearly core demand is strong, but the market has not failed to notice. We maintain our wide-moat rating and our fair value estimate.
Deere is enjoying persistently strong demand in both ag and construction in most geographies, and reaping the operating leverage this affords, however, we think investors remain overly concerned about tariff effects. Amid these concerns, Deere expects U.S. farm cash receipts to be greater in fiscal 2019 than in 2018, and the crop value of production to be up in the EU, but flat in Brazil--pretty healthy. We consider tariffs to be a short-term headwind that will eventually wane, and that Deere will offset most of the impact via pricing by 2019. These have been common themes among industrials affected by tariff changes: Little impact thus far, and expectations that supply agreements and pricing power are likely to preserve margins pretty well.
Still, steel cost increases (around 50% so far) plus elevated U.S. trucking rates compressed margin guidance from 13.5% to 12.5%. Steel constitutes 10%-15% of material costs or about 5%-7.5% of net sales. Also, less than 5% of the materials spend is on inputs from China, so tariffs on these components likely impact on total materials costs little. More material is the impact on soybeans, but we think Chinese tariffs on U.S. beans will shift its imports to Brazil and U.S. beans will in part backfill the rest of the world demand that shifts to meet China’s needs. We expect relaxed trade rhetoric, and certainly resolution of grade agreements would buoy shares.
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Keith Schoonmaker does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.