Deere (DE) Beats On Q2 Earnings & Sales, Tweaks 2016 View

Deere & Company’s (NYSE:DE) second-quarter fiscal 2016 (ended Apr 30, 2016) earnings declined around 23% year over year to $1.56 per share owing to a downturn in the global farm economy and weakness in the construction equipment sector. Earnings, however, topped the Zacks Consensus Estimate of $1.46.

Operational Update

Net sales of equipment operations (which comprise Agriculture and Turf, Construction and Forestry) came in at $7.11 billion, down roughly 4% year over year. Revenues comfortably beat the Zacks Consensus Estimate of $6.64 billion. Region-wise, equipment net sales were down 6% in the U.S. and Canada, and 1% in the rest of the world.

Cost of sales in the quarter decreased 2.9% year over year to $5.53 billion. Gross profit in the quarter came in at $1.58 million, down 7.5% year over year. Selling, administrative and general expenses dropped 3.4% to $592.9 million. Operating profit declined around 10.7% year over year to $860.8 million.

Operating income from equipment operations tumbled 17% year over year to $688 million due to the impact of lower shipment volumes, less favorable product mix and unfavorable currency effects, partially offset by lower production costs, reduced selling, administrative and general expenses, and price realization.

Segment Performance

The Agriculture & Turf segment’s sales remained flat year over year at $5.7 billion. Revenues were impacted by the unfavorable effects of foreign currency translation, partially offset by price realization. Operating profit at the segment declined 4% year over year to $614 million as lower shipment volumes, less favorable product mix and unfavorable currency effects were partly offset by price realization, lower selling, administrative and general expenses, and reduced production costs.

Construction & Forestry sales went down 16% year over year to $1.37 billion, impacted by lower shipment volumes and higher sales-incentive costs. Operating profit at the segment declined significantly year over year to $74 million.

Net revenues at Deere’s Financial Services division totaled $651 million in the reported quarter, flat year over year. The segment’s operating profit was $160 million, compared with $265 million in the prior-year quarter. Net income at the segment was $102.6 million compared with $169.8 million in the year-ago quarter. This decline can be attributed to higher losses on residual values, less favorable financing spreads and a higher provision for credit losses.

Financial Update

Deere reported cash and cash equivalents of $4.13 billion at the end of second-quarter fiscal 2016 compared with $4.36 billion at the end of the prior-year quarter. The company reported cash used in operations of $312.4 million for the period of six months ended Apr 30, 2016 compared with cash usage of $154.7 million in the comparable year-ago period. As of second-quarter end, long-term borrowings totaled $24.6 billion, compared with $23.6 billion in the prior-year quarter.

Looking Ahead

Deere revised its outlook for fiscal 2016. The company reduced its fiscal-year forecast for net income to $1.2 billion from $1.3 billion due to ongoing market pressures. It projects total equipment sales to decline 9% year over year in fiscal 2016. Sales are also likely to deteriorate about 12% from the year-ago quarter in the third quarter of fiscal 2016. The projection includes a negative currency-translation effect of about 2% for the full year and 1% for the third quarter.

Segment-wise, Deere expects Agriculture and Turf equipment sales decline of 8% in fiscal 2016, including an unfavorable currency-translation impact of about 2%. Industry sales for agricultural equipment in the U.S. and Canada are expected to be down 15%−20% in fiscal 2016 owing to low commodity prices and stagnant farm income.

In the EU28, sales are projected to be flat to down 5% due to low commodity prices and farm income, including potential pressure on the dairy sector. In South America, industry sales of tractors and combines are expected to decline 15%−20% year over year due to economic uncertainty in Brazil.

Sales in Asia are projected to be flat to down modestly, largely because of the weakness in China. Deere expects sales growth of turf and utility equipment in the U.S. and Canada to range from flat to up 5%, gaining from new products and general economic growth.

The company foresees global sales for Construction & Forestry equipment to be down about 13% in fiscal 2016, including an unfavorable currency-translation effect of about 1%. The decline reflects the impact of soft conditions in the North American energy sector. In forestry, global sales are expected to be down 5%−10% from year-ago levels. The outlook for net income from Financial Services has been slashed to $480 million from $525 million for fiscal 2016. The outlook reflects less-favorable financing spreads, higher losses on lease residual values and an increased provision for credit losses.

Our View

Owing to the increased global demand for food, shelter and infrastructure, we believe that the long-term outlook for Deere remains strong. Global trends based on population growth and rising living standards remain intact, and are largely unaffected by periodic swings in farming economy.

However, declining crop prices, such as those of corn and soybean, will affect farm income. This will restrain farmers from purchasing new agricultural equipment, thereby impacting Deere. Moreover, the sluggish energy sector is a matter of concern.

Zacks Rank

At present, Deere has a Zacks Rank #3 (Hold). Some better-ranked stocks in the same sector are Altra Industrial Motion Corp. (NASDAQ:AIMC) , Alamo Group, Inc. (NYSE:ALG) and Alarm.Com Holdings, Inc. (NASDAQ:ALRM) . All these stocks carry a Zacks Rank #2 (Buy).