We See No Letup in Ag Demand in the Near Term, Which Will Benefit Deere

Equity Analyst

Dawit Woldemariam

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Deere offers customers an extensive portfolio of agriculture and construction products. We think it will continue to be the leader in the agriculture industry and one of the top players in construction. For over a century, the company has been the pre-eminent manufacturer of mission-critical agricultural equipment, which has led to its place as one of the world’s most valuable brands. Deere’s strong brand is underpinned by its high-quality, extremely durable, and efficient products. Customers in developed markets also value Deere’s ability to reduce the total cost of ownership. 

The company’s strategy focuses on delivering a comprehensive solution for farmers. Deere’s innovative products target each phase of the production process, which includes field preparation, planting and seeding, applying chemicals, and harvesting. The company also embeds technology in its products, from guidance systems to seed placement and customized spraying applications. Over the past decade, the company has continually released new products and upgraded existing product models to drive greater machine efficiency. Customers also rely on the services that Deere and its dealers provide, for example, machine maintenance and access to its proprietary aftermarket parts. Furthermore, its digital applications help customers interact with dealers, manage their fleet, and track machine performance to determine when maintenance is needed. 

Deere has exposure to end markets with attractive tailwinds. In agriculture, we think demand for corn and soybeans will be strong in the near term, largely due to robust demand from China and tight global supplies. On the construction side, we believe the company will benefit from the $1.2 trillion infrastructure deal in the U.S. The country’s roads are in poor condition, which has led to pent-up road construction demand. Looking further out, we believe precision ag will be an incremental value driver for Deere. The company recently closed the precision ag loop (in terms of capabilities) with the introduction of its autonomous 8R tractor. We estimate precision ag presents an over-$7 billion sales opportunity for the ag leader this decade.

Business Strategy & Outlook

We assign Deere a wide economic moat rating, underpinned by intangible assets and switching costs. Deere has built one of the world’s most recognizable brands, which has led to strong brand loyalty among farmers. The company has consistently provided customers with reliable, high-quality products, while working to reduce the total cost of ownership. These factors have led to Deere becoming one of the world’s most valuable brands. The strength of its brand and extensive dealer network has solidified Deere as the market leader for agricultural equipment. Deere delivers world-class products, in addition to value-added services to customers through its global dealer network. We believe smaller local and regional competitors will struggle to win market share in agriculture and construction end markets globally, allowing Deere to maintain its strong market share positions.

Deere’s intense brand loyalty among farmers and strong competitive positioning leads to pricing power. For decades, the company has consistently produced best-in-class agricultural equipment, leading to the largest installed base in the industry. Deere has been at the forefront of innovation in farming, mechanizing crop production, allowing farmers to do more with less. Today, the company’s equipment can help farmers save on operation costs (use less fuel, chemicals, and labor), while also increasing crop yields (without having to materially increase farm acreage). Farmers value premium products (high specifications and features) that can withstand high utilization and operate outside of daylight hours. We believe Deere benefits from pricing power, manifested from its brand familiarity of more than a century and ability to continually provide innovative products. Notably, the company’s large agricultural equipment command premium pricing due to the value added from its product features and technological capabilities (boosts farmer productivity). Customers come to Deere not only for the best products in the industry, but also for its ability to provide aftermarket parts on-demand and services to keep their machines running, reducing machine down-time.

Additionally, the company has been committed to improving machine efficiency. Deere’s precision agriculture solutions aid farmers in field preparation, planting, chemical spraying, and harvesting. Tillage equipment used in field preparation can utilize guidance systems to reduce overlap in each machine pass, collect data on field conditions (satellite mapping), and be flexible enough to adjust depth and down pressure maneuvers. In planting, Deere’s machines can precisely place and space seeds in the field, all while moving up to 10 miles per hour faster than previous models (without losing accuracy). Farmers can also apply chemicals (herbicides, pesticides, and fungicides) to weeds through customized spray solutions (machines can control individual nozzles to dispense a spray). When plants are ready to be picked, Deere’s products can harvest more capacity, without reducing crop quality or losing crops, in addition to saving on fuel costs. We believe Deere’s superior product performance supports the firm’s brand equity and pricing power.

Deere’s products help farmers save on farming input costs, limit machine maintenance and repair costs, ultimately leading to a lower total cost of ownership. We believe this dynamic exists for a few reasons. First, the company’s focus on improving machine efficiency through product innovation has boosted productivity for farmers through the reduction in input costs (less chemicals, fuel, and labor needed to produce crops compared with years past). Deere’s precision solutions allow farmers to become more informed on what’s driving higher crop yield, from optimal seed placement to targeted chemical spraying. Second, the company’s higher-margin aftermarket business provides farmers priority on proprietary parts and services through its extensive dealer network, limiting service intervals and machine down-time. Additionally, machine connectivity helps both customers and dealers track data (machine utilization rates and productivity) to inform future service needs, allowing farmers to plan maintenance versus having to service machinery when they fail (can be disruptive in farming given finite windows to carry out farming operations).

The total cost of ownership is a focus for customers in developed markets, who look for machines that help minimize on future costs (labor, maintenance and repair, spare parts, fuel, and insurance costs) and are not necessarily looking for the cheapest up-front equipment (primarily a focus for customers in developing markets). Cheaper equipment can increase the likelihood of machine failure during operation, leading to lost productivity that cuts into an operator’s profitability (mission-critical equipment). Fuel consumption costs are another lever that operators can focus on to drive down total ownership costs. Deere offers a wide range of products that enhance fuel efficiency, specifically through its electric drivetrain offerings. These products also help the company address carbon emissions concerns; which is increasingly becoming a point of focus for regulators. We think Deere’s risk to increased emissions regulation is moderate given its continued focus on producing next-generation products that reduce machine emissions.

We believe Deere is a leader in the agriculture industry when it comes to helping customers reduce the total cost of ownership. Its products employ better efficiency and output for farmers compared with competitors, allowing them to spread costs over the lifetime of equipment (operating leverage as crop yields increase). We believe this dynamic supports its brand value in the eyes of customers looking to optimize their operations.

We also think Deere’s construction business is strong, thanks to its Wirtgen acquisition in 2017. Prior to the acquisition, the company’s product portfolio was focused on earthmoving equipment, such as, bulldozers, graders, wheel loaders, and excavators. That quickly changed as Wirtgen expanded the product portfolio to include both road construction (milling, paving, and compacting) and mineral equipment (surface miners, crushers, and asphalt plants). Today, the move has taken Deere’s construction business from being a top 10 global player to a top three player behind Caterpillar and Komatsu. Customers value Wirtgen’s premium brands given its ability to consistently deliver strong product performance. We believe this has led to the construction business developing pricing power. The segment’s profitability has improved since the acquisition, showing the near term looks bright. Additionally, we think Wirtgen’s strong position in the road construction business globally gives Deere access to new customers in emerging markets.

Deere’s extensive dealer network distributes products and provides access to proprietary aftermarket parts and services across multiple geographies. The breadth of Deere’s dealer network is unmatched, with over 2,000 dealer locations in North America and approximately 3,700 globally (has a significant presence on every continent). These dealers are often very large organizations that exclusively sell Deere products. We think it’s very difficult for existing competitors and new entrants to replicate the size and coverage of Deere’s dealers. Fully stocking a branch is challenging without similar product breadth to Deere, hence, why many competitors’ products are sold at dealerships that carry multiple product lines. Deere’s value proposition not only consists of its high-quality products, but it also includes the reliable product support provided by dealers. When customers need parts or machine servicing, they can rely on the dealer network to reduce their machine down-time.

Deere’s mission-critical equipment and increased focus on its installed base through aftermarket and service offerings keep customers from switching. The company’s machines perform mission-critical functions for farmers, who work during a finite window during the year. For customers, switching to an alternative product poses significant risk to their operations, with the potential for disruptions from machine failures and long lead times to service equipment. The high cost of failure associated with switching away from Deere’s products increases the likelihood of missing valuable time to plant and harvest crops, ultimately cutting into a farmer’s profitability. Deere’s service agreements give customers priority on proprietary aftermarket parts and services from dealers, making it easy to understand what the total cost of a machine will be throughout its operating life.

Furthermore, customers invest a significant amount of time and money into machinery, creating additional friction to switch products. The purchase price of heavy machinery can run up into the hundreds of thousands (and can get into the low-million-dollar range for combines), in addition to the time it takes machine operators to fully train on a machine to reach optimal productivity. The company’s parts distribution and extensive dealer network provide customers with aftermarket parts and reliable services to ensure their equipment operate efficiently, saving them from the headache of machine down-time and from having to search for parts independently (parts are not easy to replace). Customers also find value in Deere’s strong secondary market, where sellers of used equipment benefit from high resale values, helping reduce the total cost of ownership.

We do not think Deere’s wide economic moat faces any substantial threats from environmental, social, and governance risks. Deere has exposure to product safety issues, carbon emissions and environmental regulation, but we do not view them as material enough to include in our valuation. Product safety issues include both customer injuries while operating Deere machinery and injuries suffered by Deere employees in the production of products. Carbon emissions regulation is increasingly a topic of discussion, but we think Deere is already hedging against this risk through the development of next-generation products that reduce the carbon emissions of its products, namely its electric drivetrains.

Additionally, we think the effect from climate change and regulation by government authorities will likely be incremental rather than immediate. Both the agriculture industry and academic institutions are studying how the effect of changing weather patterns will impact farmer growing operations. For example, academic institutions are focusing on the effects of growing crops in warmer climates. Technology is being used as a critical input to understand what factors drive successful crop generation under this scenario. Deere is also exposed to environmental regulation, largely stemming from the environmental impact that agricultural machines have on soil and water quality. We believe Deere faces little risk on this front, as the company continues to invest in next-generation products that will aim to reduce emissions.

Another important topic in the agriculture space is the focus on gasoline blending mandates for internal combustion engine vehicles by government authorities around the world (corn is a major input to the ethanol used in gasoline blending). We think biofuel targets will lead to modest ethanol gasoline adoption, acting as a support to corn demand. However, this positive factor could be offset over the next two decades, as governments start to push for electric vehicle adoption, moving away from ICE vehicles.

Wide

Economic Moat

Deere & Company

Deere & Co. engages in the manufacture and distribution of equipment used in agriculture, construction, forestry, and turf care. It operates through the following segments: Agriculture and Turf, Construction and Forestry, and Financial Services. The Agriculture and Turf segment focuses on the distribution and manufacture of a full line of agriculture and turf equipment and related service parts. The Construction and Forestry segment offers machines and service parts used in construction, earthmoving, road building, material handling and timber harvesting. The Financial Services segment finances sales and leases by John Deere dealers of new and used agriculture and turf equipment and construction and forestry equipment. The company was founded by John Deere in 1837 and is headquartered in Moline, IL.

Earnings data Q4 2023

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