Published February 19th, 2017 by Bob Ciura
This is not an easy time for Deere & Company (DE). The company operates in a cyclical industry, which is currently stuck in a downturn.
As a result, Deere has not increased its dividend since 2014.
Prior to its dividend freeze, Deere had maintained a high dividend growth rate. From June 2009-June 2014, the company more than doubled its dividend.
Deere is a Dividend Achiever, a group of 272 stocks with 10+ years of consecutive dividend increases.
You can see the full Dividend Achievers List here.
Note: Deere & Company does not technically meet the criteria of the Dividend Achievers Index, and yet, it is still in the index. The reason why is unclear.
On paper, there looks to be little preventing Deere from raising its dividend. The company has an industry-leading brand, a highly profitable business model, and a low dividend payout ratio.
But the company’s momentum coming out of the Great Recession has hit a major slowdown.
As a result, while there is a decent chance Deere could raise its dividend in 2017, investors should not expect one.
Business Overview
Deere manufactures farming equipment, including tractors, combines, and more.
Its core equipment business is split into two operating segments:
- Agriculture & Turf (79% of equipment sales)
- Construction & Forestry (21% of equipment sales)
Source: December Investor Presentation, page 6
The economic conditions of the global agriculture industry are positive over the long-term, but are not expected to improve this year.
The agriculture industry boomed coming out of the Great Recession. But since 2012, the environment has experienced a sharp correction.
Falling agricultural commodity prices have depressed farm incomes.
Source: Q1 2017 Earnings Presentation, page 34
Prices of a number of agricultural commodities, including cotton, soybeans, wheat, and corn, remain far below the peak levels seen in 2012-2014.
In turn, this has resulted in reduced demand for Deere’s farm equipment.
This has resulted in a major decline in equipment sales and net income for Deere.
Source: December Investor Presentation, page 8
2016 was a rough year for Deere. Net sales dropped 8%, to $26.64 billion. Earnings-per-share declined 17%.
Performance was especially poor in the U.S. and Canada, where sales fell 13% in 2016. Sales fell a more modest 3% outside the U.S. and Canada.
Unfortunately, conditions are not expected to improve in 2017. Deere’s earnings-per-share declined 24% in the fiscal first quarter of 2017.
Growth Prospects
The near-term growth prospects for Deere are poor, driven by continued weakness in agriculture economics.
The company forecasts a 5% decline in the European agriculture industry in 2017. The U.S. agriculture industry is in even worse shape—it is expected to decline at a 5%-10% rate in 2017.
This will hit Deere’s core agriculture and turn business especially hard. U.S. farm receipts in 2017 are expected to be below the levels seen in 2012-2015.
Source: Market Fundamentals Presentation, page 8
The good news is that the long-term growth prospects for Deere remain highly promising. The most important growth catalyst is global population growth, and the ensuing growth in demand for food.
By 2050, Deere projects the global population will reach 9.7 billion, up from 7.3 billion today.
Population growth is driven by the emerging markets in Asia, such as China and India. These countries both have populations of 1 billion, expanding middle classes, and rising standards of living.
This will have two significant impacts on Deere over the long run. First, agriculture output will need to double from present levels, in order to feed the world’s growing population.
Since there is only so much land available for farming, adding nearly 2.5 billion people to the global population will place a great strain on the world’s resources.
Consequently, improving crop yields will be a focal point for farmers around the world, and Deere’s equipment will cater to this demand.
Second, urbanization will be a driving force for Deere over the next several decades. By 2050, 70% of the world’s population will live in urban areas, up from 50% today.
The migration from rural to urban areas will require significant infrastructure investment.
Dividend Analysis
Deere currently pays an annualized dividend of $2.40 per share. Based on 2016 earnings-per-share of $4.81, this works out to a 50% payout ratio.
At first glance, a 50% payout ratio should provide enough room for Deere to increase its dividend. But the company has a relatively unique dividend policy.
Deere bases its dividend decisions on operating cash flow. Because of the pressures facing the global agriculture industry, operating cash flow is projected to decline in 2017, to $2.6 billion.
Source: Q1 2017 Earnings Presentation, page 22
Operating cash flow exceeded $4 billion in 2013 and 2014, but has steadily declined each year since.
Within its financial framework, raising the dividends ranks as Deere’s third priority, behind maintaining an ‘A’ credit rating, and sufficiently funding its operating and growth needs.
Source: Q1 2017 Earnings Presentation, page 26
As a result, the company is not as committed to raising its dividend each year, as are some other companies.
To be sure, Deere is also preserving cash in other ways. The company’s fourth financial priority is to repurchase share opportunistically. However, due to the present circumstances, the company significantly curtailed share buybacks in 2016.
Source: Q1 2017 Earnings Presentation, page 29
Since Deere operates in a highly cyclical industry, the company prefers to retain cash flow when times are tough, to maintain a strong balance sheet and product innovation.
For example, Deere has continued to increase research and development expense over the past few years.
Source: December Investor Presentation, page 32
Deere routinely spends more on R&D than its competitors. It does this to position itself well to capitalize once the environment turns around.
Management targets a 25%-30% dividend payout ratio at the middle of the agriculture economic cycle. Since its dividend payout ratio is currently 50%, the company’s earnings-per-share will need to rise significantly in order for the payout ratio to fall back into the target range.
Final Thoughts
Deere has a 2.2% current dividend yield. This is still a competitive payout, as the S&P 500 Index yields 2% on average.
Over the full economic cycle, Deere investors can count on the company to raise its dividend. However, during industry downturns, investors should expect the company to hold off on dividend increases.
Deere has a very promising long-term growth outlook, thanks to a rising global population and urbanization trends.
However, an imminent earnings recovery seems unlikely—which makes a 2017 dividend increase fairly doubtful.
Investors looking for a stock in the industrial sector with better dividend growth prospects, should look elsewhere.
