Regan Takes
Intermediate Finance
Dr. Eller
26 November 2014
Deere & Co. Analysis
“I will never put my name on a product that doesn’t have in it the best that is in me” (John Deere
History). These words come from John Deere, a man who clearly understood the values and hard work
required to be successful in the business world. Integrity, quality, commitment, and innovation are the
core values of Deere & Co., which have guided the company over its 175 year history (John Deere
History). Agricultural machinery is a fast changing industry, which requires continuous innovation and
strong leadership. Through the years John Deere has proven its ability to endure significant challenges,
which is why Deere & Co. has grown into one of the most successful companies in the world.
Throughout this analysis, the financial aspect of John Deere will be discussed, along with their corporate
strategies and organizational structures. As a very large, well-established company, John Deere’s
potential for significant growth no longer remains; however, this analysis will show that John Deere is
still a strong investment option for those in need of steady, consistent returns.
Company Structure
Although Deere & Co. is widely recognized for its agricultural products, several other segments help
make up the structure of the company. In addition to the company’s Agriculture and Turf segment, which
manufactures equipment such as tractors, loaders, combines, sprayers, lawn equipment, and utility
vehicles, the company also has a Construction and Forestry segment, which provides backhoe loaders,
excavators, skid-loaders, and other related equipment (2013 Annual Report). A Financial Services
segment also exists within the company, which finances sales, leases equipment, and extends equipment
warranties to customers (2013 Annual Report). Each of these segments play a significant role in the
performance of the company, and can be analyzed independently when examining financial reports. As an
international corporation, Deere & Co. has factories, offices, and other facilities in over thirty countries
world-wide, employing over 67,000 employees (John Deere Careers).
Corporate Strategy
Maximizing shareholder wealth is one of the primary objectives of John Deere, and this idea serves as the
foundation for the corporate strategy. According to the 2013 Annual Report, John Deere hopes to achieve
shareholder value added growth through global expansion. The strategy also identifies four critical
success factors, which promote customer understanding, customer value, world-class distribution, and
extraordinary global talent. Performance target aspirations are also included in the strategy. These include
sales targets, profitability targets, and asset efficiency targets. Deere & Co. hopes to earn net sales of $50
billion in the next four years, while steadily improving operating margins along the way (2013 Annual
Report). John Deere sees strong growth opportunities based on the long-term macroeconomic outlook.
According to John Deere’s 2013 Annual Report, expected population growth means agricultural output
will need to double by 2050, which means more efficient equipment will be in high demand (2013
Annual Report). Clearly, John Deere’s strategic team has developed a very specific strategy based on
opportunities and threats that may be facing the company. Throughout this paper I will analyze the
financial statements of John Deere, and determine whether they agree with the strategy in place.
5 Years of Company Stock Price Movement
Maximizing shareholder wealth is the foundation of the strategy explained above. As we can see from
Table A in the appendix, the stock price of Deere & Co. has performed very well over the past five years.
The price of the stock saw improvement in 2009, 2010, 2012, and 2013; with the only decline coming in
2011. Over this five year period, Deere & Co. saw its price climb from $54.09 to $91.33, which is almost
a 70% increase since 2009. While this is good news for John Deere shareholders, similar improvements
were made on the market as a whole, as we can see with the S&P 500 Index return of 65.76% over the
last five years. These improvements appear very large; however, we must remember that the state of our
economy five years ago was extremely poor. Many of the companies that were able to endure the
recession have seen their stock prices recover in the last five years, which helps explain the strong
improvement in John Deere’s stock price and the value of the market as a whole (Morningstar).
Analysis of Financial Position
Debt Capitalization Ratios
Total Debt to Total Capital: This ratio measures the amount of debt in a company’s capital
structure. High debt capitalization ratios indicate large amounts of debt being used to finance various
activities within the company. Although high amounts of debt have the potential to improve returns, they
also reduce flexibility within the company and increase the risk of insolvency, which can be a red flag for
potential investors (Ross). Over the past five years Deere & Co. has seen its total debt to total capital
increase from 25% to 37% (Morningstar). This increase in debt is not necessarily a bad thing because it
indicates the recovery of the economy, and shows that John Deere is continuing to expand the company.
As the economy has improved over the last five years, lenders have become more optimistic, which has
led to lower interest rates. These rates are appealing to companies who need financing, and it appears that
John Deere has taken advantage of these opportunities as they increased debt over the last five years.
Debt to Equity: The debt to equity ratio is similar to the total debt to total equity ratio in that it
measures a company’s financial leverage. The ratio shows what proportion of equity and debt the
company is using to finance its assets (Investopedia). The use of debt financing offers threats and
opportunities for the company. There are situations where the use of debt may offer the company an
opportunity to generate more earnings than it would have without the external financing (Investopedia).
In most situations, management will make financing decisions that will be most beneficial to the
shareholders. Although the total debt to total capital ratio increased over the last five years, the debt to
equity ratio actually declined. In looking at the debt to equity ratio, it appears that John Deere is making
an effort to decrease its financial leverage, which will free up cash flow and make them even more
attractive to creditors in the future.
Liquidity Ratios
Current Ratio- The current ratio is a common liquidity ratio, used to measure a company’s ability
to pay short-term obligations. In the last five years, John Deere has seen its current ratio fall from 2.42 to
2.05, which is a decrease of roughly 15% (Morningstar) The fact that the current ratio has declined over
the last five years is not a good sign because it indicates that current liabilities are increasing at a rate
greater than current assets; however, the 2013 ratio of 2.05 is still higher than the industry average of
1.72, which indicates that John Deere is still in a good position to pay back short term liabilities.
Although Deere saw a 15% decrease, the current ratio of 2.42 five years ago may have been too high,
which could be an indication that assets were not being used efficiently. Potential shareholders should
keep an eye on the failure to pay back current liabilities because it is a very important aspect of a
company’s financial position; however, the 15% decrease should not be a concern as Deere is still well
above the industry average.
Quick Ratio- The quick ratio is another indication of a company’s short term liquidity; however,
it excludes inventories from the calculation because they are the least liquid of the current assets. The
quick ratio of John Deere is also trending down; dropping form 2.1 in 2009 to 1.83 in 2013. There is
clearly a correlation between the current ratio and the quick ratio; however, the quick ratio indicates a
company’s immediate ability to pay short term obligations. John Deere has extremely valuable inventory,
so the fact that current assets have the ability to cover short term liabilities without inventory is a good
sign for the company and potential shareholders.
Profitability Ratios
Profit Margin- Profit margin is the percentage of sales a company actually gets to keep in
earnings. Analyzing profit margin is very useful because it indicates a company’s ability to control costs
and improve overall cash flow. The profit margin of John Deere has steadily increased over the past five
years as we can see in the table. The largest jump in profit margin occurred from 2009 to 2010, increasing
from 3.8 to 7.2. The 2013 profit margin reached 9.4 which is significantly higher than the industry
average of 6.0. Comparing profit margins across firms within an industry is very useful because it shows
which companies are managing costs, and operating most efficiently. When looking at John Deere
compared to the other companies in the industry, it appears John Deere is controlling costs effectively,
which usually results from strategic planning and strong management. There are other means of
improving profit margins which may not result from controlling costs such as charging higher prices,
having talented tax accountants, or reducing interest expense through lower debt. More than likely, a
combination of these factors have led to John Deere’s improved profit margin.
Return on Equity- This ratio shows the amount of income earned as a percentage of shareholders
equity. This ratio is very useful for investors because it allows them to compare the profitability of
companies based on the money invested by shareholders. For example, if I am looking to invest in John
Deere (a large-cap company) vs. AGCO (a mid-cap company), I cannot simply look at earnings alone.
Instead, I should look at a profitability ratio such as the ROE in order to “compare apples to apples.”
Although a company like John Deere may be earning much more money than AGCO, they may not be
using shareholder investments as efficiently. As you can see from the chart, John Deere’s ROE has
increased significantly in the past five years from 15.39 to 41.39, which is a very good sign for investors.
This increase has been reflected in the 70% increase in the stock price during these years. The current
earnings are at record highs, so whether John Deere will be able to sustain them is a difficult question to
answer. AGCO, on the other hand had an ROE of 16.01 in 2013, which means that John Deere is using
shareholder investments much more efficiently than one of its main competitors (MSN Money).
Return on Assets- While ROE measures the efficient use of shareholders equity, ROA measures
how efficient management is at using its assets to generate earnings. From 2009 to 2013 John Deere
improved its ROA by roughly 180%, which is a very good sign for the company and potential investors.
John Deere’s 2013 ROA was 6.11 compared to the industry average of 4.1. Based on ROE and ROA
ratios, it appears that John Deere is operating very efficiently in comparison to the industry and its main
competitors, which should ultimately lead to strong profitability (MSN Money).
Asset Utilization (Appendix F)
Receivables Turnover- Receivables turnover shows a company’s ability to collect receivables in a
timely fashion. John Deere’s turnover has increased from 6.84 in 2009 to 10 in 2013. According to this
data, John Deere has either developed new credit terms, or has simply become more efficient in collecting
receivables. The recovering economy should have allowed John Deere to collect receivables more
effectively, which may have something to do with the significant increase (MSN Money).
Inventory Turnover- This ratio indicates how many times a company’s inventory is sold and
replaced over a period. Over the last five years John Deere’s turnover has decreased, which means they
are building excess inventory (MSN Money).
Asset Turnover- This ratio shows the amount of sales generated per asset. According to the data,
John Deere’s asset turnover has increased slightly over the past five years, which is a good sign because it
means they are figuring out ways to use their assets efficiently (MSN Money).
Market Ratios (Appendix G)
As you will see in the appendix, earnings per share and book value per share both increased significantly
over the past five years, which means the company has been performing well during this time. The P/E
ratio has declined significantly from 2009 to 2013, which means investors are seeing less growth potential
in John Deere. A low P/E ratio can also be an indication of a low risk investment, which I believe is true
for John Deere in the current economic setting (MSN Money).
Discussion of Investment Risks
There are certainly risks associated with an agricultural manufacturer such as John Deere. The
performance of John Deere is directly related to the financial position of the farmers they rely on to
purchase their products. Agricultural markets have shown signs of volatility in the past, which creates a
risk for John Deere because farmers will not be able to purchase such expensive machinery in tight
financial situations. The emergence of new technology is another risk John Deere may face. In order to
remain the industry leader in agricultural products, John Deere will need to embrace the vast changes that
are taking place in our society. If they fail to make these changes, competitors may take advantage and
steal market share in a very profitable industry. Overall, John Deere appears to be a very safe investment
when evaluating its historical ability to endure challenges in the industry. There is no reason to believe it
should lose value any time in the near future.
Beta Coefficient
According to Morningstar.com, the beta coefficient for John Deere is 1.38. This essentially means that
John Deere’s price will be 38% more volatile than the market. This seems like a reasonable number based
on the economic risk factors associated with the industry. In poor agricultural markets, farmers will not be
purchasing new equipment, which justifies the fact that John Deere is slightly more risky than the market.
Investors should not expect huge gains from this stock based on the beta coefficient; however, the risk
associated with the stock should be slightly greater than that of the market. Through the CAPM model,
which is described next, we know that a higher return will be expected to compensate for additional risk.
CAPM
Using the beta coefficient of 1.38, the risk free rate of 3%, and the historical market return of 11%, I
calculated the cost of equity to be 14.04%. This is an investor’s required rate of return, or the amount that
the investor could have earned by putting the same amount of money in a different investment with equal
risk. Because Deere’s beta is more volatile than the market, the company will need to provide higher
returns for investors in order to compensate them for taking on the additional risk. This rate will be
valuable to the firm in making capital budgeting decisions and various other financial choices.
Bond Issue
Deere & Co. has a three star bond rating according to Morningstar, and an A- rating according to
Standard & Poor’s. They currently have 18 bond issues outstanding, one of which is the Deere 3.9%
bond. This bond has a par value of $1,000 with a 3.9% coupon rate and a current yield to maturity of
4.04%. This bond is callable and has a maturity date of 6/9/2042. There is no question that debt financing
plays a significant role in John Deere’s capital structure based on the number of bonds they have
outstanding (Morningstar).
Growth Rate
I calculated a WACC of 6.74%, found the current stock price of $81.99, and the most recent dividend of
$0.60 per share. Using these numbers I was able to find the implied growth rate of 6%. This growth rate,
along with the stock price of John Deere can be compared to the market as a whole in order to determine
whether the stock is valued correctly.
Corporate Strategy Connection
After analyzing John Deere’s financials throughout this paper, it appears that their financial position and
outlook are consistent with the corporate strategy. Taking advantage of growth opportunities was the
major theme of the strategy, and based on various ratios such as the Profit Margin, ROE, and ROA, they
appear to be on the right track. All trends seem to be pointing in the right direction for John Deere, which
is an excellent sign for all of the company’s stakeholders. There is no question that Deere has made a
strong rebound from the recession, and it appears that investors should be able to count on the consistent
performance in the future.
Capital Budgeting
Although a specific capital budgeting method for John Deere is not available, there is no question that the
financial managers of the firm have some technique in place. Capital budgeting is essential for any
company, especially a firm such as John Deere who is constantly making investments worth millions of
dollars. Capital budgeting methods should allow a company to create shareholder wealth through
profitable investments. Based on discussions in class and in the textbook, NPV seems to be a very strong
method of capital budgeting because it properly discounts all the cash flows of a project, while other
methods ignore the time value of money when handling cash flows (Ross.) While the method of John
Deere is unknown, it is safe to say that there is a strong possibility that John Deere uses the NPV, or a
very similar method, to make its capital budgeting decisions.
Capital Structure (Appendix H)
After determining the book leverage and the market leverage of Deere over the past five years, it appears
that a target capital structure is in place. Both ratios have remained relatively stable since 2009; however,
it appears the book leverage is being targeted at approximately 57%. A large majority of firms use target
ratios, and data shows that large companies are more likely than small companies to use target capital
structures as opposed to other methods (Ross). There are several factors which help a company determine
a reasonable target. The tax benefits of debt obviously play a significant role in the capital structure of a
firm, and a highly profitable company such as John Deere is more likely to take advantage of the
deductible interest for tax purposes. The types of assets a business holds also impacts the target leverage
ratio. Companies with large amounts of tangible assets will have smaller financial distress costs because
of the resale value of these assets (Ross). As a manufacturer of heavy equipment, there is no question that
John Deere has significant tangible assets, which is one reason why its leverage ratio is so high. The
target capital structure of John Deere appears reasonable based on these observations (Ross).
Unleveraged Beta
The unleveraged beta is simply the beta of a company without any debt. This is valuable because it allows
investors to evaluate the risk of a company without considering the beneficial effects of issuing debt
(Investopedia). Analyzing the unlevered betas across the industry will allow us to determine the extent to
which the companies rely on tax shields, and how their risk changes when debt is excluded. Theoretically,
risk should always be reduced when debt is eliminated, which means the unlevered beta should be lower
than the levered beta. John Deere’s unleveraged beta was calculated using the following equation:
Beta unlevered=Beta levered/(1+(1-Tax)*(D/E))
The unlevered beta is roughly 0.89, which is lower than the levered beta of 1.38. This is a fairly
significant decrease; however, the decrease is reasonable because eliminating Deere’s large amount of
debt will make the company much less risky (Ross).
Dividends
John Deere pays quarterly cash dividends, and has been doing so for a very long time. Most firms who
distribute earnings to shareholders try to do so on a consistent basis in order to provide predictable
earnings for investors. In 2014, John Deere distributed cash dividends of $0.60 per share, which is an
increase from $0.51 per share in 2013 and $0.46 in 2012. John Deere’s dividend per share has gone up
drastically since the peak of the recession from 2007 to 2009 when they were only distributing $0.25 per
share (NASDAQ). This increase makes sense because increased earnings have led to increased free cash
flows, which allow the company to distribute greater amounts to shareholders. Companies who issue
dividends are usually those who cannot make use of the retained earnings in a way that will lead to higher
returns than the stockholder could make themselves. These companies usually are out of the growth stage,
and are viewed as stalwarts who no longer can make efficient use of excess cash. John Deere definitely
falls within this category as a company with limited growth opportunities. Although minimal growth can
be expected from Deere, investors looking for consistent dividend payments might be attracted to John
Deere ownership.
Deere & Co.’s current dividend yield is 2.74% (dividend.com). This percentage indicates the amount a
company pays out in dividends in comparison to the share price, which also indicates how much of the
investment will be returned through dividends. The farm and construction machinery industry dividend
yield is 1.37%, while two of Deere’s main competitors, CAT and AGCO, have dividend yields of 2.64%
and 1% (dividend.com). Based on these yields, John Deere clearly pays high dividends relative to the
industry, which is a sign of significant cash and minimal growth potential.
John Deere appears to have a dividend policy which pays out a certain percentage of earnings to
shareholders. As the earnings have increased over the past five years, so too have the dividend payments,
which is a good indication of the dividend policy established by the company.
International Operations
Deere & Co. is a global company, with customers and suppliers around the world. All international
operations experience various risks, including exchange rate issues and governmental risks. Deere &
Co.’s 2013 annual report emphasized that changes in governmental trade, banking, and fiscal policies all
have the potential to disrupt international commerce (2013 Annual Report). John Deere’s revenue from
North America was roughly $23.85 billion in 2013, which made up just over 60% of its total revenues.
Deere’s overseas revenue of $13.5 billion made up the additional 40% of total revenues (2013 Annual
Report). Although the majority of Deere’s earnings come from the U.S., a significant amount comes from
foreign countries, which brings various risks into play. The effect of exchange rate changes on cash and
cash equivalents was $11.7 million in 2013 as opposed to negative $38.8 million in 2012 (2013 Annual
Report). Clearly exchange rates have the ability to significantly impact the company’s cash position,
which can be a big concern for John Deere’s financial managers.
In order to control these risks John Deere has multiple hedges and derivatives in place. The annual report
lists various interest rate and cross-currency interest rate contracts used to hedge future cash flows from
foreign countries. These amounts offset the effects of interest rate or foreign currency exchange rates
(2013 Annual Report). Derivatives are also used as hedges for certain borrowings, purchases, or sales of
inventory (2013 Annual Report). As a global company, there are significant risks associated with foreign
operations. Based on the explanation in the annual report, John Deere seems to have strong procedures in
place to hedge these risks, and protect the firm from lost cash flows.
Conclusion
Through this in-depth analysis of John Deere, several conclusions can be made. John Deere is a fairly
stable company that will distribute consistent dividends to shareholders. The company is subject to
various risks such as agricultural market risks, exchange rate risks, and other factors which have the
ability to hinder the performance of the company. Based on the financials and the future economic
outlook, John Deere seems to be well past its “growth stage;” however, for those looking for consistent
cash distributions, John Deere is a very legitimate option.
Appendix
5 Year Stock Price (Appendix A)
5 Year Stock
Price
%
change
S&P 500
%
change
2009
54.09
0%
1,115.10
0.00%
2010
83.05
53.54%
1,257.64
12.78%
2011
77.35
-6.86%
1,257.60
0.00%
2012
86.42
11.73%
1,426.19
13.41%
2013
91.33
5.68%
1,848.36
29.60%
Debt Capitalization Ratios (Appendix B)
Year
2009
2010
2011
2012
2013
Total Debt to Total
Capital
25%
43%
35%
46%
37%
Year
2009
2010
2011
2012
2013
Liquidity Ratios (Appendix C)
Year
2009
2010
2011
2012
2013
Current
Ratio
2.42
2.32
2.07
2.24
2.05
Year
2009
2010
2011
2012
2013
Quick
Ratio
2.1
1.97
1.82
1.97
1.83
Debt to
Equity
3.61
2.67
2.49
3.28
2.1
Profitability Ratios (Appendix D)
Year
2009
2010
2011
2012
2013
Profit
Margin
3.8
7.2
8.7
8.5
9.4
Return on
Equity
15.39
33.58
42.78
44.93
41.35
Year
2009
2010
2011
2012
2013
Year
2009
2010
2011
2012
2013
Asset Utilization Ratios (Appendix F)
Year
2009
2010
2011
2012
2013
Inventory
Turnover
6.11
6.5
5.93
5.27
5.08
Asset
Turnover
0.58
0.62
0.7
0.69
0.65
Year
2009
2010
2011
2012
2013
Market Ratios (Appendix G)
Year
2009
2010
2011
2012
2013
Earnings per
Share
2.06
4.35
6.63
7.63
9.09
Year
2009
2010
2011
2012
2013
BV per
Share
11.39
14.9
16.75
17.64
27.46
Year
2009
2010
2011
2012
2013
P/E
ratio
26.75
19.18
11.97
11.52
9.94
Capital Structure (Appendix H)
John Deere Capital Stucture
Book Leverage
Market Leverage
70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
2009
2010
2011
2012
2013
Return on
Assets
2.19
4.42
6.12
5.87
6.11
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