JOHN DEERE (DE) SHORT THESIS (ER 8/16)

TLDR: SHORT JOHN DEERE

Schmidt says sales at his dealership, in general, declined by as much as 15% in the first half of the year, led by a fall in the demand for large equipment. In a sign of things to come, early orders for planting equipment for next season's soybean and corn crops are down up to 25%.

He is not alone. Half a dozen dealers of Deere's agriculture equipment across the Midwest shared similar accounts in interviews with Reuters. One of those dealers, in Geneseo, Illinois, said sales at his dealership were down 50% so far this year from the same period last year.

This is a worrying sign for Deere, which gets nearly 60% of its sales from the United States and Canada.

(https://finance.yahoo.com/news/farm-equipment-maker-deeres-dealers-171312197.html)

China’s exit piles on to a devastating year for farmers, who’ve struggled through record flooding and droughts that destroyed crop yields, and trade war escalations that have lowered prices and profits this year.

“It’s really, really getting bad out here,” Bob Kuylen, a farmer of 35 years in North Dakota, told CNBC.

“There’s no incentive to keep farming, except that I’ve invested everything I have in farming, and it’s hard to walk away.”

“Trump is ruining our markets. No one is buying our product no more, and we have no markets no more.”

(https://www.cnbc.com/2019/08/10/trump-is-ruining-our-markets-farmers-lose-a-huge-customer-to-trade-war----china.html)

Problems with extreme weather & trade war tensions have severely impacted US farms, most specifically the Midwest, where over 80% of the US' soybeans are grown. (https://www.statista.com/statistics/192076/top-10-soybean-producing-us-states/) Now, if farms are facing difficulties, they are less likely to invest and buy more machinery/equipment, hurting DE.

Since 2004, Deere has grown its credit book by 300% while boosting operating profit by only 70%. The growth in the loan book suggests that more sales are being financed then are being paid in cash. There has also been substantial growth in operating leases. While the loan book and operating leases have ballooned, sales of farm equipment have dropped by 40% since 2013. Since 2016, cash flow from operations has fallen in half, and the firm has been free cash flow negative for the last two fiscal years. Meanwhile, the share price has appreciated over 90+%.

(https://seekingalpha.com/article/4283194-massif-capital-deere-and-co)

A part of DE's business involves them offering loans/leases to dealers and farmers to make it easier to purchase their machinery. As we can see from the aforementioned, sales of their machinery are down, as well as the increase in credit extended showing us that they are dependent upon the solvency of American farmers. Additionally, the fundamentals do not look healthy, as operating cash flow has been halved over the past 3 years, and FCF has been negative for the last 2 years. Much of the 90% appreciation in share price over the past three years has been driven by a robust buyback program (75 billion), several acquisitions, and cost-cutting measures.

(https://www.fb.org/market-intel/farm-loan-delinquencies-and-bankruptcies-are-rising)

Following several years of low farm income and rising debt levels, a review of Federal Deposit Insurance Corporation quarterly call report data reveals that the delinquency rates for commercial agricultural loans in both the real estate and non-real estate lending sectors are at a six-year high.

For the first quarter of 2019, 2.5% of commercial real estate loans in agriculture were more than 30 days past due, up from 2.1% in the prior quarter and above the historical average of 2.1%. Similarly, 2.3% of non-real estate loans in agriculture held by commercial lenders were more than 30 days past due, up from 1.5% in the prior quarter and above the historical average of 1.7%. The first quarter of 2013 was the last time delinquency rates were this high for commercial lenders.

As we can see, the rate of farm delinquencies & bankruptcies is at a six-year high, which tells us that the farming industry as a whole is unhealthy. Farmers that owe existing credit to John Deere are more unlikely to pay up due to the various tailwinds discussed above, not to mention farmers aren't going to be buying new machinery if they aren't doing well financially. Things only appear to be getting worse as Trump looks to be escalating tensions with the Chinese, saying that he would be okay with canceling the already scheduled talks in September.

POTENTIAL RISKS:

This thesis may turn out to be correct but it may play out over a longer time frame (IE the effects are not yet felt this quarter)

Brazilian agriculture, (which is booming: https://www.fitchsolutions.com/corporates/commodities/brazil-agricultural-boom-continue-05-08-2019) may help save the company from its decline in US sales (unlikely)

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I welcome all criticism and discussion.

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