An Odd Report From Deere

This quarter's earnings report from Deere (NYSE:DE) is a bit of a puzzler. Then again, a quick look at the analyst estimates going into this report shows that there was not a firm sense of just how this large agricultural and construction machinery company was going to do. IN PICTURES: 5 Tips To Reading The Balance Sheet

There was a nearly 10% spread between the high and low revenue estimate for the quarter, and a 45% spread for the EPS estimates. Caterpillar (NYSE:CAT) likewise has a large spread for its next quarter, but non-industrials like Wal-Mart and Procter & Gamble have much narrower spreads - suggesting there is a wide gulf between those optimistic about an ongoing recovery in heavy machinery and those looking for a slowdown or double-dip.

The Quarter that Was
Sales were a bit light in the July quarter, as the company missed the consensus guess by more than $200 million. Still, revenue did grow 18% and volume growth was responsible for the lion's share of it (up about 13%). The Ag and Turf businesses continue to perform reasonably well with 12% growth, while the Construction and Forestry business is bouncing back (up 59%) from a deep drop in the wake of the housing bubble.

Adding to the enigma that is this quarter, Deere missed the top line number but more than made up for it on the profitability side of the equation. Gross margin jumped more than four full points from the year-ago level, and the company added even more leverage at the operating line (where operating margin rose almost five points). All in all, then, Deere nearly doubled its segment operating profit and readily surpassed the average estimate.

The Road Ahead Looks Foggy
Here is another puzzler for Deere's quarter - Deere reported that strong farm sales in North America helped to offset a bad market in Europe. In the most recent report from the Association of Equipment Manufacturers, however, sales of large farm equipment were weak in July and were weak for pretty much all of Deere's July quarter.

Where, then, did the 12% revenue come from when the market was soft? Now, perhaps it is just a question of terminology - maybe Deere sells a lot of machinery that is not captured in the AEM numbers (as in the turf segment). Or perhaps Deere is taking share away from the likes of CNH (NYSE:CNH) and Agco (Nasdaq:AGCO). Either way, it is an interesting anomaly.

Either way, the look ahead gets no clearer with a step back. Crop prices are higher now, but credit availability is not exactly "loose". On top of that, Deere's guidance for the near term was what one might call middling - clearly management expects that the weakness in Europe is going to weigh on results.

The Bottom Line
Deere is often the go-to name when investors want to play improving agriculture fundamentals and the spread of mechanized farming throughout the world. To some extent, this is a fine thesis. I have no doubt that Deere will hold its own against CNH, Caterpillar, and Agco, as well as other rivals like Komatsu (Nasdaq:KMTUY) and Mahindra, even while all of these companies try to expand their developing-word operations.

The question is whether or not all of this trumps valuation. If ever there was a case for not chasing a name, it would be in a cyclical industry like farm and construction machinery. Given the number of oddities and anomalies with this story today, perhaps it is best left idling for now. (For more, see The Successful Investment Journey) Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!