John Deere's economics

• John Deere has exhibited good, but not great, operating and net margins over the last 20 years relative to the average industrial company
• Deere has, however, produced above average returns on capital employed (that edge looked much better over the last 10 years than the 10 years prior)
• The qualitative nature of Deere's industry and Deere's strong competitive position make those above average returns seem sustainable over time

John Deere stacks up well against its competition, but are its economics compelling?

A good long term investment has strong and sustainable economics. That is to say, it generates above average returns on capital invested and can maintain those returns far into the future. How does Deere look?

One measure of good economics is superior profit margins. That isn't a necessary or sufficient condition, but a business that generates high margins shows it can add a lot of value (the difference between what customers will pay and the costs of production).

Below, I compare Deere to the Value Line Industrial Composite.

• Operating Margins (after cost of goods sold and sales, general & administrative, but before depreciation)
• Deere
• 2009-2013 (last 5 years): 13.5%
• 2004-2013 (last 10 years): 12.5%
• 1994-2013 (last 20 years): 12.4%
• 1994-2003 (10 years prior to last 10 years): 10.2%
• Value Line Industrial Composite
• 2009-2013: 16.4%
• 2004-2013: 16.6%
• 1994-2013: 16.6%
• 1994-2003: 16.2%

(The reason why I look at prior 10 years is because Deere has had an unusually strong tailwind with ethanol mandates and strong global growth over the last 10 years. Because those beneficial conditions may not last, I thought it was prudent to consider Deere's economics in the 10 years prior to that last 10 good years.)

Deere's operating margins aren't above average. In Deere's case, that is mostly caused by a higher than average cost of sales relative to the average industrial company. 

• Net Margins
• Deere
• 2009-2013: 8.2%
• 2004-2013: 7.7%
• 1994-2013: 7.7%
• 1994-2003: 6.4%
• Value Line Industrial Composite
• 2009-2013: 7.4%
• 2004-2013: 7.6%
• 1994-2013: 6.8%
• 1994-2003: 6.2%

Deere's net margins have been superior over the last 5 years. When you look farther back in history, this margin edge decreases but doesn't disappear. Deere generates an above average spread between the top and bottom line, but not by enough to be considered economically stellar.

Margins, by themselves, are an incomplete picture. More important to investors is return on invested capital.

• Return on Assets
• Deere
• 2009-2013: 4.4%
• 2004-2013: 4.6%
• 1994-2013: 4.6%
• 1994-2003: 3.7%
• Value Line Industrial Composite
• 2009-2013: 6.1%
• 2004-2013: 6.5%
• 1994-2013: 5.4%
• 1994-2003: 4.8%

Deere's returns on assets are significantly below average. I think this can be explained by Deere's large finance arm, which produces high returns on equity but low returns on assets (like most financial businesses).

• Return on Net Assets (working capital, long term debt, equity)
• Deere
• 2009-2013: 14.0%
• 2004-2013: 13.8%
• 1994-2013: 11.8%
• 1994-2003: 8.7%
• Value Line Industrial Composite
• 2009-2013: 8.2%
• 2004-2013: 8.7%
• 1994-2013: 8.5%
• 1994-2003: 8.1%

Deere's return on net assets (a measure I look at because it includes the returns on working capital in addition to debt and equity capital) are superior. I think part of this can be explained by Deere's finance arm, but also by Deere's capital efficiency when it comes to managing working capital. Deere's business looks quite strong by this measure, but you can see that in the period from 20 to 10 years ago, this edge was much smaller.

• Return on Capital (long term debt, equity)
• Deere
• 2009-2013: 20.0%
• 2004-2013: 18.6%
• 1994-2013: 17.6%
• 1994-2003: 13.5%
• Value Line Industrial Composite
• 2009-2013: 10.1%
• 2004-2013: 10.5%
• 1994-2013: 10.4%
• 1994-2003: 10.0%

Deere's return on capital also looks superior. In my opinion, this shows that Deere's business may not run on high margins, but produces a lot of value relative to the capital employed. Notice, too, that Deere's superiority is lower from 20 to 10 years ago, but still significantly above average.

• Return on Equity
• Deere
• 2009-2013: 31.5%
• 2004-2013: 26.0%
• 1994-2013: 22.3%
• 1994-2003: 18.5%
• Value Line Industrial Composite
• 2009-2013: 16.1%
• 2004-2013: 16.4%
• 1994-2013: 16.3%
• 1994-2003: 16.3%

Deere's return on equity is quite enticing. This is due to a combination of superior economics, I think, as well as a good balance of debt and equity capital deployed (particularly the finance arm). This margin of superiority diminishes when looking at 20 to 10 years ago, but does not disappear.

In addition to the quantitative data above, it's important to consider the qualitative side. Deere's business is a cyclical one, but a business that is unlikely to go away. I cannot conceive of a technology that could replace the physical nature of tractors and combines, and that qualitative nature makes for a high degree of sustainability. 

Deere's competitive position gives it an edge, too, as I described in last week's blog. Deere can stay ahead of its competition as long as management doesn't squander its lead. In next week's blog, I plan to tackle the subject of Deere's management: how likely are they to maintain Deere's competitive position and maximize its value over time? 


Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.