For our 100th Seeking Alpha article, I decided to cover Deere & Company (NYSE:DE). Since our previous coverage, Deere has significantly underperformed as the inflation risk we described materialized.

However, I believe that the company provides the resilience needed to outperform the market as a whole during a period of economic stagnation. How you decide to play is your choice; However, we view this asset as a lucrative option to buy during a market decline, as its fundamentals allow for lower losses in a bear market and excess returns in a bull market.

Without further ado, let’s get into it.

Recent operational overview

Macroeconomics

I think it’s fair to say that the global economy has entered a downturn. For example, inflation rates in major economies are rising (except China). In addition, real GDP growth is heading into a contraction phase, which could lead to lower consumer spending. Additionally, the US yield curve shows that short-term spot rates are out of control, which means the market thinks the Federal Reserve should contract the economy significantly to rein in inflation.

Nevertheless, some sectors could maintain their strength. For example, the consumer staples space is non-cyclical. Thus, investors could choose to transfer capital into its domain. This could benefit Deere as its operations correlate with the upstream commodity environment.

According to Wells Fargo (WFC) analyst Chris Carey, consumer staples will outperform given their resilient nature and ability to weather headwinds in the economy. Again, I see this as an indirect influencer for Deere.

Industry

Deere’s operating results are inextricably linked to agriculture and construction/forestry activities. The chart below indicates that U.S. agricultural exports hit a multi-year high, with record commodity prices being a major tailwind for primary producers. In addition, building permits have fallen recently. However, they remain at a multi-year high, suggesting construction equipment sales are still possible.

The figure below illustrates Deere’s market positioning in 2021 in its primary business unit, agricultural machinery. The company held a dominant position in the market last year, which is a recurring trend. Some of Deere’s competitors include Caterpillar (CAT), CNH Industrial SA (CNHI) and Kubota Corp. Japan (OTCPK: KUBTY). I would say this is an industry with high barriers to entry; thus, Deere will likely face moderate competition and, in most cases, an industry stronghold.

company specific

Although Deere’s second quarter gross (year-over-year) increased from 34.3% to 33.3%, the company’s gross and operating margins remain above its 5-year average (YCharts does not reflect not Q2 earnings, see 8-K screenshots below). The company’s wide product line has undoubtedly helped secure a large chunk of farm equipment spending over the past few years. Another critical aspect to note is Deere’s ability to cope with a tight labor market, as its net income per employee ratio is significantly better than its industry peers.

The company is well diversified. First, Deere is entering a new paradigm with the integration of autonomous features. This is an extremely necessary addition, in my opinion. I say this because agriculture is moving towards a trend towards smaller lots and higher volume, which requires precision farming/small turf products.

In addition, Deere’s recent launch of its 8R Tractor will add a lot of value to the company’s general agriculture target market, as it is expected to increase yield and improve cost structures in the agriculture industry.

Deere’s presence in the construction and forestry sectors is also becoming increasingly important, with this segment now accounting for more than 25% of the company’s revenue mix. Deere offers several forestry products, with its new 768L-II bogie skidder regarded as an innovative machine with a lot of optimism within the forestry and forestry industry.

Finally, Deere acquisition of Bear Flag Robotics in 2021 adds a lot of value because its self-driving technology is compatible with old and new Deere products on the market. Such acquisitions enable vertical integration, in turn, providing Deere with lucrative product differentiation and cost-cutting benefits.

Key endpoints

Relative valuation is probably the best method to use for Deere stocks. I say this because a DCF model would be difficult to regress given the inconsistency in growth rates during the pandemic. Also, an absolute valuation doesn’t help, in my view, as I appreciate cyclicality rather than observing trade-offs between earnings and dividends.

From a relative perspective, Deere stock looks undervalued as it trades at a discount to its normalized price multiples. In addition, the share’s PEG ratio is at a 3.7x back to the benchmark, indicating that Deere’s earnings per share growth is not valued by the market.

Transversal pricing

I looked at a few factor models to determine the relationship between Deere’s stock and the current climate. First, the first chart in this section illustrates investors’ penchant for high-dividend, value and quality stocks as the growth and momentum plays have lagged. The explanation for this is simple, factor model tests have discovered that both the short and long term data sets illustrate an asymmetry in favor of risk averse assets ahead of a possible recession.

To give some substance to my request, According to Goldman Sachs (GS) analyst David Kostin, we are 35% likely to see a near-term recession. Further, Kostin states that “In the 12 months leading up to a recession, defensive sectors and ‘quality’ factors have generally outperformed. Out of 5 recessions since 1981, the average experience has seen energy (XLE), Basic fuel consumption (XLP), Health care (XLV) and Utilities (XLU) outperform the index.”

The second and third charts in this section illustrate a cross-sectional analysis of Deere stock performance under different market conditions. The models were created by Eugene Fama, Kenneth French and Mark Carhart to identify the types of stocks that would outperform the market in certain market climates. I linked my findings to the economic outlook and factor analysis with which I started this section.

I found that Deere stock outperforms a general bull market, outperforms a value-oriented market, outperforms a small cap stock bull run, underperforms a momentum run, outperforms a market looking for profitable stocks and outperforms a market looking for high-resolution stocks. – investment rates.

So Deere stock generally outperforms the market unless the market is looking for momentum, which it isn’t at this point.

Finally, Deere’s stock profile matches current market sentiment, which is focused on quality, value and the search for dividend yield. The company’s current and fast ratios show strong solvency and liquidity, and its income statement is robust, with EPS growth exceeding its industry benchmark of 79.64%.

Potential risks

The main risk for Deere is related to materials. Points in ferrous metals and polysilicon prices make life difficult if you’re looking to build heavy machinery with integrated semiconductors. There is a risk that global supply chain issues will persist, potentially leaving Deere’s profit margins suppressed.

The essential

Deere is the type of stock that could avoid a market sell-off while still outperforming on the upside. The company’s strong market position could help it take advantage of an increase in agricultural activity, which could give rise to its stock. Additionally, the stock looks undervalued and its price metrics are attractive on a cross-sectional basis.