Deere & Co.'s (DE) U.S. farm machinery business plowed through the economic recession mostly unscathed, but the business is now attracting increased scrutiny because of concerns that farmers' appetites for new equipment is reaching its limit.
Unlike other types of capital equipment, sales of high-horsepower tractors and harvesting combines didn't collapse during the U.S. recession. Elevated crop prices provided farmers with the income and incentive to keep buying through the downturn. Sales of high-horsepower tractors in recent years have been running well above historic rates. By some estimates, farmers haven't added so much horsepower since the 1970s. North American sales of high-horsepower tractors this year are projected to reach almost 40,000 units, the highest volume since the early 1980s.
That's caused some analysts to predict the machinery market is at or near a saturation level, particularly when factoring in that most purchases of new equipment are accompanied by older machines that get added to the used equipment market.
"We've had almost a 10-year run of year-after-year better sales," said Stephen Volkmann, an analyst for Jefferies & Co. "When you have a pretty new fleet of equipment out there, any kind of random event can cause the buyer to pull back."
Volkmann last month dropped his price target for Deere's shares by 16%, concluding that Deere no longer warrants a peak-of-the-cycle price even though he expects sales and profit growth to continue because of foreign market demand and a recovery in Deere's construction equipment business.
With Deere's share of the U.S. high-horsepower tractor market above 60%, the Moline, Ill., company is viewed as the most susceptible to softening demand caused by another recession, lower crop prices or an end to the U.S. government's accelerated depreciation program for capital equipment purchases. Farmers are widely believed to be benefiting from the program that allows them to shield income from federal taxes by investing in equipment.
Investors' anxiety has been reflected in Deere's stock price, which has fallen more nearly 17% since the end of March, compared with about a 4% decline in the broad market Standard and Poor's 500 Index during the same time. Shares for rivals CNH Global N.V. (CNH) and Agco Corp. (AGCO) also have been taking it on the chin lately, falling 25% and 17%, respectively, since the end of March.
Deere, however, has done little to fan investors' pessimism. In May, the company raised its sales and profit guidance for the year. Its tractor plants are booked with orders through the end of the year. The company appears to have no trouble raising its prices to offset rising costs for materials and additional pollution controls on diesel engines, dispelling concerns about a glut of new and used equipment.
"When you look at used equipment values, they're actually holding very strong," said Tony Huegel, Deere's director of investor relations, during a conference call last month with analysts.
Some analysts maintain that focusing on equipment volumes and market saturation is misplaced because equipment sales are driven mostly by crop prices.
"As long as cash receipts and farm income stays up, farm equipment sales will too," said Eli Lustgarten, an analyst for Longbow Research.
High commodity prices motivate farmers to expand their production through the use of newer, more efficient equipment. The U.S. corn futures have soared to record levels in recent months, setting a new all-time high at $7.99 3/4 a bushel two weeks ago. Although the price has fallen nearly 20% since then, corn remains priced significantly above historic levels.
Observers also note that the higher sales volumes of equipment seen in recent years followed a prolonged stretch of anemic sales. Just 16% of the U.S. tractor fleet with engines over 100 horsepower was replaced from 2002 to 2010, a rate of about 2.3% annually, according to figures from J.P. Morgan Chase & Co. About 42% of the units sold during the period occurred between 2008 and 2010.
"We do not believe we are close to saturation," said Ann Duignan, a J.P. Morgan analyst, in a recent note to investors. "As long as used equipment prices remain healthy, farmers will continue to trade in equipment."
She's also not worried about elevated sales of new equipment flooding the used market with machinery because the number of smaller farms most likely to rely on used equipment far outnumbers larger farms that account for much of the new machinery demand. But regardless of whether a farmer operates a big farm or a small one, the amount of land farmed in the U.S. hasn't kept pace with increases in the size of the equipment fleet.
"Farmers have been buying tractors in bulk, even though they haven't been planting a terrific amount of additional acres," said Adam Fleck, an analyst for research firm Morningstar Inc. "That's a concern to us. How long and how far can [the tractor market] continue to grow?"
-By Bob Tita, Dow Jones Newswires; 312-750-4129; firstname.lastname@example.org