Can Deere & Company (DE) Sustain Its Debt?

Deere & Company (NYSE:DE)  could be one of the best stocks to own for the next 100 years. The company is involved in the manufacture and production of food and cutting of timber, two services that people will always need.  Even if we stop eating food and chop down all of the trees in the world, I believe the company would still find another market to supply.

That said, there is one thing that worries me about John Deere: the company’s rapidly growing pile of debt.

Deere’s long-term debt has grown 60% over five years. In addition, net debt has grown 37%, which is surprising considering how profitable Deere has been in the past few years.

Should I be worried about this growing debt?

Compared to Deere’s closest competitor Caterpillar Inc. (NYSE:CAT) , Deere’s net debt is growing rapidly. Joy Global Inc. (NYSE:JOY) , my favorite equipment manufacture on the market, has also increased its debt, but as I have covered below it’s the net debt to EBITDA ratio that reveals the most about these firms.

This chart, constructed from the table above, highlights the rising debt of Deere. Deere’s cash pile is growing as well; however, it is not growing faster than debt, resulting in a rapidly rising net debt position as the company borrows money faster than it can pay it off.

Caterpillar’s debt profile shows a different picture. While Deere & Company (NYSE:DE) is increasing net debt faster than its cash balance, CAT’s net debt pile is falling as the company reduces short term debt and improves its cash position.

In comparison to both CAT and DE, JOY has a great debt profile. The company had a net cash balance of $800 million 2010 and this strong cash balance has offset the majority of the company’s debt over the past five years. However, after recent acquisitions JOY’s net debt has grown leaving the company with a smaller cash balance and a $1 billion net debt position.

However, I believe that Joy will soon be able to pull itself back to a net cash position as the company remains extremely cash generative.

So in comparison to its competitors, Deere has a poor debt profile and poor cash management.

Net debt to EBITDA

A more balanced way to look at company debt is net debt to EBITDA. This method gives a comparable number to compare the company against the industry.

This chart highlights the deterioration of Deere’s position.

Deere & Company (NYSE:DE) has consistently had the worst debt to EBITDA ratio since 2009. That said, although Caterpillar has had the highest levels of debt in dollar value, on a net debt to EBITDA basis the highest CAT’s ratio has been is six – slightly below that of Deers’s highest figure.

However, this was in the middle of the credit crunch of 2009, so it is understandable that CAT would have lower earnings, and as a result a high net debt to EBITDA ratio.

Deere’s ratio also peaked at 6 in 2009, but it rose back up to six last year – a year when Deere achieved record earnings; this indicates that Deere’s debt has risen much faster than the company can comfortably finance.

Joy Global has kept its net debt to EBITDA ratio below 1 over the past five years, signifying the company could pay off all of its debt in less than one year from earnings.

Financing Costs

Fortunately, Deere’s financing rates are low and the company is able to borrow at a very low interest rate. Deere’s financing costs have not been more than 10% of EBIT since 2008. CAT’s rates have been even lower, and Joy’s financing rates are high because the company is smaller.

As Deere’s financing rates are so low, it indicates to me that DE can continue to sustain its debt in the current environment. However, if there is a sudden fall in earnings or interest rates go up, Deere could start to struggle. Indeed, with a net debt to EBITDA level of 6, it would take Deere more than six years to pay its debt pile off – if orders remained at their current strong levels.

Overall

So overall, at current levels I believe John Deere is able to sustain its debt. However, even though Deere is currently generating record earnings, net debt is still six times EBITDA.

If Deere continues to generate record earnings then the company can manage its debt but if earnings start to fall, the company borrows even more or interest rates rise, John Deere could face some very serious problems with its debt.

In addition, when Deere’s debt is compared to its competitors the company appears to have the highest net debt to EBITDA ratio and the fastest growing net debt position. That said, Deere is still able to finance its debt relatively cheaply.

Deere & Company (NYSE:DE) is able to sustain its debt, but only if all factors remain constant and the company continues to achieve record earnings–not to mention interest rates remain low.

Data Source: Saxo Capital Markets, Marketwatch

The article Can Deere Sustain Its Debt? originally appeared on Fool.com.

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