Deere’s existing dealer network has a captivated customer base that helps the company maintain number one market share in agricultural machinery and number two market share in construction equipment in North America.
Besides customer relationships, maintaining extensive distribution networks is a critical piece of Deere’s value proposition. Most of its heavy equipment costs several hundred thousands of dollars and is used for mission-critical, time-sensitive tasks such as planting crops. Minimizing unplanned downtime is essential.
Deere has more dealers than its competitors, which allows it to quickly service customers to keep their gear up and running. Service parts have historically accounted for 15-20% of Deere’s overall equipment revenue, underscoring the importance of having strategically-located and well-equipped dealers on call at all times.
Overall, we believe Deere has a strong economic moat. The company has established an excellent reputation for quality, service, and innovation that allows it to consistently raise prices and hold its dominant market share positions.
New entrants would struggle to break the long-lasting relationships Deere’s dealers have built with brand-loyal customers, and substantial capital would need to be invested to develop and manufacture competitive equipment. Smaller rivals also lack the financing arm Deere has that makes it easier for its customers to fund their large equipment purchases.
Deere’s Key Risks
Despite Deere’s numerous competitive advantages, it has little control over the factors that influence demand for most of its equipment.
With agricultural machinery driving the bulk of Deere’s profits, the company is very sensitive to farmer income.
When crop prices are high and yields are good, farmers are much more willing to open their wallets for Deere’s big-ticket tractors and combines.
However, times are not good right now for farmers.
In fact, farmers have never felt worse about their current situation as measured by The Progressive Farmer Agriculture Confidence Index, which started surveying farmers in 2010.
Demand for crops has continued to gradually increase with the world’s population over time, but excess supply has been an issue. The world has experienced bumper crops for several years, which has driven down the prices of many major crops such as grain and corn.
As seen below, net farm income skyrocketed from 2010 through 2013 thanks to strong commodity prices and healthy agricultural exports.
However, after peaking out at $123.3 billion in 2013, U.S. net farm income plunged over 50% to hit $56.4 billion in 2015.
Source: Congressional Research Service
While the USDA’s Economic Research Service expects U.S. net farm income to fall just 3% in 2016 (much less than the 27% drop in 2015), the decrease would bring farm income to its lowest level since 2002.
The ups and downs of the agricultural market are to be expected, but some investors can’t help but be reminded of the 1980s farm crisis which saw an economic crisis “more severe than any since the Great Depression.”
The farm crisis of the 1980s caused Deere to cut its dividend from 32.9 cents per share in 1981 to 12.5 cents in 1983. Annual dividend payments didn’t recover back to 33 cents per share until 1990.
Leading up to the crisis, farmers took on substantial amounts of debt to finance their land, crop inputs, and equipment.
Interest rates began to surge leading up to the farm crisis with the prime lending rate tripling to exceed 20% in 1981, an all-time high.
At the same time, unfavorable economic environments and geopolitical factors combined to cause crop prices to collapse.
