How Brazil Will Affect Deere

For Deere (DE), Brazil has been the major growth country over the past few years. Net sales for Deere from Latin America has increased at a compound annual rate of 18% from 2007 to 2012, and its Brazilian manufacturing units enabled it to double the supplier locations since 2007. Also, the Brazilian government's initiatives to boost its economy have included a subsidized financing interest rate for farm equipment. These factors have helped Deere to gain market share of around 21% in the Brazilian farm-equipment market.

To gain additional market share in Brazil, Deere will invest nearly $40 million in its fourth-quarter of 2013 to enhance its capacity for manufacturing "8R" tractors. It is also expecting to make the 8R eligible for FINAME financing -- the public program that targets investment in Brazil's economic development. The acceptance of 8R tractors in FINAME financing category will allow the farmers access to these tractors at the subsidized interest rate. Reconfiguration of its Brazil facility will begin later this year, and production of 8R tractors will begin there in 2015. With this capital expenditure in Brazil, Deere will also increase the number of suppliers in the region to enhance its presence, which will help the company grow its top-line by capturing market share from other companies such as Agco (AGCO) and CNH Industrial (CNHI), which have 47% and 25%, respectively.

Interest rate in Brazil a key concern

To control inflation, the Brazilian government is increasing the interest rate this year. The Selic overnight rate rose to 10% last month from 7.25% in April. The rise in financing cost and fall in crop prices, which supported Deere's agriculture equipment sales last year, can lead to lower demand in Brazil. Corn prices are under additional pressure as the government proposed to reduce the amount of corn-based ethanol blended into gasoline, which has supported corn prices in the past. The corn prices declined by around 40% this year, from a high of $8 per bushel to a low of $4.18 per bushel last month. This will affect Deere and other farm-equipment makers such as Agco and CNH Industrial. Rising Brazilian sales previously helped Agco's earnings to grow by 34% compared to same period last year to $126.2 million in the quarter ended in September, while Deere's earning rose by 17% to $807 million in the same period.

With the rise in financing cost, Deere and Agco expect demand in Brazil's $10 billion market to fall next year and thus may see a fall of around 10% in their 2014 Brazilian sales. However, I expect Deere with its $40 million investment in increasing 8R tractor production and constant efforts to include 8R in FINAME financing will offset some of this decline.

Brazilian National Vehicle Manufacturers Association, or Anfavea, estimated that before the decline in 2014, total Brazilian tractor sales are expected to reach a record level of 66,000 units this year, compared to 55,819 units last year with the year-over-year sales growth of more than 18%. Considering factors such as rise in interest rates and fall in crop prices, Deere has reduced year-over-year fiscal year 2014 earnings expectations by 6.75% to around $3.3 billion, or $8.55 per share, which is higher than the analyst expectations of $3 billion. I expect the company with its initiatives to maintain future growth will achieve its target and build the base for its future growth.

Conclusion

Fiscal year 2013 was one of the most profitable years for Deere, in which its EPS grew by 19% year over year. The rise in interest rates in Brazil will act as headwind for the company; however, Deere's strategies to strengthen its presence in Brazil will help the company offset some of the decline expected next year.

Deere with its future growth potential has recently raised its share repurchase authorization up to $8 billion from its existing $5 billion repurchase authorization, which was announced in 2008. Under this $5 billion authorization the company has repurchased $4 billion worth of shares. Moreover, for this quarter Deere has also declared a dividend of $0.51, or $2.04 on annualized basis, which will be payable on February 3, 2014. In the last nine years the company has returned around $11 billion through share repurchases and $4 billion since 2008.

The rise in the interest rates in Brazil will, however, put pressure on revenue next year. If its 8R tractor is accepted in FINAME financing, it will offset some of the negative effects of higher rates. Further, Deere's repurchase is expected to retain the investors' interest in the company. Considering all these factors, I recommend a hold on this stock.

Source: How Brazil Will Affect Deere

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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