Explaining Market Action Yesterday

Before getting into our initiation of a new name in our portfolio, let's discuss the stock market action yesterday. Early-to-mid trading session yesterday, all major indices were down, with the Dow Jones down more than 500 points, the S&P down nearly 2%, and the Nasdaq down greater than 2%. The move was in conjunction with (or likely caused by) a sell-off in bonds - a move higher in yields (rates). We explained the correlation between yields and valuation just yesterday morning here. The hardest-hit sector during the session was, as usual, the growth-heavy Nasdaq. During the depth of the sell-off, the Nasdaq reached correction territory, down 10% from its all-time high. 

However, the sell-off was reversed by a strong rally into the close, helped by a move higher in bonds - lowering the yields. Ultimately the Nasdaq closed 0.05% higher, Dow Jones closed down only 162 points, the S&P 500 closed down only 0.14%. Our view is that this morning we will likely open and trade higher - what traders usually refer to as a "turnaround Tuesday" after days of selling. 

Today and tomorrow we will hear from Fed Chair Jay Powell, as he testifies in front of Congress for his re-nomination. While there's always a 50-50 chance for everything, we actually think the event will be good for the market. Market has been de-risking Fed's hawkishness since last week when we received the FOMC minutes; it is unlikely that this time Chair Powell will say anything hawkish that the market has not anticipated. This actually leaves room for Chair Powell to walk back some of the hawkishness, and such tone would fuel a come-back rally. Ultimately, regardless of the outcome, our view of the economy, the stock market and our investing strategy for 2022 remains unchanged.  

That brings us to today's topic, which is our addition of an industrial name to our portfolio.

Initiating Deere (DE) 

On Friday last week, we added Deere (DE) to our portfolio. This is an agricultural equipment manufacturing company. As we mentioned in the note, the move was to de-risk our portfolio from being too dependent on Ford, and the capital was utilized towards another cyclical company. In today's post, let us introduce our investment thesis in Deere (DE).

From company:

"We conduct business essential to life. Running for the people who trust us and the planet that sustains us, we create intelligent connected machines that enable lives to leap forward. We rely on more than 180-years of experience and terabytes of precision data to know them and their businesses better than anyone else. Our easy-to-use technology helps deliver results they see in the field, on the job site, and on the balance sheet. We ensure seamless access to parts, services, and performance upgrades from take home to trade-in by providing world-class support throughout the lifecycle of their equipment, with productivity and sustainability always in mind."  

Agriculture and construction equipment company Deere & Co. is benefiting from the significant year-over-year increase in corn, wheat and soybean prices, one of the primary drivers in farmer purchasing power.

Another factor that is driving the company's revenue is the adoption of new equipment that incorporates precision farming technology. That technology is helping farmers drive crop yields higher while also realizing cost savings, which makes the new technology a productivity upgrade compared to older equipment. The global population of has risen almost 30% since the start of the century while the percentage of arable land across the globe is little changed over the last decade, according to World Bank data. What this means is we have more people looking to eat, which means driving yield improvements when and where possible, which is another driver for the upgrade to precision ag equipment. With arable land shrinking while the global population increases, farmers will need to produce more with less, which should drive demand for precision agricultural equipment.

For 2021, Deere sees a 25% to 30% increase in its Production and Precision Ag business and a 25% gain in its Small Ag and Turf business. True to form, those increases, particularly after a weak 2020, should drive significant operating margin expansion as volumes ramp up, fixed costs are absorbed and manufacturing synergies are realized. That expansion should drive a meaningful jump in earnings per share this year, and the current consensus forecast calls for Deere to deliver EPS of $18.92 vs. $8.69 last year. Meanwhile, the jump in farmer income this year should lead to continued equipment purchases in 2022, driving revenue and earnings for Deere higher year over year.

Supply chain issues and bottlenecks hampered production for much of 2021, the same story we heard with Ford; we know that 2022 is going to get better. Second, late in 2021, Deere employees were on strike in Illinois, Iowa and Kansas after union representatives failed to reach a labor agreement with the company; the issues had been resolved. We're choosing to get in now that those risks have been resolved.  

We're initiating Deere (DE) with a price target of $485, by applying a forward P/E multiple of 17x for 2023 estimated EPS of $28.67.