Drought casting shadow on Deere, ADM’s outlook
BY FRANCINE KNOWLES Business Reporter/fknowles@suntimes.com July 17, 2012 7:04PM
Stunted corn grows in a field next to a cattle feed lot in rural Springfield, Omaha, Neb., Tuesday, July 17, 2012. The drought gripping the United States is the widest since 1956, according to new data released by the National Oceanic and Atmospheric Administration. (AP Photo/Nati Harnik)
Updated: August 19, 2012 6:23AM
The worst drought to hit the Midwest in decades is expected to hit Illinois-based agricultural processor ADM and farm equipment maker Deere & Co., analysts say, and the dire situation prompted a downgrade of Deere’s stock Tuesday.
Decatur-based ADM, a grain processor whose end products include cooking oils, sweeteners, animal feed and ethanol, faces higher raw material costs amid the drought, noted Morningstar Inc. securities analyst Min Tang-Varner.
“If the company cannot pass on price increases dominated by higher corn and soybean prices, it’s very likely to get its margins squeezed,” particularly its ethanol business, she said, where margins had already been squeezed due in part to overcapacity.
ADM, which also transports and stores corn and soybeans for farmers, could see that end of its business hurt in North America as well, she said.
“Like others in the agriculture industry, we are monitoring the drought and the weather forecasts very closely,” ADM spokeswoman Jackie Anderson said in an email statement.
Meanwhile, Moline-based Deere is expected to experience weaker equipment sales from August into next spring because of the drought, JPMorgan Chase & Co. said in downgrading the stock to “underweight” from “overweight.”
In making the downgrade, analyst Ann Duignan cited expectations that crop yields will decline due to the widespread drought.
“While mathematically cash receipts continue to rise on higher prices, farmer sentiment is driven by both prices and volumes,” Duignan said in the research report. “Given the solid sales over the past five years, we believe that many farmers will simply take a ‘wait and see’ attitude to equipment purchases towards year end and into 2013.”
Farmers have been spending at elevated levels for four to five years, implying they can hold off on spending for a season to rebuild confidence and cash, she noted.
JPMorgan Chase cut its price target on Deere stock to $78 from $98.
Deere spokesman Ken Golden said given that the impact of the drought on crop yields won’t be known for several weeks, “It would be premature for Deere to make predictions.
“Historically, farm cash receipts are the best indicator of future sales of John Deere farm equipment,” he said in an email. “Our expectation for this year is that farm receipts will remain strong.”
But higher receipts haven’t always boosted farm equipment sales, according to a July Morningstar report looking at the impact of the drought on agriculture companies. In 2002 and 2006, lower production levels and crop yields brought year-over-year cash receipt growth, but led to a drop in high-horsepower tractor sales, the report said. And difficult weather conditions last year led to a nearly 30 percent increase in cash receipts, but just a single digit year-over-year climb in high-horsepower tractor sales, the report noted.
Morningstar industrials analyst Adam Fleck said Deere’s combine sales will likely suffer short-term, since farmers will be harvesting less.
Three-quarters of Illinois is suffering from a persistent severe drought, and half of the continental United States now faces drought conditions, according to the National Climatic Data Center. It is the largest area hit by drought in the U.S. since 1956.
