While China’s recent economic slowdown can only be blamed for some of the market’s recent hiccups, it’s 100% responsible for the indigestion happening at both Caterpillar (CAT ) and John Deere (DE ). As the mining, heavy construction and agriculture industries have drifted lower, much in part due to lessening demand from China, CAT and DE have fallen by the wayside.
DE is down about 11% over the last 52 weeks, while CAT has plunged 17% in the same time frame.
With such big drops, it’s easy for one’s inner value investor to get hungry. After all, here are two of America’s largest diversified machinery plays now trading for peanuts and big dividend yields. But which is better? Both have their warts and good points.
For investors, it’s time to put the old debate to rest and place our bets on the better heavy machinery play.
China and Falling Commodities Hurt
When China was expanding like gangbusters, so were the earnings at Deere and Caterpillar. China couldn’t get enough of the duo’s trucks, bulldozers and other heavy equipment. The unfortunate thing for both CAT and DE is that China decided that it had enough empty cities and began to move towards a consumption-based economy. That shift hurt CAT and DE right in the wallet over the last year.
As if China wasn’t enough, recent downturns in commodity prices have hurt incomes at mines and farms all across the globe. With less money to spend on expansion and an onus to reduce CAPEX spending, paying for the latest tractor or multimillion dollar dragline isn’t a top priority for most end users. Even less so when the dollar is rising like crazy.
With that in mind, sales at the two firms have dropped hard over the last few quarters. The latest reported quarter saw sales tank at DE and CAT by13% and 23%, respectively. Obviously, that sort of sales and profit drop is enough to make shareholders wince and flee for the exits.
Longer Term Is Still Rosy, Especially for DE
But investors aren’t concerned with relatively poor short-term performance. The name of the game is the long haul, and here the edge might go to Deere.
For starters, agricultural commodity swings tend to be shorter than metals or other materials, sometimes as short as one planting season. That has to do with the fact that you can only store food for so long before it spoils. That gives DE an edge over Caterpillar with regards to seeing a rebound in sales faster.
Second, agricultural commodities seem to have the most robust long-term demand. The world population continues to increase, recently hitting 7 billion. That number is set to hit 9 billion by the year 2050, which means a lot of mouths to feed on not much arable land. Not to mention that rising incomes have pushed many of the world’s citizens up the food chain and into higher protein/meat-based foods. That pressure for the agricultural community to perform will have them spending those big bucks over the longer haul and benefit Deere immensely.
On the flipside, resource conservation, recycling, and other sustainability measures have started to work their ways into the metals and minerals markets. That’s helping to slowly dwindle long-term demand for several key basic materials, which could spell problems for CAT over the really long haul. And if that scenario doesn’t come to fruition, DE does make an entire line of heavy construction and mining equipment. CAT, however, sold its agricultural division to AGCO (AGCO ) back in the early 2000s. Caterpillar is basically a one trick pony now.
On the stock side of things, DE wins again.
The recent drop in share prices has pushed down multiples. Deere can now be had for a P/E of 14. That compares to Caterpillar’s 19 times trailing earnings. Investors are buying into a rosier long-term picture at that cheaper price. Meanwhile, profit margins and return on equity are consistently better at DE than CAT.
And while CAT does feature the larger dividend yield, currently 4.46% versus DE’s 2.96%, Deere’s payout ratio is much lower. That lower payout ratio of around 42% provides plenty of room for future increases. Deere also wisely skipped raising its payout at the end of 2015, just like it did in 2009, to preserve some cash and bolster its balance sheet. That’ll help it weather the current storm better than CAT. It also provides firepower to take over or buy out struggling rivals like Joy Global (JOY ) or Manitowoc (MTW ).
Run With Deere
At the end of the day, it’s easy to see how DE is a better pick. With a better long-term picture than CAT and better financials, Deere has the goods to keep paying into the future, long after the current commodities mess is behind it. Looking at the two, side by side, DE is better on paper and in execution. Investors looking at the two heavy machinery plays should stick with DE. After all, that’s what Warren Buffett and Berkshire Hathaway (BRK.A, BRK.B) did.