[00:02:36] Shawn O’Malley: As an investor, though, I want to know how that translates to shareholder value and whether the company is being attractively valued today. Before we get into all that, let’s start at the beginning. For over 155 years, John Deere has used its distinctive Deere logo as the face of its brand. Headquartered in Illinois, the company’s roots are tied humbly to middle America, having been founded there in 1837.

[00:03:00] Shawn O’Malley: From agricultural machinery to diesel engines, forestry machinery, lawn care equipment, and everything in between, Deere has built out a fairly diversified business. Deere’s first innovation came way back in the day when the original John Deere himself pioneered a new way of plowing soil using steel, as opposed to the then common iron or wooden plows that were a lot less effective and would get stuck more frequently.

[00:03:24] Shawn O’Malley: The traditional way of doing business was to make the product at the time it was ordered, but that is, of course, a very slow way to do things. As Deere realized this wasn’t a viable business model, he increased the rate of production by manufacturing plows before putting them up for sale, which allowed customers to not only see what they were buying beforehand, but also allowed them to purchase his products straight away.

[00:03:46] Shawn O’Malley: Word of his products and their availability began to spread quickly, and the company soon began producing hundreds of steel plows a year. But it wasn’t until 1918 that Deere began producing its world famous tractors. While John Deere is no longer family run, it was for most of the 20th century, and that has made a lasting mark on the business’s culture.

[00:04:07] Shawn O’Malley: Over the last two centuries, Deere has endured recessions, world wars, pandemics, and new competitors at every corner, and yet it has survived. To me, that alone is incredibly impressive. Along the way, its stock has been a staple of the New York Stock Exchange after first listing all the way back in 1912.

[00:04:24] Shawn O’Malley: After having already been around for some 55 years, the company was by no means young when it was first listed either. I was even more blown away to read that throughout its 186 year history, Deere has only appointed 10 CEOs, making for an average tenure of almost 19 years. That’s a wonderful illustration of the sort of longterm mindset that permeates throughout the company.

[00:04:47] Shawn O’Malley: Compare that with the average CEO tenure for the rest of corporate America at just over four and a half years. Today, John Deere employs more than 80, 000 people and is one of the 100 biggest companies in the U. S. It continues to sit at the forefront of its niche, experimenting with new technologies like electric tractors and even self driving tractors.

[00:05:07] Shawn O’Malley: After acquiring NavCom in 1999 to add GPS capabilities to its equipment, technology became an increasingly important part of Deere’s identity. In 2017, it took another big step forward by bringing machine learning and big data into agriculture when it acquired Blue River Technology. Blue River’s technology now enables John Deere equipment to use computer vision to do things like recognize in real time whether a plant is a crop or a weed, and if it’s a weed, it processes that in a fraction of a second and then sprays the exact amount of herbicide to kill it.

[00:05:40] Shawn O’Malley: So this is some really incredible technology that’s making agriculture even more efficient and productive. And that is what John Deere has always been about. Correspondingly, Deere has made a substantial effort to develop so called smart machines to make farming faster, including through software, which would mean higher margins for the business.

[00:05:59] Shawn O’Malley: Thus, the company has said it wants to connect 1. 5 million machines in service and a half billion acres of land in use to its cloud based John Deere operations center. As John May, the company’s CEO, put it at the last Investor Day, quote, in the past, we would rely on planting more acres, increasing horsepower, and applying more nutrients.

[00:06:20] Shawn O’Malley: In short, we could always do more with more. However, today, in agriculture, we must do more with less, and our ambition at John Deere is to help our customers do exactly that. It’s also worth mentioning that, as agricultural equipment becomes more high tech and sophisticated, this has come with some controversy.

[00:06:38] Shawn O’Malley: We’ll talk more about this, but an important part of the company’s business is to provide maintenance and repair services, and third party technicians cannot service more recent John Deere models since only John Deere has access to the necessary computer code. As such, farmers have protested in favor of having the right to repair their own equipment, and argued that Deere dealerships effectively have a monopoly over repairs.

[00:07:01] Shawn O’Malley: Unsurprisingly, Deere disagrees, and claims that farmers can still conduct around 98 percent of repairs. The only repairs the farmers can’t make themselves apparently relate to software modifications, which Deere doesn’t allow them to make because the tweaks could leave them non compliant with environmental regulations.

[00:07:17] Shawn O’Malley: And then, on top of this, some equipment can be remotely locked by the manufacturer, which is how John Deere deactivated a bunch of equipment that Russian soldiers stole from Ukrainian farmers. So, in that case, that feature was useful, but you can imagine how farmers elsewhere might be frustrated that this privacy violating capability exists.

[00:07:36] Shawn O’Malley: Congress and a handful of states have gotten involved in the right to repair debate, and in January 2023, Deere capitulated and agreed to enable independent repairs of their equipment. This isn’t nearly as acute of an issue in the way that it was just two years ago, but I doubt we are at the end of this saga either.

[00:07:54] Shawn O’Malley: Turning back to the business, let’s first talk about some of the different ways that Deere makes money. John Deere has four core business segments with about 44 percent of revenues coming from production and precision agriculture, aka PPA, 24 percent from construction and forestry, 23 percent from small ag and turf, and almost 8 percent from its financial services division.

[00:08:18] Shawn O’Malley: And then geographically speaking over 55 percent of its sales come from the U S in particular, and then 15 percent from Europe, 13 percent from Latin America, 7 percent from Canada. And then the rest are from Asia and Africa. Production and precision ag obviously is the company’s major product area. Then with the most significant equipment types in that category being large tractors, sprayers, and combines.

[00:08:43] Shawn O’Malley: For reference, Deere’s large tractors sell for around 600, 000 and are absolute workhorses that farmers can use throughout most of the year. That’s the price of a house, but it can definitely be worth it. Farmers also rely on sprayers to apply pesticides and other chemicals, which can dramatically boost crop yields and retail for around 500, 000.

[00:09:05] Shawn O’Malley: And then combines, which farmers use to harvest crops, can cost over 1 million. All in all, large farm operations can have millions of dollars of equipment at their disposal. According to some industry sources, combines specifically are deer’s main competitive advantage, since their models can roughly double a farmer’s speed.

[00:09:24] Shawn O’Malley: Beyond these major equipment categories, Deere also offers custom service solutions intended to help keep equipment running, like machine monitoring, remote diagnostics, and predictive maintenance alerts. You can probably envision the types of equipment that Deere sells, so I want to spend a minute on an important element of its business that may not be obvious at first.

[00:09:43] Shawn O’Malley: And that is Deere’s financial services segment, which primarily provides financing for farmers and other workers who purchase new Deere equipment from dealers or trade in used equipment. It also offers wholesale loans to Deere dealers to help them finance their equipment inventories, and lease options are generally for 17 year terms, with the option to buy out the equipment at the end of the term.

[00:10:06] Shawn O’Malley: Deere’s dealership network is a huge asset since it effectively has over 2, 000 dealership locations in North America alone, helping drive sales for its machinery and another 1, 700 dealers outside of North America. For the most part, Deere uses its own equipment as collateral, so that helps insure some of its loans.

[00:10:25] Shawn O’Malley: But ultimately, the financing division is not about lending in the way that a bank might be. The division primarily exists to enable more sales of Deere products. When you’re buying equipment that costs more than a house, in house financing options make it all the more convenient for farmers to make a one stop purchase.

[00:10:42] Shawn O’Malley: So I guess they’re not taking outsized financial risks here, and I find some comfort in knowing that they’ve been working with farmers for not just decades, but centuries. They really know their customer and who they’re lending to probably better than anyone. This isn’t some random bank trying to get into agricultural lending.

[00:10:58] Shawn O’Malley: Deere’s expertise in this space is hard to beat. They probably know more about the agricultural industry than some agricultural banks devoted solely to lending to it, since they have so much data on their customers. When you look at Deere’s balance sheet, you might be turned off by its 60 billion of debt, but this actually is mostly tied to loans made by its financing division, so the company is not nearly as highly leveraged as it may seem.

[00:11:22] Shawn O’Malley: As mentioned, Deere provides financing for two parties. The dealers that buy the new equipment from Deere and the individuals who buy the equipment from those dealers. In effect, then, Deere Financial is the main client for Deere’s manufacturing division. What I mean is that, basically, when someone wants to buy a Deere tractor, they’ll get a loan from Deere Financial, and they agree to payment terms for the length of the loan and an interest rate on that loan.

[00:11:47] Shawn O’Malley: Deere Financial likewise borrows money to pay Deere’s manufacturing team up front while collecting payments with interest from the customer over time. So while Deere earns revenue from the interest it charges to the customers on their loans, because Deere Financial isn’t actually a bank, they have to go and borrow money too to backstop that loan, which they get charged interest on as well.

[00:12:09] Shawn O’Malley: Hence the massive amount of debt on their balance sheet. But this debt is backed by real equipment sales. It’s not speculative or high interest debt that they’ve carelessly accrued. As long as there’s a low risk of the customer not repaying the loan and the customer pays a higher interest rate than it costs Deere to borrow funds at, then the whole exchange is profitable for Deere Financial.

[00:12:31] Shawn O’Malley: Behind these financial and sales efforts, employees are encouraged to think of each business relationship as one that could survive 75 years or more. That might seem absurdly high until you realize that many of its customer, dealer, and employee relationships are and have been multi generational. So if the financial risk involved here is too much of a turnoff, I think that’s fair.

[00:12:52] Shawn O’Malley: Though I don’t quite see it that way myself. Like I said, this is lending that’s well within the company’s circle of competence, backed by collateral that they know the value of. But altogether, Deere is a manufacturing business, a lending business, a retailing business, and even a software business all wrapped into one, which is why I find the company so interesting to learn about.

[00:13:10] Shawn O’Malley: As Leandro of the Best Anchor Stocks blog describes the company, quote, At first sight, Deere might seem like a low growth, boring company, but the company is currently in the midst of a transition that will not only bring faster growth, but also a transition to higher quality and more recurring profits.

[00:13:29] Shawn O’Malley: Leandro’s coverage of John Deere is excellent, so I’ll continue to reference parts of it and link to his full research article in the show notes below for this episode. For transparency, I also pulled from a post on Value Investors Club by an investor under the pseudonym Madmax989, so I’ll link to that as well.

[00:13:48] Shawn O’Malley: I’ve teased this a bit already, but at the core of this transition is Deere going from just selling equipment and parts and then doing maintenance on that equipment to now pushing towards selling services that can be monetized through a more recurring revenue model via subscriptions, which could have a huge positive impact on the company’s business quality and cyclicality.

[00:14:07] Shawn O’Malley: As John Deere’s CFO said in 2023, we are confident in our ability to produce higher levels of returns through the cycle while dampening the variability in our performance over time. This will lead to higher highs and higher lows for our business. Markets love predictable and sizable recurring cash flows.

[00:14:26] Shawn O’Malley: So if true, this is something to really be excited about from an investment perspective. And by the end of this episode, you should have a good feel for whether you think that is plausible or not. Management expects recurring revenues to make up around 40 percent of the business by the end of the decade.

[00:14:41] Shawn O’Malley: This is a business that’s fundamentally crucial to the modern world. We only consume more and more food each year while populations grow and take up more space, leaving less and less land available to feed everyone. That requires continuous innovation to get more out of every acre, and few companies have played a role like John Deere has in ensuring we can produce enough food for society over time.

[00:15:05] Shawn O’Malley: At heart, John Deere is about saving farmers on costs, which is really the only metric farmers can compete on since they sell commodities. The company’s moat grows wider and wider as management keeps plowing profits back into the research and development of innovative new products, providing farmers with much needed crop yield improvements and costs lessening as they battle the challenge of feeding a growing population with a more hostile and dynamic climate working against them.

[00:15:31] Shawn O’Malley: It’s also important to note that farmers grow crops as food for both humans and animals. For instance, much of the corn and soy grown in the U. S. goes to feeding livestock being raised as meat for human consumption. And some crops are valuable as biofuels. 40 percent of U. S. corn is used to produce ethanol, and 25 percent of soybeans are used for biodiesel.

[00:15:52] Shawn O’Malley: Agriculture globally is a massive business, generating over 5 trillion in gross production value in 2022. It’s up nearly five times over the last three decades, and comes out to a compound annual growth rate of 5. 5%. To grow all that food, farmers must use different fertilizers, seeds, chemicals, water, labor, fuel, equipment, and farmland, which amount to the input costs for everything that’s produced.

[00:16:17] Shawn O’Malley: The biggest costs, proportionately, are the land, the fertilizer, and the equipment. Land and fertilizer alone actually make up more than half the cost, followed by the equipment, which, like land, is a fixed cost. Interestingly, about 40 percent of the world’s arable land is in North America, which is the most mechanized and productive region on the planet for agriculture.

[00:16:39] Shawn O’Malley: For farmers though, the biggest variable in that productivity is arguably fertilizer, which gives plants the nutrients that are building blocks for growth. Different nutrients like nitrogen, phosphate, and potash serve different functions, and farmers are mostly insensitive to fertilizer prices since they have to use them regardless of cost.

[00:16:56] Shawn O’Malley: Fortunately for them, fertilizer prices are down considerably from their covid peaks. But Deere’s identity has certainly expanded beyond agriculture. In 2017, Deere acquired Wirtgen Group for 5. 2 billion, which immediately made the company a leader in road construction machinery focus remains on making our world a bit more productive.

[00:17:18] Shawn O’Malley: Across Deere’s business segments is a commonality in that, besides financial services, the other three units primarily sell equipment, and then these equipment sales produce further revenues in the following years from parts replacements and service. To produce its machinery, Deere relies on 26 North American and 45 foreign factories for manufacturing, and distributes its products through 12 North American and 11 international facilities.

[00:17:43] Shawn O’Malley: Overall, Deere owns around 70 million square feet of facilities and leases an additional 13 million square feet. Using its extensive independent dealer network, the company sells equipment product lines around the globe. These dealers buy the equipment from Deere and later resell it to farmers or construction customers.

[00:18:02] Shawn O’Malley: And dealers are not just responsible for reselling this equipment, but also for servicing the equipment throughout its life cycle. As I’ve said, maintenance is such a big part of the story because these machines are how farmers make their living. It would be devastating to have a tractor out of commission for an extended period of time during a harvest season.

[00:18:19] Shawn O’Malley: So Deere’s approach is all about minimizing downtime as much as possible. Naturally Deere targets the largest scale farmers with its biggest agricultural equipment and precision farming technologies. As bigger operations typically require higher horsepower machines, while benefiting the most from even minor yield improvements thanks to higher end tech.

[00:18:39] Shawn O’Malley: Deere invested heavily throughout the 20th century in creating large equipment that would specifically suit U. S. farms. According to the USDA, around 40 percent of America’s farmland is operated by farms that generate sales of more than 500, 000 per year with an average farm size of 445 acres. So, America has some big farms, and for decades, deer has catered to that.

[00:19:01] Shawn O’Malley: For context, almost two thirds of European farms sit on less than 12 acres, so the agricultural footprint of a typical farm in the US is just massive, and it’s similar in South America as well. But across the world, and particularly in Europe, farms are increasingly consolidating and thus growing in size on average, which makes them better candidates for John Deere’s Large Machines.

[00:19:24] Shawn O’Malley: Farmers also tend to purchase most of their equipment from the same brand to simplify operations, or in some cases with family farms, simply because that’s the brand their family has always used and was handed down to them. If you’re wondering how much family dynamics really matters, here’s a stat for you.

[00:19:39] Shawn O’Malley: 97 percent of all US farms are family owned, and family farms account for 90 percent of all farm production by value. Prior to the digital era, farmers would be loyal to a brand like Deere, but might also buy competitors equipment for less essential purposes. With the advent of digital technology and the cloud, that is becoming a lot less common, in the same way that Apple or Android phone owners usually prefer to buy computers, tablets, and other smart devices with the same operating system.

[00:20:07] Shawn O’Malley: For the most part, that loyalty has worked in Deere’s favor, though the company has tried to freshen up its approach to marketing. With tech enabled precision agriculture becoming core to Deere’s operations, its marketing has revolved around not just selling equipment, but selling solutions. As in, you’re buying a solution for your farm.

[00:20:24] Shawn O’Malley: You’re not buying a piece of equipment anymore. Through building its own technology out and a handful of acquisitions, Leandra writes that what Deere has managed to build is a technological ecosystem for the farm. This ecosystem is sold as a win win proposition, aiming to make farmers more profitable while enabling deer to reap part of this value add through a per use and or subscription based model.

[00:20:47] Shawn O’Malley: Take, for example, its See & Spray technology. Thanks to this tech, farmers enjoy significant savings as they only use fertilizer for bushels that require fertilizer, and according to the company’s most recent quarterly earnings call, See & Spray is now used on over one million acres of land. Before See & Spray, farmers had to spray all crops, even if only 20 percent of the crop needed it.

[00:21:09] Shawn O’Malley: Clearly, using less fertilizer introduces significant savings, since fertilizer costs are a big chunk of farmers variable costs, and even better is that these savings don’t come at the expense of crop yields either. The same is true with herbicides and pesticides. Deere’s machines can see in real time whether a plant is diseased and can kill it off as needed, and as a result of more efficiently recognizing where to spray, Deere claims they can reduce herbicide use by up to 67%.

[00:21:37] Shawn O’Malley: New technologies are typically first retrofitted into existing equipment, and then as adoption goes mainstream and reaches, say, 70 or 80%, they’re embedded into new machinery where an even higher premium for the new features can be charged. As a result of all this new tech enabled equipment, John Deere provides farmers with a virtual operation center to access on their computer or mobile devices.

[00:22:00] Shawn O’Malley: Basically, it aggregates all of the data that’s been collected about their land, how it’s being used, their crops, how their machinery is performing, and more stuff like that. And this is super helpful for planning out a planting or harvesting season, monitoring in real time how things are going, and analyzing whether further optimizations can be made in the future.

[00:22:19] Shawn O’Malley: The Operations Center API has over 250 interconnected software apps to support farmers, including Harvest Profit, an app that helps farmers track the economics of their business, sort of like how a roomba maps out your home and learns how to vacuum it more efficiently. John Deere’s equipment does the same thing.

[00:22:38] Shawn O’Malley: They build a map of the farmer’s acreage, learn its nuances, and then share those findings with the farmers. This could be super subtle stuff like pointing out that there’s some overlap where the farmer is unnecessarily tilling, seeding, or spraying the same few inches or few feet in a row. Or providing suggestions on the exact speed to drive equipment at for maximum efficiency without going too fast and, for example, not spraying crops properly.

[00:23:04] Shawn O’Malley: Deere can also recommend to farmers what varieties of crops to grow. Where specifically on the property to grow them and what crop protections, like certain types of pesticides, should be applied. Farmers work at such massive scales that seemingly small optimizations can make a big difference. Your typical corn farmer in Iowa might oversee thousands of acres of land, plant hundreds of millions of seeds, and lay down hundreds of thousands of pounds of fertilizer.

[00:23:32] Shawn O’Malley: There are also so many other variables involved, like how much rainfall there’s been that year, average temperatures, and how late or how early a frost came. Weather can be a hugely complicating factor that farmers need assistance with. What’s really powerful about Deere’s machine learning here is that it’s not just learning about your farm.

[00:23:50] Shawn O’Malley: It’s been trained on years of data from thousands of other farms. So, there’s just a massive backlog of data to build on and make recommendations off of, and that recommendation engine is only getting more powerful over time. Deere has more sensors taking in agricultural data than anyone. After signing a deal with SpaceX to use its Starlink services, Satellite connected machines are another big part of the story for deer and providing internet to rural areas to keep machines online.

[00:24:19] Shawn O’Malley: For instance, about 70 percent of Brazil’s productive agricultural land is not internet connected. And even in the US, about 30 percent of arable lands aren’t. Imagine a farmer in Iowa for a moment, let’s call him Fred. Realistically, Fred has 40 chances in his lifetime to optimize the economics of his farm and pass on a profitable operation to the next generation.

[00:24:40] Shawn O’Malley: Deere’s aim, then, is to help farmers like Fred accelerate their learning through the power of data and multiply their chances for success. What if Fred could instead learn from 40, 000 other lifetimes through insights gleaned from the digitalization of farming? In digitizing farms, there are now more than 640, 000 connected deer machines in the market, double the level from 2022, and expected to triple by 2026.

[00:25:08] Shawn O’Malley: As tiers management said, the data flywheel gets more powerful as we connect more equipment, collect more data, and generate insights that are not available to individual farmers alone nor to our competitors. As such, the medium term goal is to connect 1. 5 million machines across 500 million acres of land.

[00:25:27] Shawn O’Malley: Here’s another line from the company showing it’s capabilities in action. Quote, We take the high resolution planting data from the planter, we send it to the operations center, and we create a digital representation of where each seed was planted in the field, and this knowledge of the planting lines is then sent back down to the sprayer and back down to the combine so that when farmers enter the field, our equipment can navigate the field using the precise location of each plant that was recorded in a prior step.

[00:25:56] Shawn O’Malley: This all shows why there’s a good case to be made for how the agriculture industry is evolving from one off equipment sales to more software as a service. What’s also powerful about this dynamic, from Deere’s perspective, is that if they can genuinely produce a product that’s more efficient for farmers, then generally speaking, once one farmer adopts it, most others will have to.

[00:26:18] Shawn O’Malley: Otherwise, they will no longer be cost competitive, and it’s not like they can make up for that by just charging higher prices for corn or wheat. Unlike with new editions of an iPhone where you can just shrug off some marginal advancements in technology, even marginal improvements can be a big differentiator for farmers in terms of the returns they can earn.

[00:26:37] Shawn O’Malley: To show what I mean, here’s an outline of what the economics for farmers in the U. S. might look like. A typical US farmer growing soybeans or corn might earn 500 or 800 per acre in revenue with a 50 percent gross margin and a 5 10 percent net profit margin in a normal year. Just taking the middle point of those number ranges, a farmer with 700 acres growing a staple crop might earn a profit of around 34, 000.

[00:27:02] Shawn O’Malley: Depending on whether they own the land, how they account for their own wages, subsidies, and other revenue streams they may have, the income they actually earn can vary pretty widely, so that’s just a simplified number showing what things might look like, but obviously this is not a high margin business, and saving costs thanks to using the latest tier equipment can go a long way to improving those slim margins.

[00:27:24] Shawn O’Malley: Operating expenses tend to be mostly fixed for farmers, with land being the biggest single line item, so changes to gross profit largely fall to the bottom line, making farm incomes very cyclical. And since farmers are Deere’s biggest customers, that’s in large part why Deere’s business is so cyclical too.

[00:27:42] Shawn O’Malley: For context, according to the Wall Street Journal, on average, about 7 percent of farmers globally replace their equipment each year, with an average useful life of around 17 years. So, equipment purchases are infrequent, and farmers can afford to wait a bit depending on their income in a given year, the needs of their operations, or whether say interest rates are abnormally high, but eventually they do have to make replacements.

[00:28:06] Shawn O’Malley: I won’t spend a ton of time on it, but Deere also produces equipment for what it calls small agricultural and turf operations. In some ways, these are like all purpose vehicles. One of this division’s bestsellers is called the Gator. They’re used everywhere, but I’ve seen them a bunch at high school and college sporting events.

[00:28:23] Shawn O’Malley: They’re sort of like golf carts on steroids that athletic staff love to whip around. And these small ag tractors to yourselves are a fraction of the size of the tractors it sells to larger scale farms, obviously. So it’s small ag and turf segment targets a more retail customer and started doing so through big box retailers like Home Depot and Lowe’s more than 20 years ago.

[00:28:44] Shawn O’Malley: This sales approach is one of the big differences between the smaller equipment that Deere sells and its machines for more commercial purposes, where sales of larger end machines primarily happen through Deere’s dealer network. Despite the stark difference across both segments, it was not until 2021 that Deere split off reporting for its smaller agricultural and turf equipment.

[00:29:04] Shawn O’Malley: While many things might have led management to make that distinction, the main one is probably the rise of precision ag, which is currently much more suited to large agricultural operations. Moving on to describe Deere’s competitive positioning, I’d say this is no easy feat because they produce so many different products and sell them all around the world, but I’ll generalize to sort of give a big picture that is hopefully helpful.

[00:29:28] Shawn O’Malley: Before I tell you about Deere specific competitors though, let me say that Deere benefits comparatively from its massive scale, giving it economies of scale in manufacturing and more resources to spend on R&D proportionately, in addition to its outstanding brand awareness, which further supports sales efforts.

[00:29:46] Shawn O’Malley: Thanks to Deere’s size, even though it spends less as a percentage of revenue on R&D than its next biggest competitor, its absolute spending is four times higher. So that’s a pretty incredible technological competitive advantage, especially for an industry that’s increasingly being defined by technology.

[00:30:03] Shawn O’Malley: And Deere’s well earned reputation has created a whole culture around customer loyalty to the brand, as many farmers proudly don their yellow and green hats while spending most of their equipment budgets at Deere every year. Some farmers say support for Deere is almost territorial or religious, so there’s a real subculture built around owning their products.

[00:30:23] Shawn O’Malley: Deere is the biggest player in an oligopolistic industry, with the most direct competition coming specifically from C&H Industrial and AGCO, though neither match Deere’s size. And Deere seems to be the vastly higher quality operation, given that it’s operating profit margin is about 8 percentage points higher than them both.

[00:30:43] Shawn O’Malley: When I say the industry is an oligopoly with a few big players, with Deere at the forefront of the pack, I mean it. In 1900, there were 166 tractor companies. Today, there are only three full line tractor companies, Deere, C&H, and AGCO, and they collectively control 72 percent of the global market. For agricultural equipment, Deere in particular has 25 percent of market share globally and holds over 40 percent of the North American market by itself.

[00:31:12] Shawn O’Malley: Within North America, they have 60 percent of the market for combines and about two thirds of the market for new high horsepower tractors, so for certain products, Deere is far and away the leader. The competition in construction and forestry machinery is much broader, but Deere is still third in these industries behind Caterpillar and Komatsu.

[00:31:32] Shawn O’Malley: The competitive landscape across other geographies varies, but in short, Deere seems to be an established player worldwide, but does not enjoy a competitive position as strong as that in the U. S. An important benefit for Deere of its scale and sprawling dealership network is that all these locations reduce the distance an average customer has to travel for maintenance work, which is extremely important to all of Deere’s customers, whether they’re harvesting corn or working on construction sites.

[00:32:00] Shawn O’Malley: And Deere’s large footprint in the US certainly contributes to it being a more distinguished market leader there. I do think Deere’s innovation isn’t just corporate buzz either, it really separates them from the competition. Both C&H and AGCO are playing catch up after years of being well behind. C&H, for example, acquired a business called Raven for 2. 1 billion dollars in 2022. Raven makes guidance systems, crop spraying gear, and driverless navigation systems that C&H sells on new machines and retrofits. But many in the industry saw the acquisition as inherently an admission that C&H was behind Deere in building their own tech, making it necessary to buy Raven.

[00:32:42] Shawn O’Malley: In contrast, Deere’s growth has been largely organic and it operates just one tractor and combine brand, John Deere. Recognizable by its ubiquitous green and yellow colors, whereas C&H and AGCO operate multiple brands, so they don’t have the same singular recognition that the John Deere brand has.

[00:32:59] Shawn O’Malley: Honestly, when you haven’t followed a company or industry for years, it can be hard to know the nuances of these kinds of things. Still, by most accounts, it seems pretty well accepted that Deere is the industry leader, both in size and technology. Deere’s management has been quite effective with strategizing and driving industry trends, but also equally capable in financial discipline, too.

[00:33:21] Shawn O’Malley: They’ve overseen a balance sheet healthy enough to earn an A rating from credit rating agencies. And that has ensured that they have access to low cost, short and long term funding as needed. And while it’s often so tempting for companies to acquire other businesses as a way to artificially create growth, Deere’s management team has used M&A selectively, with the 2017 purchase of Wirtgen for 5. 2 billion being the most important acquisition in recent years, while coming at a modest 9. 5 times operating earnings. Wirtgen meaningfully enriched Deere’s road building business while complementing its existing business in earthmoving equipment. The deal moved Deere’s construction equipment business from being the 10th largest in the world to number 3.

[00:34:03] Shawn O’Malley: They also have been diligent about returning cash to shareholders through both dividends and buybacks. Over the last decade or so, Deere has generated nearly 50 billion of operating cash flow, with three fifths of that going toward capital expenditures that are reinvested into the company, 7 billion toward M&A, around 10 billion toward dividends, and 22 billion on share buybacks.

[00:34:23] Shawn O’Malley: Those massive buybacks have been enough to effectively gobble up 20 percent of Deere’s total share count. For the record, large dividend and buyback programs by themselves aren’t objectively a good thing. Dividends are probably the least preferable in my opinion, because not only is Deere paying income taxes on that money, but now they’re paying it out to shareholders who have to pay income taxes on it again.

[00:34:45] Shawn O’Malley: And then when it comes to share buybacks, these are only really creating value for shareholders if the share repurchase price is below the company’s intrinsic value per share, which is sort of abstract, but the point is, I don’t want to see management just buying back stock at any price. We want them to be very intentional about it.

[00:35:02] Shawn O’Malley: But all in all, share buybacks are more beneficial for remaining shareholders because they don’t create a taxable event. The stock price might go up, and you will own a larger chunk of the company, but no taxes are owed from your perspective. So ideally, I like to see companies either fully reinvesting in growth opportunities if they can do so with any remaining cash, and if there aren’t sufficiently attractive investment opportunities, then an intelligent approach to share buybacks is okay too.

[00:35:29] Shawn O’Malley: That’s a bit of a tangent, and I’m definitely being a bit of a perfectionist, but there are good, less good, and bad ways to return capital to shareholders. My impression of Deere is that they do a decent job striking this balance between reinvesting and not letting cash sit idly on the balance sheet, and thus either paying it out as dividends or doing buybacks if the stock is trading at attractive levels.

[00:35:51] Shawn O’Malley: Management actually aims to pay out 25 35 percent of normalized earnings as dividends each year, meaning not the actual earnings that year, but an adjusted number based on where we are in the agricultural capex cycle. I take it as a good sign as well that besides the great financial crisis and a down cycle in agriculture between 2014 and 2018, the company has continually grown dividends for many years.

[00:36:14] Shawn O’Malley: Altogether, since 2004, Deere has returned an impressive 60 percent of its cash flow from operations to shareholders. For Deere, the future remains all about staying on the cutting edge. According to both Deere and third party estimates, it was a nearly 160 billion addressable market for incremental advances in agricultural, construction, and forestry technology.

[00:36:36] Shawn O’Malley: The company expects to capture about 25 percent of that value in the coming years. That implies that Deere has 38 billion of additional revenue growth opportunities before it. One example of what this would look like is Deere’s focus on building self driving agricultural vehicles. While some equipment can already be remotely controlled, imagine if almost the entire process was autonomous.

[00:36:59] Shawn O’Malley: You could run tractors and combines 24 7 with no sick days. This isn’t a distant dream either. They plan to have a fully autonomous corn and soy production system by 2030, including spring tillage, planting, spraying, harvest, and fall tillage. Deere is also leaning into climate tech, too. They recently introduced electric drivetrains for their equipment.

[00:37:21] Shawn O’Malley: These help to reduce fuel costs and carbon emissions, and their use often comes with government subsidies, which are complemented by the fact that many farmers have on site renewables, like wind and solar, to help power their vehicles. Correspondingly, Deere offers its own battery technology and charging infrastructure.

[00:37:38] Shawn O’Malley: Deere is just such a cool company to me. Maybe I was the only one who didn’t realize it, but I had no idea they were such a trailblazing company in this way. I’ve only been more and more blown away as I’ve learned more about them. It’s easy to get excited about all the different things they’re working on, especially since they have such a strong track record in bringing their capabilities to life.

[00:37:58] Shawn O’Malley: Continuing to look ahead, the consensus on Wall Street seems to be that Deere’s revenue will be flat in 2025, but will grow again by 4 percent in 2026, and Morningstar forecasts approximately 5 percent annual revenue growth from 2026 through 2028. For Deere, it helps that farmers are so relatively flush with cash, and their equipment fleets are older than in prior business cycles, but on the flip side, farm income is falling off its peak, and the geopolitical environment is fragile, to say the least.

[00:38:27] Shawn O’Malley: And in construction equipment, strength from infrastructure spending, thanks to large government spending plans like the Inflation Reduction Act, is partially offset by slowing growth in residential home, office, and retail construction. The biggest knock on deer as a quality compounder is simply the inescapable cyclicality of the farming industry.

[00:38:46] Shawn O’Malley: The normal business cycle has its ebbs and flows, but the ag cycle is like a chicken with its head cut off, bouncing around. Spinning can jump unpredictably based on everything from weather, crop disease outbreaks, labor availability, and commodity prices, to interest rates and government policies. But Deere’s sales are fundamentally connected to how farmers are doing, as farmers net cash flows are the biggest cyclical driver of demand for Deere’s high priced equipment.

[00:39:11] Shawn O’Malley: Beyond agriculture, Deere is tied to cyclical trends in housing market conditions, consumer spending patterns, and general economic conditions that affect demand for its lawn and garden tractors, residential and commercial mowers, and golf and turf equipment. Same story for its forestry, road building, and construction equipment.

[00:39:30] Shawn O’Malley: Deere’s global operations definitely help to nerf some of this cyclicality since different countries have different weather and economic trends, but it doesn’t completely eliminate the fluctuations. 2022 and 2023 were exceptionally strong years for Deere, so 2024 has marked a significant pullback in spending on their machinery, the number of sales metrics declining by 10 20%.

[00:39:51] Shawn O’Malley: 2024 was largely a below average year, with revenues and profits coming in at roughly 80 90 percent of what management thinks it can earn mid cycle. Lower commodity prices and higher interest rates, plus some abnormally high weather volatility have made it a bad year for the global agricultural industry.

[00:40:10] Shawn O’Malley: Without a doubt, Deere has felt the effects of that, which again, is not unexpected. So don’t let big year over year declines in revenues, profits, and even profit margins scare you. I’m not saying to write these off if they’re worse than expected. That’s just what happens in cyclical businesses like Deere.

[00:40:27] Shawn O’Malley: Looking at 2024, Deere’s CEO says they were at the same point in their business cycle in 2020, meaning 2020 is a better year for comparison than, say, 2023 or 2022. In 2024 versus 2020, operating profit margins were 7 percentage points higher, showing how Deere has structurally lowered costs and improved profitability throughout the organization.

[00:40:49] Shawn O’Malley: When thinking about risks with Deere, there’s a lot to consider. Misreading the business cycle around agriculture and machinery spending more broadly could mean investing at a bad time, or totally miscalibrating your valuation for the company. Deere is also exposed to potential union related issues since 80 percent of its US production and maintenance employees are unionized, as are most international employees as well.

[00:41:11] Shawn O’Malley: 10, 000 of Deere’s workers went on strike back in 2021 for five weeks. Beyond the production disruptions was the cost of the negotiations themselves, where Deere agreed to immediately raise salaries by 10%, with more raises promised in the future and a 8, 500 signing bonus. The incremental cost of these salary increases will come out to around 300 million a year, according to Deere’s CFO.

[00:41:36] Shawn O’Malley: More speculative risks include the possibility that plant based diets and lab grown meats will change food consumption patterns globally, which would ripple back and affect big agriculture in the future. Changes in inflation and interest rates can also have considerably negative effects on farmers and their ability to continue spending on the latest machinery.

[00:41:54] Shawn O’Malley: And then there’s of course an element of credit risk in Deere’s financial services subsidiary, where an economic downturn could trigger an above average wave of defaults on machine and equipment purchases. There are also all sorts of operational risks, from falling short of promised technological innovations to building up too much or too little inventory.

[00:42:12] Shawn O’Malley: Being an industry leader in the way that deer is can be a blessing and a curse, too. As it sits at the forefront of agricultural equipment, this just means that every other company is coming after them specifically. Complacency, then, is a real risk for Deere. Resting on its laurels is the worst thing it could do.

[00:42:29] Shawn O’Malley: You could probably say as well that a lack of high insider ownership at Deere is a risk in its own way, in the sense that this could be a red flag about the culture, management’s incentives, or just whether management has much faith in the business at current valuation levels. This is sort of a mixed bag.

[00:42:44] Shawn O’Malley: On the one hand, I always pay attention to insider ownership because it can definitely signal important things about the company. On the other hand, high insider ownership can mean that management is being egregiously compensated with stock options that are very dilutive to existing shareholders.

[00:42:59] Shawn O’Malley: Otherwise, for a company as big as Deere, it just takes a very, very long time to accrue a meaningful stake in the company. And given that the company is almost 200 years old, the original founders, who would naturally be the largest shareholders, are long gone. And as time has passed, I’d say it’s not surprising either that their descendants have ultimately diversified their wealth.

[00:43:19] Shawn O’Malley: The point is, this isn’t some tech startup where the CEO has no skin in the game. This is an old and massive company. So even for someone who’s been on the management team for a decade to accrue what you might call a significant stake would be challenging. The 120 billion market cap, you need to have more than 1 billion worth of stock just to have a 1 percent stake in the business.

[00:43:39] Shawn O’Malley: And as I said, if an insider today can build up that large of a stake, they’re probably being way overcompensated at shareholders expense. What matters more than the percentage of insider ownership is the incentive structure for management. And Deere made an excellent change to its compensation structure in the early 2000s by prioritizing shareholder value added as the core metric for manager’s compensation.

[00:44:02] Shawn O’Malley: Former CEO Robert Lane led the initiative after concluding that the company had done a good job creating value for employees, farmers, and communities, but had not been a great company for shareholders. The goal then was to make Deere an outstanding company for shareholders too, and by all measures, the change in compensation structure has worked as hoped.

[00:44:21] Shawn O’Malley: For example, instead of just incentivizing management to reach specific revenue or profit targets, the new incentive structure relates more to capital allocation, connected to metrics like operating profit margins, return on assets, and more. Return on equity for the financial services division. So I’m not losing sleep over what you might consider an uninspiring degree of insider ownership since they focus on large insider ownership is typically more realistic with smaller or at least younger firms.

[00:44:47] Shawn O’Malley: You might find it interesting though that Bill Gates is actually one of the largest investors in Deere, which compliments the fact that he’s also the largest owner of farmland in the US. So through his firm, Cascade Investments, Gates is all in on agriculture with enough conviction in Deere to own more than 7 percent of its total outstanding shares.

[00:45:06] Shawn O’Malley: That’s a massive position. Bill Gates is obviously a smart guy, and I’d imagine that Deere stood out to him as he built up his investment in farmland and learned more about the agricultural industry. Before I get into Deere’s valuation, I want to share an anecdote on John Deere. Investing legend Phil Fisher called this the scuttlebutt approach to investing.

[00:45:25] Shawn O’Malley: The idea is to try and talk to as many stakeholders as possible in a business to understand it. Anecdotes are only worth so much individually, but you can sort of build a mosaic of insights from conversations with employees, customers, and competitors. For me, I always try to take a scuttlebutt approach to investing and ask people what they think, or at least go on someplace like Reddit and see what’s organically being said.

[00:45:48] Shawn O’Malley: So I spoke with my colleague, Clay Finck, who hosts our We Study Billionaires podcast, and whose dad and brother are actually farmers in Lincoln, Nebraska. Clay told me that most farmers where he’s from use John Deere, and the big farmers especially seem to always use Deere. From his perspective though, it wasn’t so black and white as to say whether people love the company.

[00:46:07] Shawn O’Malley: He said that with his dad, it’s tough to say whether he likes the brand at all or not. While he would probably never switch to another brand, Clay feels that John Deere and other big players in the agriculture industry are squeezing margins for everyday farmers like his dad. He told me that a big reason his dad used his Deere is that they have dealers nearby to help him fix equipment, which again very much aligns with the research I’ve read on the company.

[00:46:28] Shawn O’Malley: Where Clay’s grandpa could fix equipment on his own, the technology is too high tech nowadays, so his dad frequently has to call the dealers to fix things, and that assistance is not cheap. Accordingly, Clay and I both believe that having dealers all over the country is a strong moat for deer.

[00:46:43] Shawn O’Malley: Willingness to pay up for quality machinery and loyalty to a brand like deer is not an irrational perspective to have, even if farmers are sometimes frustrated by the company, given that the cost of large tractors spread over their useful life represents only about 2 percent of farm revenue. This is a much lower percentage than a farmer would spend on seed, fertilizer, and labor, and yet these machines are vital.

[00:47:04] Shawn O’Malley: So even if they’re not always happy about being stuck in the middle of Deere’s product ecosystem, they’re still likely to keep paying up. Farmers have a short, weather restricted window to complete a task, such as seeding or reaping, And it is critical that the large farm machinery is working when needed.

[00:47:19] Shawn O’Malley: So like I said, having a robust dealer network for repairs is a major advantage. A good scuttlebutt approach is more thorough than this and talks to many more people, but it’s always reassuring to hear real testimonies to things you read about in some wall street analysis or earnings report. Turning toward Deere’s valuation, one of the tricky parts of this is that it’s not just Deere’s revenues that swing during cyclical turns, their profit margins can fluctuate wildly too.

[00:47:44] Shawn O’Malley: Deere’s operating profit margins swung from 15 percent in 2013 to 9 percent in 2015 and has leapt higher to over 25 percent today. So if you were really trying to build out a discounted cash flow model to value the company and project its growth, you’d have to not only get its revenue growth right, but you’d also have to have a good feel for where its profit margins would go correspondingly as well.

[00:48:05] Shawn O’Malley: Margin swings to this extent are not that common, and it really does complicate the evaluation by adding in more layers of assumptions. However, I do think Deere’s higher profit margins are here to stay, since they’ve mostly come from price increases that customers have absorbed thus far, as well as from subscriptions and parts services that are higher margin.

[00:48:24] Shawn O’Malley: It’s also good to see that even in downturns, Deere has remained profitable, and during these downturns, they tend to cut down on overhead expenses rather than R&D, which is good because R&D spending is critical for developing new technologies that will drive the company’s next wave of growth. In the book, The John Deere Way, David Magee writes that, quote, John Lawson was with the company for 44 years and never remembers a time anyone suggested cutting back on research and development spending, even in the toughest times.

[00:48:53] Shawn O’Malley: This is one of those instances where culture really matters. Clearly, Deere has a culture of thinking long term. You could easily take shortcuts and reduce R&D spending in a given quarter to boost profits, but that would ultimately come at the cost of the company’s reputation and new products. And I mentioned this earlier, but Deere seemingly carries a massive debt load, but in reality, these are mostly just loans that Deere Financial has made in underwriting customers equipment purchases.

[00:49:17] Shawn O’Malley: Net debt of $60 billion in a company with $110 billion of market value for its equity would be pretty extreme. At the end of 2023, only about $8.4 billion of its outstanding debt was tied to its equipment operations. With the rest being connected to Deere Financial. This segment also has 6 billion of cash, so the net debt is just a bit over 2 billion, which is a much more conservative picture.

[00:49:41] Shawn O’Malley: Leandro adds in his analysis that quote, there’s no denying that financial services runs with high leverage. The financial business and leverage is a requirement to obtain acceptable returns. We also know financial businesses tend to get into significant trouble due to this leverage when things turn south occasionally.

[00:50:00] Shawn O’Malley: Am I not worried about Deere following a similar path? The answer is no, and for several reasons. He adds, First, the company has been operating in this niche for almost two centuries. We could argue it knows its customers, both farmers and dealers, well. Looking back, we can see that the company’s lost provisions have never spiraled out of control, not even during harsh downturns.

[00:50:21] Shawn O’Malley: This makes sense, considering Deere understands the cycles, farmer economics, etc. And again, it’s worth mentioning that if Deere Financial did have to collect on an outstanding debt, the collateral would be Deere’s own equipment with a high residual value even when used. So that adds further peace of mind here.

[00:50:38] Shawn O’Malley: Whenever valuing a cyclical business, it’s important to keep in mind that valuation metrics like the price to earnings ratio will typically look the cheapest the company is earning the most since investors are expecting those above average profits to normalize going forward. And we’ll look the most expensive at the bottom of the cycle when earnings are the most depressed.

[00:50:57] Shawn O’Malley: It’s sort of the opposite of what you might normally expect. A higher P. E. can mean that the stock is cheap if earnings are depressed, and a lower P. E. can mean expensive if earnings are elevated. So thinking about a fair valuation multiple adds another layer of complexity to any valuation of Deere. For starters, I want to begin with an approach outlined by Aswath Damodaran when assessing cyclical businesses.

[00:51:17] Shawn O’Malley: He suggests averaging out the operating margins for a cyclical business over the last decade, and then multiplying that margin by the company’s last 12 months of revenue. With Deere, you might, for example, have a higher than normal revenue figure, but that’s offset by averaging out the profit margins, since the average margins over the last decade will be lower than at the peak of the cycle.

[00:51:36] Shawn O’Malley: Doing this gives you a rough proxy of what Deere’s normalized operating profits look like, and then so long as you have an estimated growth rate for the company’s earnings, return on capital, and cost of capital, you can estimate the value of Deere’s operations. It’s hard to go through that process in a podcast format, but in this week’s Intrinsic Value Newsletter, I’ll show how this is done.

[00:51:55] Shawn O’Malley: From there, to get the per share stock value, you’d make some adjustments to this operating asset value by adding the value of the company’s assets, like any cash, then subtracting out debt and dividing by the number of shares outstanding. In the basic model I built for Deere, I Aswath Damodaran and found that the stock was, at least through this lens, pretty overvalued.

[00:52:15] Shawn O’Malley: That said, averaging the last decade’s margins to normalize Deere’s profitability doesn’t account for the fact that the company is increasingly relying on software subscriptions and other services that have higher profit margins. If you take management at their word and think the company can hit 20 percent normalized margins versus their 14 percent average operating margins over the last decade, then that improves Deere’s value per share considerably, but I still found it to be modestly overvalued.

[00:52:40] Shawn O’Malley: In a third, even more optimistic scenario, since management said 2024 represents about 80 to 90 percent of their mid cycle earnings, we could correspondingly add a multiplier to Deere’s 2024 revenues to try and get a normalized revenue number and then slap on management’s targeted 20 percent operating profit margin too.

[00:52:58] Shawn O’Malley: That basically embeds two layers of optimistic assumptions for both revenue and margins. And correspondingly, if those are accurate, then they do get a valuation for the company where the stock looks more attractively priced. But obviously there’s a reason I said this was the optimistic scenario. You’re putting a ton of trust in management’s projections just to justify a modest premium to the stocks current valuation, which isn’t something I generally feel great about.

[00:53:22] Shawn O’Malley: And I’ll add that when you value different companies, you don’t always have the same conviction in your numbers. I’m not equally confident in the accuracy of every valuation. Similar to how I felt about trying to value Coupang, there are a lot of moving parts here at Deere, so I’m not particularly confident in my valuations.

[00:53:38] Shawn O’Malley: Not only are Deere’s cyclical sales a complicating factor, but so is Deere’s financial services division. All that leverage and borrowing expenses makes it tricky to value the rest of the company’s operations in a vacuum. And then when you consider that Deere has a large and growing software business, there are all sorts of adjustments that need to be made to capitalize R&D.

[00:53:58] Shawn O’Malley: Without going on too much of a tangent, current accounting rules don’t reflect economic reality for many tech companies. Because most spending they do on developing applications and software mostly has to get expensed immediately, which can artificially reduce net income pretty substantially. Yet if a company builds a factory, it can depreciate the cost of that over 30 years.

[00:54:17] Shawn O’Malley: So the point is that technology costs often get ridden off immediately, and you’d want to adjust at least some portion of R&D expenses to reflect that the software John Deere has built will have value for years. And again, that’s a complicated process too. I probably sound like I’m copping out of putting in the extra effort to build an extremely thorough model for Deere, but there’s a good reason that Warren Buffett has a too hard basket for stocks.

[00:54:41] Shawn O’Malley: You don’t necessarily get any extra reward for figuring out how to value Deere’s manufacturing business, accounting for the effects of its financial services division, and then adjusting its accounting to reflect that its software technologies are lasting assets. Given this, it’s probably best to just rely on a very simple mental framework for thinking about the company’s potential returns to shareholders.

[00:55:02] Shawn O’Malley: Free cashflow is what drives returns for shareholders. And today management says they’re generating about 80 percent of mid cycle earnings. So we’re in the midst of a down cycle with a 3. 6 percent free cashflow yield at the time of recording. I just divide that number by 0. 8 to get an estimate of normalized mid cycle free cash flows.

[00:55:20] Shawn O’Malley: Doing so suggests a 4. 5 percent free cashflow yield and so long as the company can continue growing revenue between three to 5 percent on average, with more of that revenue coming from higher margin subscriptions and tech services, then earnings per share could rise even faster than revenues at 5 percent or more per year.

[00:55:37] Shawn O’Malley: A 4 percent plus free cashflow yield plus 5 percent earnings growth, plus Deere continuing to be aggressive about buybacks makes a pretty strong case for Deere growing earnings per share by 10 percent or more over the next few years. And you’d expect the stock’s performance to closely follow that. I think the story here for Deere is how much you believe in their technology and thus their ability to transform a chunk of their revenues from being just machinery sales to being more subscription based with higher profit margins.

[00:56:04] Shawn O’Malley: There are all kinds of tech enabled add on services that Deere can offer and if that works out as hoped, that will be a huge boon for the business in a few different ways. Firstly, less cyclical revenues are always a good thing for stability in business planning. Correspondingly, subscription based revenues have a negative cash conversion cycle, meaning Deere gets paid up front before services are rendered, and, therefore, can treat that float as a form of interest free financing, which is really advantageous compared to paying to produce a tractor first, then getting paid for it later once it’s sold.

[00:56:36] Shawn O’Malley: From the stock’s perspective, an improved cash conversion cycle and less cyclical revenues would almost certainly boost the company’s valuation across different multiples because markets generally pay up for earnings quality. The more predictable that earnings are, the higher the price to earnings ratio typically, and as Deere migrates from a more cyclical business to a less cyclical one, relative improvements in the average PE ratio throughout the business cycle would be a real tailwind for investors returns.

[00:57:04] Shawn O’Malley: I said this earlier, but just so you have it at the top of mind, again, by 2030, Deere hopes to have 40 percent of its revenues coming from recurring sources, with 10 percent coming from subscriptions specifically. So we’re still in the early stages of that transition, but it’s very much on the horizon.

[00:57:19] Shawn O’Malley: However, I will say, Deere will always be a company oriented around equipment sales. As Leandro frames it, quote, I don’t anticipate Deere will look like a software business in the coming years, but the transition to a more software like model should undoubtedly improve the company’s margin and cash conversion profile.

[00:57:37] Shawn O’Malley: All in all, I remain impressed by Deere’s long history, customer loyalty, ability to remain an industry leader for so long, commitment to innovating on behalf of farmers, and management’s focus on creating value for shareholders. Just looking at the company’s returns on invested capital in the past few years, Deere has had some impressive results even in light of the post pandemic era being an upcycle for the agricultural industry.

[00:58:01] Shawn O’Malley: Looking at Deere’s core equipment sales business, so not counting the financial services division, its ROIC has surged higher in part because the company has been able to raise prices so meaningfully in the last few years. Pricing power is the best way to boost returns because it comes at no marginal expense.

[00:58:19] Shawn O’Malley: There’s no cost to raising prices besides potential fall offs and sales volumes. But for Deere, higher prices more than made up for any corresponding declines in sales volumes, contributing considerably to its return on capital calculations. This is a good demonstration of how Deere’s business quality has already improved, and for many of the reasons we’ve discussed today, I expect it will continue to improve.

[00:58:40] Shawn O’Malley: I really try not to rely excessively on models if there’s a more common sense way to understand things, and with John Deere, I feel that it’s a high quality company that’s becoming increasingly greater quality. With that said, Deere is going into my too hard pile. I’ve learned a lot studying the business, and it is one I’m going to keep tabs on and maybe revisit in a future episode, but I probably won’t have FOMO either if it does well, simply because I just don’t feel as though I understand it well enough.

[00:59:05] Shawn O’Malley: With well north of a hundred billion dollar market capitalization, Deere is just so big. Think about the company you work at and the nuances of trying to understand everything that’s going on there. It just gets so much harder as the business scales up, so I don’t necessarily expect to find many large cap companies bordering on mega cap that are easy to understand in full or aren’t already trading at fair value.

[00:59:25] Shawn O’Malley: For now, I want to focus on opportunities where I can walk away and feel like I understand how the business is structured, who it’s competing with, what’s going on in the geographies it operates in, and all that sort of stuff. Deere’s global operations with so many different product lines means that it’s competing directly and indirectly with dozens and dozens of different companies and is vulnerable to many different factors.

[00:59:46] Shawn O’Malley: With time, I might get more comfortable with that, but with only a week to research the company, you can see why I put it in my hardpile. It probably doesn’t help that I grew up in the suburbs, so the agricultural industry is completely new to me, and it’s no simple thing to wrap one’s head around. When I compare Deere with Ulta, I can clearly envision who Ulta competes with because I’ve been to Sephora and use Amazon almost every day.

[01:00:08] Shawn O’Malley: They also only operate in the US and have one core business model. And they don’t have a huge technology focus either. For better or worse, Ulta is much more understandable to me, and I’m probably biased by that, but I’d rather be biased in that way than invest in businesses that I don’t understand well enough.

[01:00:24] Shawn O’Malley: So I don’t plan to add Deere to our intrinsic value portfolio, but I do want to hear what you think. On Spotify and YouTube, you can leave your comments below and tell me whether you agree with the decision. With that, I’ll wrap things up today with a timely quote from John Deere himself. The man behind the brand tells us, quote, I will never put my name on a product that does not have in it the best that is in me.

[01:00:49] Shawn O’Malley: It’s safe to say that mentality has continued well on after his death. Before I go, I want to give one last shout out to Leandro of the Best Anchor Stocks newsletter for his excellent coverage of John Deere. And I also want to mention that if you’re planning to be in Omaha this year for the Berkshire Hathaway shareholder meeting, please don’t be a stranger.

[01:01:08] Shawn O’Malley: The Investors Podcast Network is hosting two nights of events with free food and drinks, and I’d love to meet you in person there. For more information, just email shawn@theinvestorspodcast.com. Thanks for listening, and I’ll see you again next week as I break down another fascinating business, and look for high quality investments to add to our intrinsic value portfolio.

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