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The agricultural boom that was fueled by rising crop prices, including for corn, soybeans, and wheat, enabled Deere (DE) to harvest massive profits last year, but the sun is now setting on that bullish cycle. Although DE easily beat Q1 EPS expectations, mainly due to favorable price realization on its machinery, the company lowered its FY24 net income guidance to $7.50-$7.75 bln from its prior forecast of $7.75-$7.85 bln. The mid-point of this new guidance represents a yr/yr net income decrease of approximately 25%.

• When DE issued its initial FY24 net income guidance in November, there was a belief that the company was simply taking a conservative approach with its outlook. After all, the company raised its FY23 net income forecast a couple times last year. However, with DE now lowering its guidance, it's clear that this is not a case of the company just trying to manage investors' expectations.
  • While it's been well understood that this upward cycle has already peaked, the guidance cut is catching some participants off guard, indicating that agriculture fundamentals have weakened more than anticipated.
• CEO John May acknowledged as much, stating, "Moving forward, we expect fleet replenishment to moderate as agricultural fundamentals normalize from record levels in 2022 and 2023.” A combination of declining farming incomes due to lower crop prices and high interest rates have cooled off the formerly hot market for tractors, combines, and other ag equipment. This is seen throughout DE's three business segments.
• In Production & Precision Ag -- DE's largest segment -- net sales declined by 7% to $4.8 bln as a result of lower shipment volumes. The sales decline is similar to last quarter's 6% drop, but what's different is that operating margin decreased in Q1.
  • Specifically, operating margin eroded to 21.6% from 23.2% in the year-earlier quarter. In Q4, operating margin expanded to 26.4% from 23.4%. Unlike Q4, DE was unable to fully recoup the negative impact of lower volume and higher SA&G costs through price realization.
• The same is true of the Small Agriculture & Turf segment, which sells smaller tractors and lawn mowers. After falling by 13% in Q4, net sales plunged by 19% in Q1 to $2.4 bln, while operating margin dipped to 13.4% from 14.9%. Last quarter, operating margin ticked higher to 14.4% from 14.3% as DE benefitted from favorable sales mix and price.
• Construction & Forestry was the strongest performer with sales remaining flat yr/yr at $3.2 bln. That is fitting because this segment closely competes with Caterpillar (CAT), which reported better-than-expected Q4 results on February 5. Still, the relatively stronger sales performance wasn't enough to prevent operating margin from slipping to 17.6% from 19.5% as DE experienced lower shipment volumes and higher SA&G and R&D expenses.

The main takeaway is that the downturn in the agricultural industry is a bit more severe than initially suspected, as reflected in DE's guidance cut. There are still some positive factors working in DE's favor, such as the trend towards smart tractors and an aging equipment fleet, but 2024 is shaping up to be a more challenging year.