News Analysis date published New: 
Wednesday, August 22, 2012 - 12:00
New Date created: 
Wednesday, August 22, 2012 - 12:31
New Date last updated: 
Wednesday, August 22, 2012 - 12:00

This Farming Stock Could Greatly Benefit from the Drought

Wednesday, August 22, 2012 12:00 PM

The worst drought in more than 50 years has slammed the U.S. agricultural industry this summer. About 46% of the lower 48 states are in severe drought conditions, according to the latest U.S. Drought Monitor Map.

The situation has become so bad, that the U.S. Department of Agriculture has designated 1,369 counties across 31 states as disaster areas. This is the highest number of regions declared as disaster areas in the USDA's 150 years. As you can imagine, the lack of rainfall has hurt crops, particularly corn this year.

This is especially disturbing when taking into account that the largest corn crop since 1937 was planted this year. The common-sense conclusion to the drought is that farmers are likely going to take a huge hit, with many not surviving financially into the next season.

Fortunately, reality is far different. U.S. farmers entered this drought period at their overall strongest financial position in history. This is because of a record-high 2011 farm income, soaring land prices and all-time low debt-to-asset ratios of the agricultural community.

Combine this with crop insurance, and the drought pain can likely be mitigated this year. Looking at the situation in a positive light, the drought will force crop prices higher. If they stay higher, then 2013 may turn into a banner year for farmers.

Remember, droughts are temporary.

And this is precisely why investors can make a lot of money with farm stocks, particularly the ones in value territory like Deere & Co (NYSE: DE).

Despite the actual economic effect of the drought potentially being much less than expected, Deere has been slammed down into what I think is a value buy zone.

The company missed analysts' forecasts by a shockingly high 33 cents a share. Shares plunged more than 6% on the news until bargain hunters stepped in to buy the stock at a discount.

My take is that things are not near as dire as this quarter's numbers make it out to be for Deere.

Deere's global second-quarter sales soared 15% year-over-year to $9.59 billion. Operating profit increased 12.6% year-over-year to $1.21 billion in the same period. Operating income, however dropped $9 million from $529 million a year ago to $520 million this year.

The company blames significant product innovation costs for the weak quarter, which is just a short-term bump.

Deere's price-to-earnings (P/E) ratio of 10 is well below the sector's average of 15.9. Combined with a 2.5% annual dividend makes the knocked-down stock look quite appealing.

Technically, Deere is in the classic value zone buy area. The disappointing quarterly results knocked shares off their uptrend to support in the $74 range. Price has since stabilized and bounced back above the 50-day moving average, but remains in the technical value zone.

Risks to Consider: The global economic slowdown, particularly the slowing in China, may weigh on Deere's future. But the company is projecting solid growth through into the foreseeable future, despite the risk of a global recession. In addition, 18 out of 42 professional money management firms decreased their holdings in the company's last reporting period. Remember to always position size properly relative to your risk tolerance and always use stops.

Action to Take -- > I love Deere at these levels. Buying now in the $77 range makes total sense technically and fundamentally. The projected price is $90 within 18 months and stops should be at $72 at this entry range. It may be long-term churn before the stock gets to new highs, but this dividend-paying gem should make the wait worth it.

David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.