How Deere Stock Could Benefit From Sustained Inflation

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Deere stock trades at 14.7 times its expected free cash flow per share over the next 12 months.

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Justin Sullivan/Getty Images

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Even the Fed admits it—inflation will be a much longer part of our lives than most imagined. This could be good news for industrial stocks.

Last week, Federal Reserve Chairman Powell stunned the market when he said it was time to stop using the word “transient” to describe inflation and warned that central banks would end their bond-buying program. can accelerate.

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In some ways, he was clearly acknowledging: The consumer price index reading in November rose 6.2% year over year, though no one expects inflation to stay that high. According to the St. Louis Fed, average annual inflation for the next five years is expected at 2.8%, but it is still well above the pre-pandemic level of 1.8% in 2019.

“Transitary is dead,” says Tom Porcelli, economist at RBC Capital Markets.

Industrial stocks are typically not the first companies to benefit from high inflation. Manufacturers often have contracts with their customers that must expire before prices can be raised. Commodity producers usually profit immediately, which is why energy stocks performed so well when prices started rising. But after some time, industrial companies may raise prices to protect their profits from high material cost. This is especially true when inflation remains persistent, says James Camp, managing director of strategic earnings at Eagle Asset Management.

Yet investors have not been very interested in industrial stocks. The Industrial Select Sector SPDR Exchange-Traded Fund (ticker: XLI) has gained 18% over the S&P 500 in 2021.‘s
23% profit. The sector has seen over $225 billion inflows into global ETFs since September 2019, according to data from Citigroup. That’s well below the $325 billion that flows into ETFs full of oil producers and basic ingredients manufacturers. “Investors should turn to more diversified economic-sensitive exposures such as … financials and industry, versus near-term inflation beneficiaries,” writes Scott Kronert, global head of ETF research at Citigroup.

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This means that industrial stocks are trading at relatively low demand multiples. According to FactSet, the Industrial Select Sector SPDR ETF trades at 20.5 times expected free cash flow, down from 23.5 times the S&P 500. Industrial stocks have historically traded at valuations in line with the broader index. The cash flow of this sector is expected to grow by 28% in 2022 and 17% in 2023.

The recent sell-off in industrial stocks has left some names particularly cheap. Deere (DE), for example, trades at 14.7 times its expected free cash flow per share for the next 12 months, down from its five-year average of 20.7 times. This is despite the fact that the $107 billion agricultural and construction equipment maker expects free cash flow to grow in the high teens over the next two years.

Edward Jones analyst Matt Arnold argues that the valuation likely does not reflect Deere’s growth. “You don’t have to buy [the stock] And there are expectations to crush the company,” he says.

Deere could have beaten those expectations anyway. In recent weeks, the company has been charging its customers prices that are 7% to 8% higher than a year ago, Arnold says, which has helped push analyst sales estimates higher. With Deere stock down 10.3% over the past three months—the S&P 500 has gained 0.1% during the same period—it may be time to buy the plunge.

write to Jacob Sonenshine at [email protected]

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