After you receive this Alert, we will make the following trades:
-- Sell 100 shares of Crown Castle International (CCI) at or near $179. Following the trade, the portfolio will own 200 CCI shares, roughly 0.9% of the portfolio's assets.
-- Sell 270 shares of Bristol-Myers Squibb (BMY) at or near $57.60. Following the trade, the portfolio will own 530 BMY shares, roughly 0.8% of the portfolio's assets.
-- Sell 200 shares of DuPont de Nemours (DD) at or near $72. Following the trade, the portfolio will own 400 DD shares, roughly 0.7% of the portfolio's assets.
-- Buy 115 shares of Deere & Co. (DE) at or near $340. This trade will establish a new position in DE shares, which will account for 1.0% of the portfolio's assets.
As we continue to review the portfolio's existing holdings, in addition to examining the potential upside in each holding we are also examining the overlap among them. For example, in the healthcare and pharmaceutical space, the portfolio has exposure to AbbVie (ABBV) , Abbott Labs (ABT) and Bristol-Myers Squibb. There are also multiple holdings in chemicals - DuPont and Linde (LIN) - and companies poised to benefit from the 5G buildout in devices, networks and the Internet of Things - Skyworks Solutions (SWKS) , Marvell Technology (MRVL) , Cisco Systems (CSCO) and Crown Castle. There are other examples as well.
Over the last few weeks, we've started to introduce new positions to subscribers - Skyworks, Applied Materials (AMAT) and Starbucks (SBUX) - that not only bring different exposure into the portfolio but also have favorable upside prospects. Those moves added exposure to food-retail, cybersecurity, and RF semiconductors.
We'd like to do more in the way of widening our exposure. It's not that we don't like some of the existing holdings, but rather we want to capitalize on opportunities out there while also improving the portfolio's diversification.
That brings us to the trades here on Monday.
We're going to slowly reduce the portfolio's exposure to Crown Castle, DuPont and Bristol-Myers Squibb as we add new positions and scale into some of the recent additions.
In the near term it might look like the portfolio is becoming a tad unwieldy, but it's part of the plan that ultimately will widen its exposure while eventually modestly shrinking the number of positions from what will be 35 after today's new addition.
In a perfect world, the portfolio will have 26 to 30 positions of varying sizes and some degree of cash on hand so we can remain flexibly opportunistic. To be clear, we are not in a rush to get there - we would rather take our time, using the old carpenter saying of "measure twice, cut once" to get the portfolio to the right number of positions with the proper exposure with the best-positioned companies.
Initiating a Position in Deere & Co.
Agriculture and construction equipment company Deere & Co. is benefiting from the significant year-over-year increase in corn, wheat and soybean prices, one of the primary drivers in farmer purchasing power.
Another factor that is spurring a sizable increase in the company's revenue this year and should do so in the next few is the adoption of new equipment that incorporates precision farming technology. That technology is helping farmers drive crop yields higher while also realizing cost savings, which makes the new technology a productivity upgrade compared to older equipment and makes Deere a sustainability play. With arable land shrinking while the global population increases, farmers will need to produce more with less, which should drive demand for precision agricultural equipment.
For 2021, Deere sees a 25% to 30% increase in its Production and Precision Ag business and a 25% gain in its Small Ag and Turf business. True to form, those increases, particularly after a weak 2020, should drive significant operating margin expansion as volumes ramp up, fixed costs are absorbed and manufacturing synergies are realized. That expansion should drive a meaningful jump in earnings per share this year, and the current consensus forecast calls for Deere to deliver EPS of $18.92 vs. $8.69 last year. Meanwhile, the jump in farmer income this year should lead to continued equipment purchases in 2022, driving revenue and earnings for Deere higher year over year.
So why have DE shares retreated to around the $340 level from almost $390 in early September?
Two reasons. First, supply chain and related bottlenecks are hampering production at not only automotive companies but also heavy and specialty truck companies, such as Paccar PCAR and Oshkosh Corp. OSK. Odds are Deere has seen its production schedule impacted as well. Second, more than 10,000 employees who are members of the United Auto Workers are on strike in Illinois, Iowa and Kansas after union representatives failed to reach a labor agreement with the company. Talks are ongoing, and while we suspect there will be a resolution the timing of one is uncertain.
In our view, the pullback in DE shares reflects the worst of those two items. We also recognize that once a new contract with the UAW is signed, the probability of DE shares snapping back increases significantly. As such, we are starting our new position in DE with a longer-term view. We recognize that in the short term the two above items will weigh on DE's September quarter results as well as its December quarter guidance. Given where crop commodity prices are and farmers' desire to drive productivity and yields with precision ag equipment, we suspect Deere's backlogs have risen nicely as well. That will set the stage for the coming quarters as the company and the UAW settle. And yes, we've started to see consensus expectations for Deere's 2022 EPS move lower to $21.92 from $22.30 a month ago.
Given the above, we recognize DE shares could move lower in the near term, another reason why we are baby-stepping into this new position. We will plan to nibble and build our position in DE near current prices or if possible at ones that will improve our cost basis.
In developing our price target, we've given that 2022 consensus EPS a further haircut to account for the potential impact of the two items we discussed above that are weighing on the shares. While it could prove to be conservative, we're going to base our $390 price target on 2022 EPS of $18.50. We achieve that price target by applying a discount to the average peak price-to-earnings (P/E) multiple of 21.1x at which DE shares have traded in the last several years.
As data confirm our revenue thesis for Deere and as the company settles with the UAW, we'll look to revisit consensus 2022 expectations as well as the discounted P/E. For now, however, we see upside of about 15% for DE shares, but that is before the company's annualized dividend, which sits at $4.20 per share. While the current yield of 1.2% isn't much, utilizing the historical dividend yield adds another layer of comfort to our initial price target. Adding that leads us to assign a "One" rating to this starter position in DE shares.
Until we have clarity on the supply chain and strike issues, we would be inclined to be buyers of DE shares up to $350, and once the shares pierce that level, we would be inclined to revisit our One rating once we have that clarify.
Deere Is Ready to Sprint
With a sharp drop from all-time highs we saw Deere pull back and revisit the lows from June just a couple weeks ago. That seemed to be a good low-risk entry point, as plenty of sellers were washed out back in June and the stock surged to all-time highs in short order. Whether that same response will happen again is unknown, but certainly $325 appears to be really good support.
The 200-day moving average is resistance right now and above there is the 50-day moving average; we see that line is about to cross the 200-day to the downside, which would be considered a death cross. It's somewhat negative but may also serve as an entry point if the stock is far enough away from the moving averages.
Moving average convergence divergence (MACD) is on a buy signal, while the Relative Strength Index (RSI) slopes down and is making higher lows on that indicator. So, we have a mixed picture; price action is improving while volume trends are starting to turn bullish. A few more strong days and through that 200-day moving average and we'll see this stock start gliding higher. Deere is a high-quality company that is on sale here.