So what do you do when your John Deere and your entire business revolves around selling really expensive equipment to farmers who have been absolutely decimated financially by low crop prices and can no longer convince commercial banks that they're worthy of additional debt needed to buy fancy new tractors? Well, you take some plays from the automotive industry, that's what. Here's how it works:
Step 1: Setup a captive financing arm to underwrite all of the credit risk that no reasonable commercial ag bank would touch with a 10 foot pole.
Step 2: Boost your tractor sales volumes by financing every farmer who walks through your door with a soybean dream and pulse.
Step 3: When you run out of farmers willing to buy your brand new shiny green tractors then just start selling all your production volume to yourself and then lease it to customers at an attractive price. This way you can still show sales growth and never have to cut production volume.
Step 4: Finally, when it all goes horribly wrong because used tractor prices crash due to the flood of off-lease volume and brings down the new market with it then you take a one-time charge to write-off the losses, wall streets forgives you...it was just a 1x charge, right...and then you promptly rinse and repeat.
From the looks of the charts below, we'd say John Deere is currently on the tail end of 'Step 3' as loan and lease balances are soaring and write-offs are just starting to spike.
As the Wall Street Journal points out today, John Deere has literally become the 5th largest agricultural lender in the country behind commercial banks Wells Fargo , Rabobank, Bank of the West and Bank of America, according to the American Bankers Association. But it's not just equipment financing risk the John Deere is underwriting these days as they've also started financing short-term working capital loans to help farmers buy everything from seed to chemicals and fertilizers and equipment spares.
Since 2013, the total value of equipment leases held by Deere is up 87%. Loans for farm equipment purchases, meanwhile, have fallen 10% since peaking in 2014, reflecting sliding machinery sales.
Short-term credit accounts for farmers—used for items such as crop supplies and equipment parts—are up 38% since the end of 2015. As of early 2017, the bank operation of Deere Financial had handed out about $2.2 billion. It is close on the heels of the No. 4 agricultural lender, Bank of America, which has about $2.6 billion out.
“Deere Financial is a massive force,” said Robert Wertheimer, a Barclays analyst. Deere, which accounts for about two-thirds of all the big tractors sold in the U.S., “is able to influence this market. They have more market power than most companies.”
Of course, the best possible thing for an industry plagued by oversupply and below market commodity prices is for someone to step in and subsidize even more production...it's just basic economics really.
In shoring up the ailing sector, Deere’s loans may be helping draw out the pain for farmers, allowing them to continue to rack up debt despite a glut of grain world-wide that is keeping a lid on crop prices. The increase in equipment leasing, meanwhile, is weakening Deere’s own market for sales.
If crop prices remain subdued, “you’re just prolonging the agony and potentially building up [farm] losses instead of cutting the pain, cauterizing the wound and stanching the flow of financial blood now,” said Scott Irwin, an agricultural economist at the University of Illinois.
Meanwhile, John Deere shareholders have been handsomely rewarded for the company's strict adherence to the 4-step plan we outlined above which would seemingly serve to prove that selling extremely expensive equipment into and extremely cyclical end market is, in fact, recession proof and immune from the ag cycle...who knew?
“Our core mission is to support sales of equipment,” said Jayma Sandquist, vice president of marketing for the U.S. and Canada for John Deere Financial, the company’s financing unit. “It’s a cyclical industry. We’ve built a business that we can manage effectively across all cycles, and our performance would indicate we can do that.”
The financing arm has shielded the Moline, Ill., company from the worst of the farm slump, keeping factories and dealers intact and investors satisfied with profits. Despite a 37% drop in sales of its farm equipment since a record high in 2013, Deere’s stock price is up 72% from its recent low in early 2016 and up 22% since the start of 2017.
Of course, we've seen how this movie ends before. As it turns out, there's a step-by-step guide to that process as well:
Step 1: A flood of off-lease volume crushes pricing for used ag equipment
Step 2: New sales and lease volumes tank due to more attractive deals for used equipment
Step 3: John Deere buries its head in the sand and refuses to cut production volumes because that would be an admission to shareholders that recent volume declines were something more than 'transitory.' So production is maintained and new dealer inventories around the country surge.
4. Now, it's only a matter of time before new equipment prices crash as well....
5. ...and that's when the write-downs start...
Then again, maybe we're wrong and 'everything actually is awesome'.