Event: DE reports its fiscal Q4 earnings tomorrow morning before the open. The options market is implying about a 4% one day move, which is above the 4 qtr avg of about 3.5% and in line with the 8 qtr avg of about 4%. Notably, DE stock has ended lower after earnings for the past 7 quarters.
Sentiment: Wall Street analysts are negative on the stock, with 8 buys, 10 holds, and 8 sells, though the average 12 month price target is around $86. Short interest is at 4% of float, which is actually near its highest level over the past 5 years (though a relatively low level on an absolute basis). DE is down 5% year-to-date.
Options Open Interest: Open interest indicates more puts than calls by a ratio of 1.4 to 1. The past 1 month volume has been slightly skewed towards puts, at a ratio of about 1.1 to 1. December expiry has the most open interest of nearby maturities. The Dec 80 puts have over 30k of open interest, and the Dec 85 and 87.5 calls both have over 10k. DE’s low price of 2013 is $79.50.
Price Action / Technicals: DE has traded in a remarkably tight range over the past 5 months:[caption id="attachment_32759" align="alignnone" width="600"] DE daily chart, 200 day ma in black, Courtesy of Bloomberg[/caption]
This chart has little need for annotation. The 200 day ma around 85.50 is important resistance, and the 79.50-80.50 area is crucial support for DE. Interestingly enough, the stock is unchanged since late 2007 and late 2010, so there are a lot of buyers and sellers who have transacted around the $80 level.
Volatility: The recent decline in realized volatility is evident from the daily chart above, which demonstrates the very tight range that the stock has not breached for months. Realized volatility is at multi-year lows:[caption id="attachment_32760" align="alignnone" width="600"] 30 day implied volatility (red) vs. 30 day realized volatility (blue), Courtesy of LiveVolPro[/caption]
Despite that low level of realized volatility, implied volatility is near the 24-25 area where it was prior to the last few earnings reports, so traders still anticipate that DE might move a bit more on and after earnings. A break of 79.50 on the downside or 85.50 on the upside could lead to a new volatility regime indeed.
Our View: Deere has been a major underperformer relative to the broader market over the past few years. The company has actually grown earnings in both 2012 (18% year over year) and 2013 (expected 11% year over year), but the stock has been flat in the past 2 years. The valuation, at less than 10x earnings, seems cheap, but investors are concerned with future earnings growth.
Analysts project a 10% decline in earnings in 2014. Corn prices are at 3 year lows, jeopardizing the future outlook of agricultural equipment investment. The real question mark for market participants is going to be on guidance rather than the past quarter (for which expectations are low). DE’s cheap valuation certainly implies a low bar.