Deere (DE) is one of Warren Buffett’s top dividend stocks and has increased its dividend 12 times since 2004.

Falling crop prices have caused demand to drop sharply for Deere’s tractors and combines, but the best time to buy high quality dividend stocks is usually during periods of distress. Warren Buffett seems to think so and added to his stake in Deere during the fourth quarter of 2015.

Let’s take a closer look at Deere’s business as we consider it for our Top 20 Dividend Stocks portfolio.

Get The Full Series in PDF

Get the entire 10-part series on Charlie Munger in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues.

Business Overview

Deere was founded in 1837 and has since grown to become one of the largest manufacturers of agricultural and construction equipment in the world. Many of Deere's products retail for several hundred thousand dollars and are mostly sold through its independent dealer networks.

The company's Agriculture & Turf segment accounted for about 75% of Deere's equipment operating profit last fiscal year. Some of its key products include tractors, combines, corn pickers, and mowers.

Deere's Construction & Forestry segment accounted for the remaining 25% of operating profit and includes products such as backhoe loaders, excavators, crawler dozers, and dump trucks.

The company also has a Financial Services segment that lends money to Deere's independent dealers and end customers when they purchase equipment on credit or need a lease.

By geography, close to 60% of Deere's sales are generated in the U.S. and Canada.

Business Analysis

With a rich operating history dating back more than 175 years ago, Deere is one of the most iconic American companies of all time.

Many of Deere's competitive advantages are rooted in its long-standing operations and the conservative culture it has embraced throughout its corporate life.

As a testament to the company's consistency and steady culture, the Roman Catholic Church has had more popes than Deere has had CEOs since it was started in the 19th century.

One of John Deere's infamous quotes has continued to guide the company from one generation to the next:

“I will never put my name on a product that doesn't have in it the best that is in me.” – John Deere

Deere has relentlessly focused on improving the productivity of its customers by listening closely to their needs and heavily investing in product development.

Deere spends over $1.4 billion annually on research and development and has been named as the number one innovator in the heavy industrial equipment industry by the Patent Board. According to a Bloomberg article, some of Deere's products literally have more lines of software code than a space shuttle!

As a result of Deere's product innovation, the company has developed a pristine reputation for quality and reliability. Customers know they will achieve a lower total cost of ownership by buying their equipment from Deere.

Deere's reputation for quality has made it one of the top 100 brands in the world and allowed it to consistently raise its prices at a low-single digit rate virtually every year, including recessions.

Even with U.S. agriculture equipment sales expected to fall by 15-20% in 2016, Deere expects to realize 2% pricing gains across its equipment operations this year.

The company's pricing power is built on more than just the quality of Deere's products. In fact, one of Deere's biggest competitive advantages is intangible in nature – the relationships its independent dealers have with their customers.

Deere has amassed the largest network of independent dealers in the U.S. agricultural industry. These dealers have developed strong, multi-generational relationships with the farmers in their communities.

Many dealers have been passed down from generation to generation and know their customers really well.

Farmers are generally loyal people, too. According to a survey of 2,000 Midwest farmers, about 65% of respondents described themselves as brand loyal, and a whopping 77% of John Deere customers described themselves as brand loyal.

Deere's existing dealer network has a captivated customer base that helps the company maintain number one market share in agricultural machinery and number two market share in construction equipment in North America.

Besides customer relationships, maintaining extensive distribution networks is a critical piece of Deere's value proposition. Most of its heavy equipment costs several hundred thousands of dollars and is used for mission-critical, time-sensitive tasks such as planting crops. Minimizing unplanned downtime is essential.

Deere has more dealers than its competitors, which allows it to quickly service customers to keep their gear up and running. Service parts have historically accounted for 15-20% of Deere's overall equipment revenue, underscoring the importance of having strategically-located and well-equipped dealers on call at all times.

Overall, we believe Deere has a strong economic moat. The company has established an excellent reputation for quality, service, and innovation that allows it to consistently raise prices and hold its dominant market share positions.

New entrants would struggle to break the long-lasting relationships Deere's dealers have built with brand-loyal customers, and substantial capital would need to be invested to develop and manufacture competitive equipment. Smaller rivals also lack the financing arm Deere has that makes it easier for its customers to fund their large equipment purchases.

Deere's Key Risks

Despite Deere's numerous competitive advantages, it has little control over the factors that influence demand for most of its equipment.

With agricultural machinery driving the bulk of Deere's profits, the company is very sensitive to farmer income.

When crop prices are high and yields are good, farmers are much more willing to open their wallets for Deere's big-ticket tractors and combines.

However, times are not good right now for farmers.

In fact, farmers have never felt worse about their current situation as measured by The Progressive Farmer Agriculture Confidence Index, which started surveying farmers in 2010.

Demand for crops has continued to gradually increase with the world's population over time, but excess supply has been an issue. The world has experienced bumper crops for several years, which has driven down the prices of many major crops such as grain and corn.

As seen below, net farm income skyrocketed from 2010 through 2013 thanks to strong commodity prices and healthy agricultural exports.

However, after peaking out at $123.3 billion in 2013, U.S. net farm income plunged over 50% to hit $56.4 billion in 2015.

Deere DE Dividend

Source: Congressional Research Service

While the USDA's Economic Research Service expects U.S. net farm income to fall just 3% in 2016 (much less than the 27% drop in 2015), the decrease would bring farm income to its lowest level since 2002.

The ups and downs of the agricultural market are to be expected, but some investors can't help but be reminded of the 1980s farm crisis which saw an economic crisis “more severe than any since the Great Depression.”

The farm crisis of the 1980s caused Deere to cut its dividend from 32.9 cents per share in 1981 to 12.5 cents in 1983. Annual dividend payments didn't recover back to 33 cents per share until 1990.

Leading up to the crisis, farmers took on substantial amounts of debt to finance their land, crop inputs, and equipment.

Interest rates began to surge leading up to the farm crisis with the prime lending rate tripling to exceed 20% in 1981, an all-time high.

At the same time, unfavorable economic environments and geopolitical factors combined to cause crop prices to collapse.

Farmers' debt-to-income ratios

1, 23  - View Full Page