Morning Note: Market news and updates from Alphabet (Google) and Deere & Co.

Market News

US equities moved higher last night – S&P 500 (+0.5%); Nasdaq (flat) – although tech stocks were held back by Alphabet (see below) which fell 5%.

Markets continued to assess the Federal Reserve’s monetary policy outlook after mixed economic data. The Fed Bank of Chicago President Goolsbee suggested interest rates could move “a fair bit lower” and expressed confidence that inflation is easing toward the target. The 10-year Treasury yields 4.42%, while the dollar headed for an eighth straight weekly gain.

Gold is approaching $2,700 an ounce, rising for the fifth straight day, and on track to gain nearly 5% this week, as investors turned to safe-haven assets amid increasing geopolitical risks.

In Asia this morning, equities slumped in Hong Kong (Hang Seng, -2.0%) and China (Shanghai Composite, -3.1%) as weak tech earnings hit sentiment – bellwether Baidu briefly fell 10% in Hong Kong following a decline in revenue. In Japan, the Nikkei 225 rose by 0.7%.

The FTSE 100 is currently trading 0.6% higher at 8,204. UK retail sales (ex. fuel) fell by 0.9% month on month, well below the 0.4% forecast. However, GfK’s UK consumer confidence gauge rose unexpectedly by three points to -18 this month after the budget ended uncertainty over tax and spending. Sterling trades at $1.2571 and €1.1989.

Brent Crude traded higher at $74.50 a barrel, while European natural gas jumped to the highest in a year due to rising tensions between Russia and Ukraine.

Source: Bloomberg

Company News

Alphabet’s shares fell 5% yesterday following an announcement on Wednesday night by the US Department of Justice regarding potential remedies for an anti-trust ruling.

Alphabet is the public holding company for Google, one of the world’s most recognised and widely used brands. In addition to the core search engine, the group owns digital video platform YouTube, Google Cloud, web browser Chrome, mobile operating system Android, Gmail, Google Maps, Fitbit, and autonomous driving company Waymo, among others.

The group has a strong track record of innovation, leaving it well placed to capitalise on a wide variety of technological themes, such as digital media, e-commerce, video advertising, the cloud, the internet of things, driverless cars, and artificial intelligence. We believe the shift to internet-connected devices and streamed TV means the growth of advertising dollars on Google Search and YouTube has much further to run. Machine learning capabilities should also help advertisers get higher return on investment and encourage them to continue to allocate their advertising budgets to Google.

The company has six products with more than two billion users each and another nine with more than 500m users, most of which we believe are far from being fully monetised. The group’s structure allows it to own a portfolio of businesses with different time horizons, while its broad offering provides a competitive edge. Capital allocation is strong and spread across internal R&D, accretive M&A, and large shareholder returns.

Political and regulatory headwinds have become more elevated in recent months. Most importantly. In August, a US Federal judge ruled Google acted illegally to maintain a monopoly in search. The anti-trust lawsuit challenged the company’s commercial agreements with search distribution partners Apple, Android OEMs, and other web browsers to be pre-installed as the default search engine.

On Wednesday night, the US Department of Justice (DOJ) outlined to the judge overseeing the case a list of requests and potential remedies. These include:

- The company must sell its Chrome browser to a buyer approved by the US government and should not be allowed to re-enter the browser market for five years. Although Chrome isn’t a direct revenue driver for Alphabet, it helps bring users into its Google ecosystem, where it can drive advertising revenue, collect the data, and form partnerships to monetise the platform.

- Google may elect to fully divest Android to a buyer approved by the US government. If Google chooses to retain control of Android but fails to comply with presented remedies, the government may petition the court to order the divesture of Android.

- Google should be prohibited from making payments to third parties to make Google the default general search engine in their products, including ending exclusive agreements in which Google pays billions of dollars annually to Apple and other providers.

- The company must share data and search results with rivals in order to end its monopoly on online search.

- The company may also be forced to unwind its AI partnership with Anthropic.

In response, the company has said the DOJ’s approach would result in unprecedented government overreach and would harm US consumers and businesses and shake American competitiveness in artificial intelligence. The company is concerned the DOJ is already signalling requests that go far beyond the specific legal issues in this case.

Google will respond in detail to the DOJ’s proposals in court next month and make its broader case next year. US District Judge Amit Mehta has scheduled a trial on the proposals for April 2025. Once he makes a final ruling, which he is expected to do by August 2025, Google is likely to appeal. As a result, in the absence of a settlement, the case could drag on for years.

There is then Apple’s response to consider if Google can no longer be the exclusive default provider on Safari. One potential scenario is Apple building its own search function. However, this would be a costly, capital-intensive initiative (c. $10bn upfront and $4bn-$6bn p.a.). Apple might also partner more deeply with Microsoft’s Bing and OpenAI. However, in the trial Google highlighted that Microsoft would have to pay Apple 122% of Bing’s revenue simply to match Google’s current payment to Apple.

There is also the political uncertainty given the impending change of government administration in the US. President-elect Trump has previously questioned whether breaking up the company was a good idea and has suggested Google is important in technology competition with China. Once in office, the new President will be able to appoint a new head of the DOJ’s antitrust division who will have authority to change strategy, negotiate settlements, or withdraw from cases entirely.

Overall, while the proposed remedies are severe, they provide investors with some clarity on the worst-case scenario. This comes ahead of Google’s proposed final remedies next month and the judge’s final decision next year, which we would hope will be more balanced.

In the meantime, trading at Alphabet remains strong – the recent Q3 results were better than expected, driven by momentum across the business especially in cloud and subscriptions, and strong margin dynamics. Further the shares trade on a valuation (18x ex-cash) below most of the other tech majors and at a level we believe is very attractive for a company exposed to several areas of long-term secular growth. In addition, the company is returning capital to shareholders via a share buyback programme and a cash dividend.

Source: Bloomberg

Yesterday lunchtime, Deere & Company released results for the financial year to end-October 2024. Despite ongoing market challenges, the numbers were better than market expectations as a result of lower production expenses and cost controls. The group set out guidance for the new financial year and, in response, the shares were up 8% in US trading hours.

Deere is a global agricultural and construction equipment company with annual sales of almost $52bn. The group has a strong track record of innovation, a comprehensive distribution infrastructure, and global after-market capability. The group’s strategic aim is to outpace industry growth and generate a mid-cycle operating margin of 15%.

The business is benefitting from broad trends based on population and income growth, especially in developing nations, which are driving agricultural output and infrastructure investment. In addition, technological advances and agricultural mechanisation are expanding existing markets and opening new ones by helping customers increase their productivity, profitability, and sustainability.

The company believes it has incremental addressable market opportunities of more than $150bn that can be targeted through engaging with more customers and increasing levels of connectivity. The focus is on helping customers manage higher costs and increasingly scarce inputs, while improving their yields, using Deere’s integrated technologies.

However, in the near term, conditions in the global agricultural and construction sectors have been challenging because of higher interest rates, squeezed farming incomes, and lower government support. As a result, fleet replenishment has moderated.

During the latest financial year, worldwide net sales and revenue fell by 16% to $51.7bn, while net sales of equipment declined by 19% to $44.8bn. In the final quarter to 31 October, worldwide net sales and revenue fell by 28% to $11.1bn, while net sales of equipment were down by 33% to $9.3bn, in line with the market forecast.

Net income fell by 30% in the year to $7.1bn, versus the forecast to be around $7.0bn. In the final quarter, net income declined by 47% to $1,245m, while EPS fell 45% to $4.55, albeit well above the market forecast of $3.87.

The Production & Precision Agriculture segment includes large and certain mid-size tractors, combines, cotton pickers, sugarcane harvesters and loaders, and soil preparation, seeding, application and crop care equipment. During the final quarter, sales fell by 38% to $4.3bn due to lower shipment volumes. Operating profit declined by 64% to $657m, mainly due to lower volumes partly offset by lower production costs. The margin slumped from 26.4% to 15.3%.

The Small Agriculture and Turf segment includes certain mid-size and small tractors, as well as hay and forage equipment, riding and commercial lawn equipment, golf course equipment, and utility vehicles. During the final quarter, sales fell by 25% to $2,306m, with lower shipment volumes partly offset by higher pricing. Operating profit was down 47% to $234m, with the margin falling from 14.4% to 10.1%. Construction & Forestry sales fell by 29% to $2,664m, while operating profit fell 36% to $328m.

The group’s Financial Services division reported adjusted net income down 9% to $173m, due to higher provision for credit losses, partially offset by income earned on higher average portfolio balances and lower expenses.

Deere’s balance sheet is robust, with net debt of $56.7bn, a level consistent with supporting a credit rating that provides access to low cost and readily available funding. The group has a policy to raise its dividend “consistently and moderately”, targeting a 25%-35% payout ratio of mid-cycle earnings. The latest annual dividend was raised by 16% to $5.88 per share.

Looking forward, market conditions are expected to remain weak due to subdued farm incomes and inflationary pressures which will continue to impact demand for the company’s equipment. In response, Deere will continue to take steps to reduce costs and strategically align production with customer demands. Against this backdrop, net earnings are forecast to fall from around $7.0bn to $5.0bn-$5.5bn, slightly below market expectations. Operating cash flow of $4.5bn-$5.5bn is forecast. By division, net sales are expected to decline by 15% in Production & Precision Agriculture, 10% in Small Agriculture and Turf, and 10%-15% in Construction & Forestry.

Source: Bloomberg