Deere & Company (DE) is expected to be hit hard as China’s latest round of tariffs is aggravating the woes of an already struggling U.S agricultural sector.

The U.S Agriculture industry has been grappling with low commodity prices and sluggish farm incomes over the past few years. Moreover, tariffs imposed by China on U.S. agricultural exports last year dealt a severe blow to the industry as China is the largest export market for U.S. agriculture producers. Per American Farm Bureau, farm bankruptcy filings have gone up 13% in the 12-month period ended June 2019. Further, delinquency rates for commercial agricultural loans are at a six-year high.

Farmers have thus been more cautious about spending on farm equipment, which in turn put pressure on Deere’s top line. China’s recent announcement to hike tariffs between 5% and 10% on U.S. goods worth $75 billion including agricultural products, in two stages on Sep 1 and Dec 15, 2019, thus raises a red flag for Deere’s customers.

Apart from the impact of weak farm equipment spending on Deere’s top line, its margins continue to bear the brunt of higher raw material costs on account of the implementation of tariffs.

During third-quarter fiscal 2019 conference call, Deere, one of the major names in the Manufacturing - Farm Equipment industry, lowered its expectation for net income for fiscal 2019 to about $3.2 billion from the prior $3.3 billion citing the ongoing trade war and a weak agricultural sector. For the Agriculture & Turf segment, Deere anticipates industry sales of agricultural equipment in the United States and Canada to be flat in fiscal 2019 compared with the prior fiscal year. The segment’s overall fiscal 2019 sales are expected to be up 2% year over year.

So far this year, shares of Deere have gained 3.9%, underperforming its industry’s growth of 4.5%.

Silver Lining

However, it’s too early to write off Deere as we believe strong results from the Construction & Forestry segment will help negate the impact of a weak agricultural sector and tariffs. Notably, in the first three quarters of fiscal 2019, the segment’s sales improved 11% and operating profit improved 66% from the prior-year comparable period. This was aided by the Wirtgen acquisition, higher shipment volume and price realization, somewhat offset by unfavorable foreign exchange.

As a reminder, Deere acquired the world’s leading road-construction equipment maker, Wirtgen, for $5.2 billion in cash and debt in December 2017. The buyout significantly enhanced Deere's exposure to global transportation infrastructure. The company updated its synergy target to 125 million euro by 2022.

With order books extending into the fourth quarter, the segment is poised for improved results for fiscal 2019. Deere projects global sales for Construction & Forestry equipment to rise 10% in fiscal 2019. For the fiscal, U.S. GDP, total construction investments, housing starts and oil activity remains at supportive levels for equipment demand. Equipment rental utilization remains high and rental rates are likely to trend higher in 2019. Global transportation investment this year is expected to be up about 5%, spurring demand for road construction equipment, which bodes well for Wirtgen.

Deere is also assessing cost structure by reviewing organization efficiency and footprint assessment, which in turn will help improve margins. Deere will benefit from concerted focus on launching products with advanced technologies and features, which provides it a competitive edge. The company remains focused on revolutionizing agriculture with technology in an effort to make farming automated, easy to use and more precise across the production process. Consequently, Deere continues to invest in technology leadership and data analytics.