AGCO Corporation (AGCO) Earnings Call Transcript & Summary

[Audio Gap] Andy Beck, who's the CFO; and Greg Peterson here to my left, who heads up IR. So again, thanks for coming, guys. Good to hear some perspective from AGCO, who is -- as you know, is a pure-play in global ag equipment. So I guess I'll just launch into Q&A. And if anyone has any questions as I go along, just raise your hand. I'll make sure to get you.

So maybe, Andy, we'll, I guess, start, I guess, by looking backwards. In terms of fourth quarter '19, obviously, it came in below where you had expected. Just maybe walk through some of the drivers that as you -- as it kind of played out, how you think that -- or basically what gives you confidence that those don't recur. And maybe just help kind of put some finer points around some of the major deviations in terms of how the end of the year shaped out versus your expectations.

Sure. Yes. In terms of our fourth quarter results, there were few factors that we highlighted that were -- influenced our results a lot. First of all, there were some areas of warranty that we made provisions for in the fourth quarter that primarily related to a few product offerings where we needed to go back into the field and correct some performance issues with the products that we wanted to make sure that we got done to make sure our customers were satisfied with their support and all those kind of things. The key one on that was relating to a new baler product. And again, these are finite programs, well defined in terms of what the fixes that we anticipate we need to do, how many units are out there and there's a certain cost to do that. So those are -- those were relatively large-type programs, not something that we typically see and certainly influence the results quite considerably here in the fourth quarter. But as you go forward, again, it's not something that we would anticipate having to do on a regular basis. We have -- obviously feel good about the quality of our products. And from time to time, we'll have something like that, but it's rather unusual. The other area where we had some unusual costs related to our grain and protein business, where we've been doing some strategic review of that business and looking at ways to improve the overall profitability and performance of the business. And we made some decisions in the fourth quarter about branding and product offering, where -- in order to rationalize that. So we're moving from -- particularly in our ag business, from 2 brands to 1, which affects some dealers and affects some of the product offerings that we had. And that, on a onetime basis, created some cost in terms of obsolescence of inventory, warranty, things like that, that was a direct result of that decision-making that we had. So that's something that should be behind us as well. The last item that affected our business was more normal operations in terms of -- we did come short of our revenue targets for the quarter. And that really resulted around market conditions, where we thought the markets would be versus where they ultimately ended up. We were light on sales and -- particularly in South America, where we had predicted a relatively flat fourth quarter market, and the market was still down probably about 15% or so. In Europe, the market was down, I think, over 10% and we had anticipated some softness but not to that degree. And then in Asia Pacific, Africa, some issues in Australia particularly with the dry weather and some of the fires, and that disruption created some lighter business there, so missed the mark on the revenue side and that certainly hurt the profitability of our fourth quarter. And those were the key elements of that. So as we look forward into 2020, the question is -- obviously, what you're asking is how does that influence going forward. The first 2 items, I think, were again specific in nature and shouldn't be something that we would see happening in 2020 relating to those items. So the question is I think more about our market prediction and how we think the markets will evolve in 2020 versus what we saw at the end of 2019. Basically, what we did, looking at 2020, was kind of looking at the absolute market size of what we predicted when we talked about it in December and was anything that happened in the fourth quarter really changed those predictions or those forecast. And based on working with our teams on that, we really stuck with those absolute market sizes. What that evolved to was still being down slightly in North America and in Europe but really up now in Brazil, where we had said flat, I think, in December but since December came -- since fourth quarter came in lower, it actually means that it's got to be up now. But overall, the conditions in Brazil, we think, are good for the farmer. Financing is available. So there's a lot of things that give us comfort that we think that the market could be up this year. But those -- that's the real thing, I think, for obviously all of us to watch is -- where these markets were evolved. There's a lot of factors to take into account until we get into some of the key retail selling seasons, particularly starting with the spring season. We'll start to get a better feel for whether our forecast are on or do we need to make certain revisions.

And just in terms of the market, you just highlighted Brazil. What -- in terms of North America and Europe, just -- again, it's a highly fluid situation and things change. But would you say you're leading more incrementally more positive, more negative in terms of North America and Europe?

I think as we indicated in our last call, Martin indicated that he thought that there could be some upside on North America. Again, we're calling for it to be flat to down. And there's obviously reasons for that in terms of uncertainty around farmer income levels, possibility they won't get any further aid payments, and so income could be down. And so those are some of the influences of why we called the market as it is. With the trade deal solidifying between China and the U.S. and the possibility that China's now starting to buy agricultural products back in from the U.S., there is a potential that, that could stimulate demand, stimulate prices as well. And I think farmers are eager to buy equipment if the conditions are right. And the age of the fleet is very old right now. There is a pent-up demand that could come about. But the conditions in terms of their financial position, their confidence level kind of need to get aligned for them to pull the trigger and want to buy equipment. And so we're -- I think it's still a wait-and-see attitude. But if they could see some recovery in commodity prices, we certainly see some upside in demand here in 2020. So that one's probably on the upside. Europe, I would say, a little less so in terms of upside potential. We do see that -- and there's a belief that the market's starting to stabilize again. The confidence index are stabilizing. Feedback we're getting from our dealers is that they don't see another significant negative down quarter. But again, until we get into the spring season, I think it's a little early to be able to call that.

Yes. I think we -- because of -- there's the dearth of indicators to watch, there's probably way too much emphasis put on the few that do exist, so like the European sentiment one. But it has been a noticeable improvement here over the last, again, 2, 3 months. But for what it's worth...

Yes. It's still in the lower quadrant. So you got to keep that in mind but at least maybe show some stabilization. There are a number of issues in terms of having another weaker harvest here and 2019 had another very dry season. So that affected their production and their confidence. We've seen after kind of a good run on the dairy sector, the milk prices are trending down a little. So that was a bit negative in terms of what that sector's looking at. And then there was a lot of discussion around environmental regulation of farms and a lot of political discussion about that, which I think took the attention away as well and added some concern amongst farmers. Not -- none of those have really resolved, but things are stabilizing, I think, from an attitude standpoint.

Yes. In terms of the read-throughs that Agritechnica provides or maybe doesn't provide, is that -- I mean was the tone -- did it suggest one thing it didn't play out? Like was there a conclusive tone, I guess, or feedback from that? Or does it -- is it not something like a barometer anymore?

I think feedback and tone was good at those shows, so a little bit surprising how the market, I think, performed in the fourth quarter. But I think those reasons that I outlined were the real key causes. But still overall, there's a real interest in the technology and the type of solutions that we are bringing and our industry is bringing to farmers. And for them to be competitive, to be more profitable, they know they need to take on a lot of this new technology. And so I think they're very interested in that. And it makes -- this shows very beneficial for us to show what kind of product offerings that we can bring in the future to these farmers.

Maybe I'll switch a bit to the margin opportunity, which I still think is a pretty -- potentially good story there in terms of the potential upside that exists. And as you think about that 10% margin and a target that's been out there, enough time has elapsed. As you think about -- relative to that initial expectation, are there areas within that programs or parts of the market that as you look back, say, "Well, we thought this was going to occur and that hasn't?" Or while we didn't anticipate this and it's actually been more of a -- like, do you think about just the -- some of the key buckets within that, that played into that 10% target? Anything that you look back and say...

Well, I think the key variable there is volume. And we anticipated that we would be at a certain market size and volume level. And our margins are very dependent on volume levels and capacity utilization in the plants and leverage of our cost structure over a revenue base. And because of that, it's hard for us to give time lines and all those kind of things as it relates to margin improvement because we are relatively volume-dependent. And so as we said in our last analyst meeting, we anticipate that we can get to that 10%. But at this revenue level, we're going to have a gap. So we need to see market recovery, volume improvement in order to reach that 10% goal in a reasonable time frame. In terms of the building blocks to get there from our own operations, I think we feel like we've made a lot of good progress in terms of developing solutions and our product offerings that are more platform-based so that we get a better leverage on our purchasing volumes. Rather than splitting -- divide by our 3 brands, we're building products that are -- have many more common components and features. And so that allows us to get a better leverage there. We still think there's opportunity for continued purchasing benefits from being more professional and leveraging our buy, consolidating our supply base and those kinds of things, moving to lower-cost country environments. There's a lot of opportunity there. So that's still in place. We still think we have ability to improve productivity in our plants. And so those are key elements. We're making investments in automation and high-technology manufacturing in order to achieve lower cost. So those have worked out as planned and we continue to see opportunities there. The one area, I would say, certainly off track is our margin performance in certain business units. So South America has been a challenge for us. We localized a new range of products in Brazil, did it in a very short period of time, and it has eroded our profitability from a margin standpoint for those products. And so we've got work to do to correct that situation, reduce the cost of those products along with hoping for a market recovery there and get our profitability improve there. So that would obviously help us overall if we can achieve that. And then we talked a little bit in our last call about the GSI business, and that's more of a market issue. So that probably would equate mainly to market recovery that we'd like to see, but that has good, incremental margins particularly on the grain business side where the market's relatively weak. And so from a mix standpoint, that's going to improve our offering and improve our margins. But we're doing quite well with premium product, smart technology in the product where -- that's helping us grow. So that should be new opportunities for margin enhancement. We're also -- we're globalizing the Fendt offering, which is a premium product. So that helps our mix and helps us grow in the high horsepower sector, which is typically a higher margin sector of the business. And we're trying to do more things to get a bigger proportion of our dealers' parts business. So that's another high-margin sector of the business. So how responsive we are, how we can manage and work as partners with our dealers and servicing our customers' equipment, we think, will help us grow margins in the future as well. So there's still a lot of things that we have on our plate to achieve and we think that, that will help us continue to move margins up. In 2020, we expect to see margin improvement. And that's certainly built into the forecast that we gave at the beginning of the year.

Just to go back on the parts and the responsiveness, is that a function of adding brick-and-mortar like distribution capacity or...

No. It's -- I think we have a good network there. And the key is responsiveness. So typically, we're promising parts availability either same day or within 24 hours. And so we've got a network that enables us, in all our key markets, to be able to deliver that type of responsiveness. It's actually more of the inventory management and the logistics to achieve that. And we have very high-rated parts operations around the world in terms of their fill rates, which is the measurement of how often you do meet those time requirements on orders. And we think we're -- I don't know if we're best in class but we're up there in terms of our ability to do that. There are other ways to support our dealers in terms of helping them with predictive maintenance, maintenance programs, those kind of things that bring customers back in, make sure their equipment's working well, and those are the kind of things that help us get more parts business in the future.

As you go across the geographies, I mean relative to that 10%, obviously, Europe is already -- has been running above that. I think there's a number of reasons obviously contributing to that. But how will the -- you talked about expanding the product portfolio and building that out. I would think that -- I guess if you're -- if the share and the percentage of the mix today of that business is 100-plus horsepower being the largest category, what are the other areas of opportunity? And as you build that out, I would think that would, all else equal, be detrimental or weigh on mix. And so how is building out a larger platform additive to margins?

Well, I think that you want to get to the proper scale of those businesses. And so those businesses, if we can grow them, hay equipment, combines, we'll get to the scale level to where the margins are going to be good. So right now, they're sub where we want them to be because of scale. And so as we build out and grow, we'll see good incremental margins there. So I think that should be additive to the overall margin profile. Secondly, the market continues to enrich itself in terms of -- as you point out, to the higher horsepowers to more premium product. There's a high demand for the high tech -- for the technology offerings that we have in Europe. And as the -- our market shares are typically better as you move up in horsepower. So those trends -- and we've already seen it, I think, in our results, are contributing to the mix and contributing to an ability to continue to improve margin along with what I'd already described in terms of what we're doing in our purchasing area, in our manufacturing facilities also helping us achieve better margins in Europe. So as you point out, we're performing well in Europe. Our margins are very good but we still see areas of opportunity for the future.

Yes. Combines is an obvious category that I left out that would certainly, I would think, help margins in a big way as you -- to the extent you can improve the scale. What is the -- just remind us there in terms of what -- where are the product offering. I know that that's an old legacy business in Italy, I believe, that you purchased way back. Just update us there in terms of where the shares have...

Yes. So we have a combine business for years in Europe but really not -- with relatively modest market shares focused probably more on the small to medium-sized combine business, as you say. The legacy was an Italian offering which again would be more on the small to medium-sized combines. So over the last 4 or 5 years, we've developed a brand-new technology combine that we call the IDEAL Combine. It's a multi-brand offering under the Fendt brand and the Massey Ferguson brand. It was designed and developed basically from a clean sheet of paper, really using, we believe, new capabilities, new approaches, whereas most of our competitors' combines are built from generations maybe 10 or 20 years ago. And so this was kind of a fresh approach to the development of the product. Our goals were to create step changes and key measurements that combines need to have in terms of throughput, capacity, grain loss, fuel efficiency, all those kinds of things. And we think we've achieved that. If you do demonstrations with our combine, they perform very well. We're in the -- this 2020 will be the -- now the second season of the product. First season went relatively well. We learned a lot about the combine. There's a maturity level that we're -- curve that we're working on. So there's a number of changes that we'll be making to the product to correct the issues that we learned in its first season, and we're making those. So we expect to see good growth in the second year of the offering. And that's a comment for both Europe and for North America. And then in South America, where we've now localized the production and we're doing the demonstrations of the product this year in the 2020 season. So that will be in -- will be a -- we're a year away from commercially selling the product in South America. So we're still very positive about the performance. The customer reaction is very good. Our orders are very good for the product and looking forward to performing well here in the second season in 2020.

It's added, from a dealer standpoint, that there's a competency that comes with servicing combines. Is there -- I would assume the dealer base in Europe is well positioned to be able to accommodate that. Was there more investment required in the part of the dealer base in North America or...

I would say similar requirements for both. Our dealers were either more focused on selling tractors than combines. Or in some cases, they're selling a competitive combine. And so we did need to improve the capabilities of those dealers. So we've, first of all, not just given the product to all our dealers. We selected key dealers that we think either were willing to put in the investment in terms of the right people and the right coverage to handle that product because it is quite an investment. And then we've also invested around that in terms of field support and all those capabilities so that customers feel like they're being really well taken care of on this new product. So I think that was -- our best result in 2019 was the feeling from the customers that we were reacting very quickly to any issues that were coming about, and that gives them confidence to continue to invest in this new product.

Are there many dealers left, if any, that -- or split brand with the [indiscernible]

Well, in North America, there are the -- a lot of the Caterpillar dealers also sell cost combines. And so they're...