AGCO Corporation (AGCO) Earnings Call Transcript & Summary

Great. Good morning, everybody. Thank you for joining us. This is Steve Volkmann with Jefferies, and we are kicking off AGCO session. So very pleased to welcome both Andy Beck, Chief Financial Officer; Greg Peterson, who looks after IR, and we are going to do sort of a fireside chat with the 3 of us. And if you have any questions, I'm told there is a box at the bottom of your screen where you can type in such questions, and I will relay them to the team here. You can do that at any point during our conversation. So feel free to go ahead whenever you -- the mood strikes you. So with that, Andy and Greg, welcome. Thanks for joining us.

Good morning, Steve.

Obviously, little different conditions than we're used to, but I think it will work and glad to speak with you today.

Great. Great. So far, so good. So let's kick it off with maybe a little bit of a recap of kind of what we saw in the quarter, which was obviously very strong. I think the real kind of standout was the margin expansion and you saw margins significantly improve in both North and South America. So maybe just take us through kind of how that happened and what is your outlook kind of for the rest of the year?

Greg, why don't you handle that?

Absolutely. So if you think about how we started the year, Steve, both in North and South America, coming into 2020, both of the professional farm sectors were what we would say significantly below mid-cycle. So pent-up demand, we were expecting to see some improvement. And of course, as always dependent on what happens with farm economics. So coming in, starting with North America, we had a good first quarter, as you mentioned. We have some seasonal products that helped us in the first quarter. Our Precision Planting business, you can imagine, farmers want to get their new planting equipment ahead of [ warmer climate ]. So the first quarter is the most important quarter for our Precision Planting business, and that did well. That business in the first quarter was up about 30%. So the way that business works, about half of the sales for the full year happened in the first quarter and most of our margin. So that significantly helped our business in North America. Also, coming into the year, we had said one of our major focuses was going to be growing our Fendt business. And so we've started to bring Fendt tractors from our German factory into the U.S. market. We've redesigned it such that the big row crop farmers now, it's compliant with the [ requirements ] in North America. And so it's been a major effort for us to grow that business. And so we had good success. That part of the business was up double digits in the first quarter. And then lastly, our parts business was also improved. I think that was up close to 10% in the first quarter. And our focus really over the last couple of years has been improving our digital capabilities. So that's making our web presence much more user friendly. And so that contributed to our parts growth in the first quarter, along with what our guys were telling us, is that the farmers really wanted to do more one-stop shopping. And so some of the things -- some of the components, the parts that we were selling weren't things we typically do well with. So things like belts and simpler parts, filters, those kinds of things that farmers can go to their local repair guy, local repair shops and do a lot of that themselves. So we were very fortunate in the first quarter that we're able to capture a lot of that. And that transition also into the second quarter where we enjoyed year-over-year parts growth in the second quarter. And so moving into the second quarter then we had, again, some good seasonal products. Our hay business is very seasonal and was strong in the second quarter. And then equally important in the second quarter was our grain and storage business. Margins in that business were up very significantly compared to 2019. And if you remember last year, we were going through in the second quarter -- early last year going through the big spike in steel prices. And so we weren't able to price for that in a manner that was as timely as we would've liked. So we got caught in the second quarter of last year, and that impacted our grain and protein margins in North America. So much improved results there. So a combination in the quarter also with some parts growth. So again, we had significant year-over-year margin improvement, a couple of hundred basis points of margin improvement, really both quarters. And so I mentioned that many of those products, especially Precision Planting in first quarter and grain and protein in the second quarter are very seasonal. So as we move into the back half of the year, our margins are going to look more similar to what they look like in North America last year. So kind of mid-single digits in the second quarter and really breakeven-ish in the fourth quarter. But again, we're -- and then lastly, on North America, we are working, especially as we get into the fourth quarter, to move down our dealer inventories. And that will impact our sales volumes in the fourth quarter. So we'll have lower sales volumes, lower production in the fourth quarter. And then lastly, in terms of North America, we're doing an SAP implementation in our Jackson, Minnesota facility, which will also impact our sales, the timing of our sales. Some of those -- in that facility, we make big self-propelled sprayers as well as assemble big wheel tractors. And so we'll move some of that production into the third quarter, and some of that likely will slip into 2021. So a lower volume in the fourth quarter, so breakeven-ish. And then shifting to South America. Again, we came into 2020 with -- again, been well below mid-cycle. The last couple of years, we've really felt very low, the results of having very low volumes. The industry was down significantly. As a result, we were in a loss-making situation in that business. We also were going through a product transition. So we were localizing our latest and greatest tractor technology into our Brazilian factories. And with that, there was a lot of resourcing that we are in the process of doing and still very much in process, so we still have a number of suppliers that are still either euro or U.S. based. So with the weaker currency that we have in Brazil with the real trading at over BRL 5 to $1 now, it's a situation where we're obviously very interested in getting as much of that component based localized. So we're working really hard to do that. In the second quarter in South America, we did benefit, number one, from higher volumes. Our sales ex currency were up 20%. So that obviously is helpful both with overhead absorption, but also just with that top line growth. And in addition to a stronger market situation, we did benefit from some of that sourcing work that we're doing. And then lastly, in South America, we did benefit from a very strong quarter in Argentina. They're going through some challenging times with the devaluing of their currency. And we did see an urgency in terms of the farmers wanting to convert their pesos into tangible products. So we a saw very strong year-over-year growth, close to 70% year-over-year growth in the second quarter in Argentina. And that was especially helpful for our margins in the second quarter. We are selling Brazilian-made tractors and selling mostly in U.S. dollars. So the margins on those Argentine sales were very good and did help our margins in the second quarter. So as we go into the back half of the year in South America, we're not expecting that same level of year-over-year growth in Argentina. The good news is we have started to see the Brazilian market begin to pick up and start to do some of that replacement that we've been looking for. So we are looking for -- in a constant currency sense, we are looking for year-over-year growth in the back half of the year, and we are looking for our margins to be breakeven-ish in the back half of the year. So a quick flyover, Steve. Hopefully, that's helpful.

Yes. Very comprehensive. I guess we're done now. So just a couple of quick follow-ups, and I do have a couple from the field here already. But again, if anybody wants to ask questions, just go ahead and type them in. So in Brazil, what's the sort of the trajectory for getting where you want to be from a localized sourcing perspective?

Yes. Steve. On that note, with the currency weakening in Brazil -- the real has weakened significantly. At the start of the year, around -- in the 4s and now it's more like BRL 5, all the way up above BRL 5.50, back down to about BRL 5.30. We have a higher import content than we're -- than normal in Brazil because we brought in a lot of new tractor models. It's a couple of years to localize those in Brazil, but still have a much higher core content than we had in the past. And so with the real weakening, that's challenging to those product costs that we already had talked about being higher than our target level. And so we've really put a lot of emphasis on localizing components in Brazil from those -- from that imported content. But that takes time. It's not something you can do overnight. Obviously, you go with the biggest hitters first and then you work your way down, but you have to find the supply base, do the testing, get it into the manufacturing process. So a lot of steps there. So I think we're looking for the in-sourcing process to be probably a year, 1.5 years and lead to -- probably get to where we want to be. In terms of the overall margins, we're looking for progressive improvement. Some of it is going to be due to the in-sourcing of components and really looking at all aspects of the product cost of these new models, resourcing, renegotiating with our supply base and the in-sourcing processes. We're also looking at how to look at all of the features and the configurations of the tractors, making sure that we've got the proper pricing for everything or if it's not something we can price for maybe despec-ing and taking some cost out that way. So really trying to be comprehensive in what we do in terms of our tractor models. The other aspects of our margin improvement opportunity is to grow outside of the tractor market. We're doing quite well in planters, which carries a good margin for us. We're really partnering with Precision Planting. We've got some of the more -- some of the features of the Precision Planting products and the new planters, and so that's going quite well. We also want to grow our combine business. Our market shares on combines and sprayers is much lower than tractors. So we'd like to inch -- get those moving higher and that should drive more margins. So it's about getting strong in high horsepower sector where there is more margin, and it's about trying to get the -- working on the tractor margins through cost reduction and pricing actions.

Okay. Great. And as we look down the road, I don't know, 2 to 3 years or something, what can margins be like in South America? I mean they've been fairly low for a while now, but it sounds like you have your hands around that. So what's possible down there?

Yes. We'd like to see, again, progressive year-over-year improvement over the next number of years. I think we don't see any reason why we can't get it back up to our corporate margins in total. But that will take a while, and that market continues to be challenging from -- as Greg talked about it, it's -- the volumes are quite low, below average volumes. And so an improvement in the overall market with more volume will certainly help us a lot as well.

Okay. And a question from the field here around inventories and just kind of some commentary around inventories, both dealer but also maybe even a little bit more focused on your company inventories and sort of what are the opportunities there.

Yes. So we're -- had targeted dealer inventory reductions in all of our major markets this year. We wanted -- really wasn't that we felt like our dealer inventories were too high, but with the weaker market conditions this year and looking at the disruptions that we've had in production levels, we felt like this was an opportune time to really challenge ourselves to get our dealer inventories lower. That usually translates to more efficiencies in our factories, more build-to-order type processes, which is more efficient. It also helps us with our pricing and discounting, if those units stay too long on the dealer lot, then there is typically either warranty issues or dealer -- or discounting that has to go on. So overall, having lower dealer inventories is good for the business. It's good for us, and it's good for our dealers because it's a cost for them to carry inventory. Obviously, they want a certain supply of inventory to be able to have penetration and show the product, but having too much is typically a waste. And so we've challenged all of our regions particularly North America and Europe to drive down some dealer inventories during this year. And that probably will impact our revenues, probably between 1% and 2% this year. But we think that will be helpful as we move into 2021.

And what about company inventory? Are there some opportunities there?

Yes. Company inventory, we're targeting that to enhance our cash flow this year. We felt like we had too much inventory in our plants. We had some issues with production earlier in the year, obviously. And we also believe we can drive down some inventories in certain regions. We're targeting a company inventory reduction of over -- probably between $75 million and $125 million this year.

Okay. Great. That's helpful. And then maybe let's switch back to kind of the bigger picture relative to margins. I think your target over time is kind of 10%, you've talked about. Can you just talk about sort of the key buckets that are required to get there? How much of that is volume? How much can you do kind of irrespective? And what are the key drivers and time frames for that?

Yes. We've talked about margin improvement being a real critical success factor for us. We think that really is an area that we needed to focus on, and we really got the teams, we think, moving in the right direction in terms of managing our margins, and it starts with pricing initiatives and how to make sure you're really pricing for everything you do within your parts operation as well as your machinery operations, all the way through, obviously, the procurement of the components. That's -- a major proportion of our cost is done through buying materials. So probably about 70% of our cost of sold -- cost of goods sold is materials. And so a lot of initiatives there to consolidate our supply base, get more leverage out of our supply base and we're making good initiatives on that every -- year-over-year to improve our cost structure from that standpoint and then productivity in the factory through investments in new automated manufacturing equipment is really helping us as well. So there's the kind of year-over-year improvement that we're looking for in terms of what we do in our purchasing operations as well as productivity in our plants. Beyond that, even the mix of what we sell, we're focusing on growing our high-premium products, our high-horsepower products, they typically carry higher margins, to improve and grow some of the non-tractor segments, as we talked about in South America already as well as Europe and generate more revenue and more margin there. And then we want to improve the margins, as I've already discussed, in South America, and that will help our overall margins. So we've talked about a 10% margin target, and we've got a ways to go to get there. I would say about half of that is -- we have good line of sight from what we're doing with our initiatives. And then the other half will take a little longer to get there or if the volumes pick up by some market recovery, then we'll -- we can get there much sooner.

Okay. Good. And then maybe specifically, I mean, you've done some kind of global platforms, I guess, small tractor, medium tractor, we have the combine kind of rolling out now. How important is kind of the global combine in terms of adding margin as you roll that out?

We're a huge player in the combine business, and we made a major investment to develop a really brand-new combine from clean sheet of paper. It's -- really performs well in the field in terms of productivity and throughput, green laws, all those kind of important factors. It's running very well. Now we're just now probably pretty much into our second season. So still got a lot of work to do in terms of the maturity of the product as well as getting customers. So we've had a good first year selling the combines. We expect to grow that this year, and we move on from there. So we're still really early in the process of developing a stronger combine following around the world. And all of our markets, we think we have potential to really expand our combine market shares and business. And so that really helps us be a stronger player overall in the high-horsepower sector. And so I think it's not only just selling combines, but it goes with being -- taking customers that want to also buy high-horsepower tractors, sprayers, planters and really serving them in all of their needs. And that combine is a piece of that puzzle. And so I think that's the reason we want to make that investment so that we really had what we thought was a really good balanced portfolio of high-horsepower equipment that can serve the professional farmer. And we feel really good about our product lineup now and feel like it stands up next to all of our competition. So those are really key -- a key success factor in terms of the overall within that sector, more than just looking at it from a product standpoint.

Okay. Great. And maybe it's something that didn't get quite as much focus on the call. Maybe let's just switch to kind of end markets and specifically Europe, which is obviously your most important. Now how would you characterize Europe? I mean where are we in the cycle? What's going on relative to sort of farmer health and farmer -- government payments? We're seeing lots of those here, but what's going on in Europe? And just how do you sort of view that market, assuming COVID sort of passes? How do you view that market over the next couple of years?

Greg, do you want to try that one?

Sure. Yes, absolutely. So coming into the year, we would have said that Europe was much closer to mid-cycle than probably the other developed markets. So we've had 2 or 3 years of really solid demand. And then coming into the year and with the pandemic kind of unfolding, I think the sentiment in Europe took a pretty strong step back. Europe I think maybe felt the impact of the virus before we did here in North America in a bigger way. There was -- there were more broad shutdowns, and we did see demand pull back. The good news, though, as that happened, the underlying fundamentals for the farmers are, actually -- continue to be okay. Wheat prices are up pretty significantly from last year across Europe. The harvest will be better, has been better in most of the regions. The common agricultural policy, which is what drives the subsidies in Europe, provides about 30% of income, and so that continues to flow without any interruption. There has not, however, been across most of the markets, special payments like the farmers here in North America received. Having said that, another important aspect of the, I guess, sentiment picture has been the fact that CAP policy comes up for renewal and actually the current program ends in 2020, and the new one starts in 2021. And there was some thought that there would be some reductions to that -- those direct payments for farmers and with some additional rules around sustainability. More recently, good news for farmers is that it looks like those payments are going to be held pretty constant in the new plan. So that, I think, would help to -- could maybe shore up some of the concerns farmers had about the near future. And then more recently, we've also seen some actions in one of the bigger markets, Germany. They have done some things with their VAT tax program for the rest of the year. Those rates have been reduced. And then there was also some changes to the tax depreciation rules. I believe it's just for this year, but that will help farmers as they're able to take some accelerated depreciation deductions this year. So we're hoping that translates into some additional demand. But because -- well, for a lot of reasons, the revenue base across Europe is pretty diversified in terms of their crops, both in terms of row crops and dairy and livestock that, that market tends to be steadier. So we're hoping as we get into the back half of the year and have more normal production, hopefully, the supply chain holds up through the rest of the year that we'll see some stabilization in that market as we get into next year.

Okay. Great. And then another one from the field here. This is sort of a big topic, so maybe it will be the last question. But the question, I guess, is around Precision Ag. And the fact is obviously you did a great job with Precision Planting. It seems like people are really stepping up and buying that stuff even though it's more expensive. But I guess the question is, how do you compete with others who might be green in this respect? And is there a risk that the systems that are getting set up over there might be sort of sticky and keep people from sort of giving you a shot, I guess, is the way to look at it? And so maybe you can just sort of talk about how you see the whole precision sort of strategy playing out relative to competitors.

Sure. I'll take a first stab at it. And maybe, Greg, you can add on after. Really, when you talk about Precision Ag, there's so many aspects of it, and we sometimes tend to maybe categorize someone as leading here or there, well -- whereas, really what's happening is we're all taking -- have different strengths in this sector. We're all kind of focusing on different aspects of it. So for instance, you mentioned Precision Planting. It's a business that we acquired a few years ago. And you made the comment that they're more expensive. Well, really, what it is, is a big savings because they're really selling retrofit kits to be able to really get your existing planter to the most up-to-date technology and without having to buy a new planter. So maybe half the cost in order to get all the features that you want, get all the productivity and yield enhancement that we've developed through our Precision Planting business. Also the Precision Planting team is bringing out new innovations each year trying to solve farmer problems. So their product pipeline is very strong, and we'll continue to see, hopefully, a lot of new and innovative features in the products that they sell going forward that bring yield and bring profits to the end user. And so that should help continue to drive demand there. And the innovation that they're bringing is very unique and very different selling process. They're going through their own distribution network. And so we feel good about the growth opportunity of Precision Planting business and through that retrofit market going forward. On a broader scale, when you talk about Precision Ag and all of the features that we are adding to our existing products, whether it be in guidance and telemetry, so the connectivity between machines or within what we call smart machines, like in our combines where our combines have significant number of sensors that help self-adjust the combine to make sure it's operating in an optimal manner, those are all things that we feel very strong -- we're in a strong position with in terms of how well our products have a lot of innovative features that are adding yield, adding cost savings to the end customer.

All right. With that, I'm sorry...

Are we running out of time?

Yes. I don't want to get -- have us get cut off here, but...

Oh, I'm sorry. Okay. Well, I would just say that we think we're doing well, Steve, on that. So we're going to remain competitive in that as well.

On that note, I think we'll wrap it up. Thank you guys very much, and we'll move on to the next one.

Okay. Thank you.

Thanks, Steve.