AGCO Corporation (AGCO) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm Courtney Yakavonis, Morgan Stanley's U.S. machinery analyst. And next up, we are continuing our discussion on ag equipment with AGCO. But before we begin, please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to Morgan Stanley sales representative. So as many of you know, AGCO is a leading manufacturer of agricultural equipment globally and I'm very pleased to have with us this afternoon, Andy Beck, AGCO's CFO ; as well as Greg Peterson, Head of Investor Relation. Andy and Greg, thank you so much for joining us virtually today.

Thank you.

So I want to kick it off with some questions. [Operator Instructions] So Andy, maybe we can just start off talking about farmer sentiment. There's been a lot weighing on the farmer over the past few years, whether it was trade frictions in 2018 and then a tough planting season last year, now COVID. So how would you characterize farmer sentiment today? And more importantly, the willingness of farmers to invest in Ag equipment?

Sure, Courtney. As you pointed out, there's been a number of factors that contributed to somewhat weaker demand. Overall, when we look at where we are in the cycle or where our sales are in the different regions, certainly, North and South America, our industry sales, retail sales of equipment are below midpoint or a 10-year average, however you want to look at it. And even in Europe, I think they're lower. Europe is always a little more stable of a market, less cyclical, but even their markets are below average at this point. So there's a lot of contributing factors. The most important one is really the lower commodity prices that we've experienced over the last few years. Farmer incomes have been a little more challenging. Margins aren't as strong. And in those environments, clearly, their investment levels go down. We certainly know that there is a replacement demand out there, particularly in North and South America, where the last big sales periods were 6 or 7 years ago, and we always talked about farmers wanting to replace equipment more in a 3 to 5-year time frame. So there's clearly a replacement demand and -- but that's always been mitigated by weaker commodity prices. You mentioned weather issues last year. And then this year the COVID-19 and the uncertainty surrounding that. But I would say that we're seeing farmer sentiment be a little bit stronger now than we had been a little more solid. There's still a lot of concerns about their margins and where commodity prices are. But I think they feel like things are stabilized a little more. And we are seeing a little more activity in the retail space, particularly in South America, we see markets improving their margins in Brazil because of the weakening Real has really helped the farmer, and I think confidence is growing there. They've been locking in their prices for this year and even into next year. So a little bit building confidence there. There are some markets in South America that are still a little weak, but in the big market of Brazil, we're clearly seeing some improvement. North America, the retail numbers on high horsepower equipment are down this year. In terms of sales, the last few months have been a little better but still down. But with the rising commodity prices, they've improved over the last few months, with seeing some buying of China, buying commodities from the U.S. and with the prospect of some government payments coming in, we believe that there could be some -- a little bit more confidence in the market than what we had at the beginning of the year. So things are little bit improving. But still, we expect the market to be down on the big equipment. On the small equipment in North America, buying conditions have been very strong. On the small tractors, we've seen double digit growth. There's going to be a point where that starts to dwindle out, but the conditions have been very good on the small equipment so far. And then in our biggest market in Europe, we had a really weak first half because of the lockdowns and the lack of production of product that we were able to do. We were shut down in our factories in big parts of second quarter and weren't able to deliver all the equipment to customers. So we knew there would be a catch-up in demand in the third quarter, and we're starting to see that. The second quarter in Western Europe was down 22%. And we've seen some couple months now in the third quarter where the demand's been up year-over-year about between 5% and 10%. So that catch-up is happening. Probably, once we get into the fourth quarter, we're probably really subject to normal demand again. But we see products being delivered and customers receiving their product here in the third quarter. In Western Europe, what's -- a number of things factoring in there, agricultural prices for the farmers are pretty good in Europe, the wheat prices are the most important price there along with dairy. Those are all relatively solid. From a harvest standpoint, kind of a mix condition, wheat harvest has been relatively weak, particularly in France and the U.K. but stronger with corn and rapeseed, so kind of a mixed result. We are seeing the German market be up, and that's somewhat because of some tax incentives that were put in place for this year in Germany, but we're also seeing France and U.K. down, which are the other 2 big markets in Europe. So mixed results. But overall, our teams would tell you that the sentiment is improving in Europe and there -- things are getting a little bit more back to normal after the disruptions in the second quarter. So all in all, yes, things are kind of stabilizing, I would call it, in the market in terms of farmers' attitudes.

Great. Maybe you can talk a little bit about your Precision Planting business. I believe it was up over 30% in the first quarter and was one of the strongest contributors to your North America sales and margins. So can you just share with us what's the uptake on that business? And how do you see the opportunity for growth going forward in both North America and the rest of the globe?

Yes. Greg, you can take that one.

Sure. So Courtney, our Precision Planting business today is mostly a retrofit business and -- which is a is a great way for farmers to be able to take advantage of a lot of new planting technology without having to invest bigger amounts of money in a full-fledged planting solution. So essentially, precision planting offers varying products that allow for different aspects of planting. So there's a feature set that allows for very rapid planting. So you've heard a lot about high-speed planting. Precision Planting enables planters to do that. They have a feature set that essentially ensures that the furrow that the planter creates is closed evenly, which ensures better germination of seeds. And then if you go kind of at the very high end of their feature set, they actually have a sensor that goes into the soil, senses organic matter, temperature, moisture levels and then plants the seed based on the analytics that it does based on those real-time conditions and changes the depth and the spacing of the seed that goes into the ground. So optimizing the yields that the farmers get as well as allowing the farmer or the technology to choose between planting a more expensive hybrid seed in the parts of the farm that needs that expensive hybrid. And then on the better soil conditions across maybe a different part of his farm, the planter is smart enough then to use a less expensive seed. So a lot of different options and features and functionality that, that product set delivers. And so we've seen significant growth, as you mentioned, not just this year but over the last several years. And today, most of that business, as I said, is retrofit, and most of it is in the United States. So the great growth opportunity for that will not only be to continue to penetrate the North American market with the retrofit business, but we're also now introducing an OEM version of a planter that features a lot of that technology that I just talked about. So that's another growth opportunity for us in North America. But when you look outside of North America, places like Brazil and Western Europe that -- where we also have a huge opportunity to improve the dynamics around farming, we've launched Precision Planting products. And today, those are mostly targeted at corn and soybeans. And -- so places like Brazil, for instance, where soybeans is their biggest cash crop is a very large opportunity for us. And then Western Europe, which is increasingly becoming a big corn market, we have some opportunity. And then longer term, we'll look to expand the product set to include the smaller grains, particularly wheat. So a lot of opportunity to grow the Precision Planting business, both in terms of retrofit, but then also now in terms of the OEM version that we're deploying. We deployed it first in Brazil and are doing very well. Later this year, we're going to introduce it into North America. So a big opportunity for us as we look forward.

Great. And we just got a couple of questions from the audience on your Precision Planting business. Can you also just estimate how much of the market is really interested in that retrofit business versus the OE side? And how much penetration you feel like you have within that market?

I mean, I think just about every farm is interested in becoming more efficient and becoming more productive. So I don't -- and I think -- so I would say, I think the opportunity set is virtually all of the acres in North America. Having said that, there are farms that their business model is to buy new and keep their equipment under warranty. So I think there's opportunities both on the OEM side and on the retrofit side. The -- and one of the interesting things that creates or makes it difficult, I guess to have competition on the retrofit side is the way that we distribute that product. Today, most of the distribution goes through seed distributors, fertilizer distributors and a minority of what we sell goes through the traditional OEM channel. So there's a lot of opportunity to penetrate further. And the good thing about that business is that farmers tend to be very conservative and very slow to change. And so what that's meant is that it's taken us, and what we have to do is demonstrate to them that this technology that we can bring to them at a much lower price on a retrofit basis is going to make a meaningful difference. And typically, we show farmers that we can pay back on their investment in a year. That's the goal for our Precision Planting business, and typically, they can do that. And farmers, like I say, are conservative, and when they see their ability to do that, they're oftentimes very willing to do that. So I don't have a great penetration number to tell you, but I would still say it's a relatively low numbers. I talked about the varying degrees of technology that Precision Planting provides. And if you get to the product set that's called SmartFirmer that has the sensor that goes into the soil, I would tell you that, that penetration rate on that product is extremely low, probably in the mid- to low single digits. So a lot of opportunity across most of the acres in North America, across many of the acres -- a lot of the acres in Brazil and a lot of them in in Western Europe. So the opportunity is significant.

And Courtney, just to add to that, if they're -- we're going to address both markets because we have the Precision Planting retrofit market addressed by Precision Planting. But we're also introducing a new planter lineup that we call the Momentum planter. It's already been introduced and very successful in South America and now being introduced in North America and it is has -- a lot of Precision Planting technology is embedded in that new planter. So if you want to buy a new planter with a Precision Planting kit on it, then we have that as well.

Great. Maybe if you could just talk a little bit about the parts growth in the first half of 2020. It's been very strong. And if you can just talk a little bit about what's contributing to that strength. And are we concerned at all that this might be in lieu of the replacement, Andy, that you had mentioned in your earlier comments?

No. We've seen, as you pointed out, very strong performance from our parts group that's really helped -- that's the high-margin business that we have, and so that's really helped our margins in the first half. You could clearly see that, particularly in our North America business, but all of our business. And the parts -- trying to figure out what's attributing that growth to a number of factors. One, we think as farmers and dealers were dealing with potential logistics uncertainties around the COVID-19, our digital capabilities and reliable logistics and delivery time promises has really allowed dealers to really rely on us, maybe more than other providers of parts that they might use on some of their later life cycle products or maybe where parts like hoses and things like that. So we think we're getting a bigger share of the dealer business. We're also probably seeing a little bit of dealers buying ahead a little bit to have enough safety stock in case there was another disruption. So we think that could be another part of it. But one of the things that we really measure with our parts business is our fill rates, which means when we get an order, how often do we fill that order within the promised time frame, which is typically overnight-type deliveries. And our rates are all at the right target range. So we know that we're performing well in terms of reliability of performance, which is really key. Dealers and customers, one of the most important aspects when you talk to customers is ability to support them in the field, have the parts available when needed and so that they can keep doing their business. And we feel like we're -- we've got the right organization and processes in place in our parts business to really meet customers' demands.

You mentioned that parts are one of the stronger -- contributors to your very strong North America margins. You've now had margins over 11% for 2 quarters in a row for North America. So is that kind of the new normalized rate that we should be thinking about for that business in the first half of the year, given you do have some seasonality with Precision Planting as well in the first half? And maybe can you help us think about -- how to be thinking about North America margins in the second half of the year, especially given your plans to underproduce in the second half.

Greg, do you want to take that? .