AGCO Corporation (AGCO) Earnings Call Transcript & Summary

Hi. Good afternoon, everyone. So my name is Chad Dillard. I'm the lead analyst for the machinery sector here at Bernstein. And I'm pleased to have Greg Peterson, who is the Head of Investor Relations; and Andy Beck, who is the CFO of AGCO. So AGCO is a $7 billion market cap company, manufactures and sells agricultural equipment such as tractors, combines, green storage equipment, and they do so globally. So the format of today is going to be a fireside chat between myself and AGCO. And I encourage all of you who are on this webcast to join in on any questions. And you can do so by clicking on the pigeon-hole link that's currently in your browser and entering the question. So without further ado, let's just dive right into it. We'll start out with just more of like some near-term questions and then dive into some of the more like the longer-term thematic and strategic questions as well. But let's start with the near term.

So my first question is with the next wave of COVID ramping up in Europe and North America in the last month, have you started to see customers change in terms of how they're approaching their buying decisions and what sort of conversations you've been having?

I wouldn't say there's been much change there. You can see we've got the inventory sales data for our North America market just recently for the month of October, and the market was up really almost across the board and all product lines. So I think from a standpoint of what our end customers are doing, they're still taking advantage of these stronger crop prices and government payments. They've got more cash flow than they did probably a year ago. And they're looking at making acquisitions of equipment here in the balance of the year. A lot of farmers will always look at their year-end tax position and make determinations whether it'd be advantageous for them to buy equipment at the end of the year based on what their income levels will be. So there could be some year-end buying, which is typical in our business because there are some tax advantages to making capital purchases at -- in a good year, a year where they have good income. So what -- from a COVID standpoint, I think the -- more of the focus has been on our own workplace availability and the ability and capacity of our supply chain. And that's been the real challenge really all year, and we're continuing to see challenges with that respect. We have one of our plants that we talked about at the end of our -- in our third quarter call, one of our plants in North America and Kansas which makes harvesting equipment, it had some challenges. We've had to suspend operations there. Some of the lines are back up and running already, and we'll have some other -- the rest of their lines, hopefully come back up during the course of the rest of the month. So seeing some issues already from that standpoint. And then in Europe particularly, we're continuing facing challenges on supply chain availability. I think the demand is picking up as well of all industrial products. So it's not just agricultural equipment that our suppliers provide. And also, they're having obviously some issues potentially for workforce issues as well. So we're working very hard on solving all those problems, and keeping our factories going which we have going right now, but those are more of the challenges than I think the end market demand at least in our business.

Got it. Okay. So we're entering an upward period where the pandemic is getting a lot worse, but where there's a lot of hope on the vaccine front that it can actually end in the relatively near term. So if you had to choose, I guess, what would you be more worried about, managing the cost structure during the near term or making sure the business is ready to respond for a greater inflection in demand? And if you could -- you can only choose one.

Well, thankfully, we probably don't have to choose one in real life. But what I would likely say is that in the -- it really adds on to the comments I've already made about workforce and supply chain challenges that we have. I would say that we need to continue to focus on that aspect of the business. And we want to deliver on the production volumes that we have in place today. That's something that we're real focused on. So I think focusing on the near term, on workforce health, supply chain availability and all those kinds of things is really the -- maintain the focus for us right now. If we saw improvement in demand, we're going to react as quickly as we can. We’ve got to work with our supply chain. I think that will be a challenge for them. But within our factories, we certainly have the capacities to grow. It will again come down to do we have the workforce in place. And so those are all about how we manage our workforce, how we keep them healthy, make sure we have the proper protocols in place and have a little luck as well.

Got it. Okay. So how big of a COVID-driven lockdown is built into your year-end plan? What levers do you have at your disposal to flex cost down further, should the lockdown tighten?

Well, we don't have that plan. So we made that very clear that within the guidance and plans that we have for the balance of the year, they don't assume any suspensions of production or disruptions caused by COVID, whatever that might -- how that might entail. So we've obviously had this situation already in the second quarter. We had a number of our facilities go down, particularly in Europe and Brazil. We actively cut costs, furloughed employees where we had the opportunity to do that and really kind of locked down as much as we could our cost and our spending in order to mitigate the impact of the production being down. And we can -- if we have to, we can go back to those types of measures again. We have felt like in the third quarter, as you saw, our results were quite good. So we were able to get a lot of catch-up in the third quarter, and we did loosen up some of the spending again. We've got some people traveling to see customers and dealers and things like that. But depending on what the lockdown entails, what kind of a situation we're in, we can kind of go back to what we were doing in the second quarter as well. So that's what I would focus on. And from an investment standpoint, we really have tried to maintain our investments in key products and new product development and technology where we could. Certainly, there were some challenges there, but we -- our guidance for the year is that our engineering -- we'll spend our engineering budget this year. So we're trying to maintain those, and we would continue to do that. But they are more challenging, if there's lockdowns again. So those are the other areas that we would not like to see happen, but they could happen, and then we'd have to reassess how to catch back up later.

So Chad, we've had -- we have had a number of questions from investors around kind of the quarterly optics in terms of our results this year and how they've been -- will be impacted by COVID. And to Andy's point, we had the shutdowns in the second quarter and then significant volume increases in the third quarter that made our sales and production volumes look good, and obviously help our margins. We -- and then as you look into the fourth quarter, Andy talked about the plant in Kansas that's closed, and included in our forecast is the production volumes in that plant that makes harvesting equipment so that’s hay equipment, balers and windrowers and combines will be down. And that's not something we'll catch up on in the fourth quarter, probably more so as we get into the first quarter. So as you look at our margins, particularly in North America, first of all, in the fourth quarter, we have -- there's good seasonality in our North American business that's more heavily weighted towards the first half of the year. So some businesses that we have, particularly around our precision planting business is heavily weighted towards the first half. Our grain and storage business is heavily weighted towards the second and third quarter. So as you look at those businesses, in the fourth quarter, they tend to be more breakeven-ish. And then when you layer on the lower production volumes around the plant in Kansas and then as well, we haven't really touched on it yet, but we do still plan to do some further dealer inventory reductions in the fourth quarter, particularly in North America and Western Europe. So when you layer those on there, our margins in North America will be significantly lower than they were in the third quarter, but probably closer to what they looked like last year. So definitely a step down from where they were. Some of that is just kind of normal seasonality. Some of it is production scheduling. Now we have similar impacts in Europe, although Europe's margins in the fourth quarter are actually going to be improved from last year, despite the fact that our sales are going to be about flat. So in the third quarter, we did a lot of catch-up and had a lot of extra production and sales volume. We came into the -- we're coming into the fourth quarter with heavy order boards. And so we'll still see good volume in the fourth quarter. But because of, again, some work to underproduce retail demand in the fourth quarter, we look to take inventories down, our dealer inventories down. And then to Andy's point, we're going to have $10 million or $15 million year-over-year increase in engineering, just as we are catching up on some of these projects. So our -- optically, our third and fourth quarters will look a bit different just because of the way the year is finishing up.

Got it. That's helpful color. So just taking a step back. So AGCO is changing CEOs at the end of the year. Martin, the current CEO, is outgoing while Eric, the current COO, is ascending to CEO. So can you just compare and contrast the management operating styles? What do you think will be different on a go-forward basis?

Well, that [indiscernible] I've been with AGCO for over 25 years and really been with the company almost since its founding and had the opportunity to work with all the great leaders that AGCO's had, starting with Bob Ratliff and then Martin for the last 16 years, and really great leaders that have helped transform AGCO to the company that it is today, starting from a really small company. And so we're really proud of what we've accomplished. And I think I believe and our Board believes that Eric is the right leader to take us forward in the future. Eric's got a great background in terms of his agricultural knowledge, growing up on a farm, working on a farm. He has an engineering background, so he has strong industrial knowledge, great amount of experience with the industry leader, John Deere, and then really 7 very productive years at AGCO, where he's already influenced a lot of what we're doing in AGCO in terms of where our investments have been, in terms of precision, agriculture, our -- a new IDEAL Combine, smart machine technology, the purchase of precision planting have all been really led a lot by Eric's influence. And so I think we've got a great leader growing -- coming into our -- to the top position. And I think we're all very excited to see where he takes us in the future.

Great. Okay. So I just wanted to address one, I guess, piece of news that came out over the last week, and that was one of the larger shareholder is advocating for the separation of the Chairman and CEO positions. And so I just want to get your perspective. I guess like what right now is the logic for maintaining that -- both of those positions under the same person? And to what extent do you think that that position will actually get split up?

Sure. Yes. Let me give you a little background first, Chad, for everyone. The 13D was filed by TAFE, which TAFE is a licensee that has -- of AGCO that is the #2 player in the Indian farm equipment market. So they have a very strong business focused on selling farm equipment in India. We, AGCO, through its Massey Ferguson ownership, has had a relationship with TAFE since the '60s, when the business was founded, and has grown quite impressively over those years. We used to have a -- we have a commercial relationship with TAFE, where TAFE supplies AGCO with low horsepower, kind of low specification equipment to some of our developing markets and even into some of our more developed markets like North America. So we have a commercial relationship. We provide the Massey Ferguson license to TAFE, who sells their equipment -- a lot of their equipment in India under the Massey name. We have -- AGCO has about a 20% ownership in TAFE. And over the last decade or so, TAFE has accumulated an ownership in AGCO to where they're a very large shareholder. They own about 16% of the AGCO shares today. AGCO has a standstill agreement with TAFE, which prevents TAFE from acquiring any more additional shares of AGCO at this time. And in 2011, AGCO named the TAFE CEO, Mallika Srinivasan to be on our Board of Directors as a nonindependent director based on the fact that we have a commercial relationship with the company. In terms of TAFE did file a 13D, which discussed their opinions on a number of governance items. As you point out, probably the primary one was they're advocating that we -- that AGCO should have split the Chairman and CEO position. Let me first point out that TAFE in their 13D also expressed their support of Eric. So this is not any statement about the leadership of Eric. All Board members and the whole management team is fully supportive of Eric. And being our future leader, this is more about a governance issue. When the Board chose to name Eric, Chairman and CEO, they obviously spent some time considering, whether they should keep those roles combined as we've had them in the past or whether that should be split in the future. And they did a very thorough review of that. Mallika Srinivasan was involved in those discussions and her opinions were heard during that time. But ultimately, the Board decided to maintain the current structure that AGCO's had where Chair and CEO are combined, along with, most importantly, that with a strong independent lead director structure, where the lead director is holding meetings with our other independent directors, also having constant dialogue with the Chairman and CEO and maintaining certain discrete duties that the lead director has. So in their assessment, the Board felt that, that lead director structure was still the way to go. It was that they felt that it served AGCO well and felt like it was because of how strong the lead director worked at AGCO, that, that was still the proper structure for AGCO and was in the best interest of our shareholders. They also felt that there was no need for a transition. Eric has been COO for 2 years, and he had worked very closely in a transition mode with Martin over those 2-year period. And so the Board felt like Eric was ready to be the sole leader of AGCO and provide one voice to the market with his broad experience and capabilities. That said, all that said, the Board decided to keep it combined. Obviously, TAFE has a different opinion and expressed that in the 13D, along with some other governance issues. And so all that said, we'll continue to engage with our broader group of shareholders to get their feedback on a number of governance issues. We've already been doing that. We'll continue to do that. And what we want to make sure is our independent directors assess these issues and make sure they're at the best interest of all of our shareholders. Since TAFE and -- has a strong commercial relationship with AGCO, which makes Ms. Srinivasan a non-independent director, it's very important that our governance process and our independent directors process these issues and make sure they're in the interest of all shareholders rather than potentially a conflict of interest with one shareholder. And so we certainly want to continue our dialogue with TAFE and are going to make sure that the decisions that the independent directors make are in the best interest of all our shareholders.

Got it. Okay. That's helpful. So switching gears to Brazil, which historically has been -- or at least the last couple of years has been an area of challenge. But in the last couple of quarters, it seems like there's some bright spots. So I guess over the last couple of years, AGCO has ceded some share in Brazil. And I'd just be curious to get your perspective on the strategy for getting it back. Maybe you can talk about how you’re aligning your product, your distribution, your cost structure to achieve this?

Sure. It's -- the Brazilian market has been quite dynamic over the last 5 to 10 years in terms of number of competitors and participants. Also, the technology acceptance by farmers has changed a lot and accelerated rapidly. And so AGCO, at one point was through our Massey Ferguson and Valtra brands was very strong in the small equipment, small farmer sector. And what's grown significantly over this period of time is the larger farms, more sophisticated farms, particularly up in the Central Midwest portion of Brazil. And so recognizing that, we've -- and there's been a lot more competition as well. John Deere was not much of a participant and now is a very strong participant in the market. So AGCO's had to respond to all those changes. And I think we've done a lot over the last 3 or 4 years. First of all, we have really refreshed our whole product line in Brazil. On the advent of Tier 3 requirements for emissions in Brazil, we had to bring in really a lot of new technology into our product line. We used to have what we call kind of a heritage line, very simple machines, and now we’ve brought in the equivalent equipment that we sell in Europe and the U.S., and we're selling that in Brazil now. We've also brought in a much stronger high horsepower product lineup, CVT technology. We've just introduced the Fendt brand in Brazil. And we've been really feel like we've had some really been in a state of flux here the last 2 or 3 years with refreshing that product line. You also have to localize all those products in Brazil in order to get the local financing incentives. So it's not just -- can't be an import/export type situation. We have to -- we had to localize all those products and produce them in Brazil. So a big challenge for the whole operations to bring that into place. And we did it over a very compact period of time. So it has hurt our performance in the last few years, but we think we're kind of coming out of that at this point. We feel really good about our product line. And it not only includes these refreshed tractors, but we've got new combines. We have -- we're really growing in the planter section. We have a new planter, we call the Momentum planter, that has the precision planting technology on it. So all the advanced Precision Ag, sensor technology in order to optimize the planting process. So that's a big improvement. We're selling more sprayers than we used to. So it's not just a tractor business anymore. We're really trying to broaden it to where we've got a full line of equipment. Our grain and storage business has improved this year as well. And so pulling all that together, we're also developing and trying to improve our distribution network. We weren't as strong in the Central Mato Grosso region of Brazil, and we've been replacing and adding dealers there. We've been replacing dealers really all [ in Brazil ] to improve our distribution network. So that's helping as well. So we're seeing our market shares recover this year, and we're seeing, obviously, our profitability improve as well. So it's all a factor of selling that full complement of products, getting our cost structure in line. And obviously, the growth in the market and the improvement in the Brazilian demand is helping as well. So all of those factors kind of helping us see improvement. So we've got a lot of work to do, Chad, there. But we think we know what we need to do, and we'll continue to focus on all those individual areas, which should contribute to a stronger business in the future.

So I just want to dig further into some margin component in Brazil. One of the biggest overhangs was the local -- or lack of localization of manufacturing. So can you talk about where you are on this journey? How much further do you need to go? And also, maybe just like weave into how to think about margins in Brazil, I see kind of like mid-cycle levels, how far away and what besides the localization do you need to do to achieve those?

Yes. As I said before, when you participate in Brazil, you need to be on get the subsidized financing. Most of the financing is -- that customers want to do is the subsidized financing from the BNDES, we call it FINAME program. And to qualify for that, you need to be have about 60% local content. So all of the products we sell, for the most part, have at least 60%. But these older mature products that we had were up in the 80% to 90% range. And so as we were rushing to get all these Tier 3 units into the market, we were getting just bumping up to the 60% and then being able to introduce the product. So we're probably more like in the 60s, where we'd like to be more in the 70s or 80s with these products. So that's the work we're doing right now. Obviously, it's -- if you can imagine, it's got to go to that component by component, part by part. So it's not something you're going to get done in a short period of time, but we're going after it. We've got teams working on, and that will be an initiative, at least for another couple of years, I would say. In terms of our margins, what we've said is we want to get those margins back up to the corporate average. And we think that we have the capability of doing that with support from the market. The market has been depressed for a number of years, and we're starting to see that recover. And you can see our margins already benefiting from that. So with a stronger market, sustained market as well as the improvements that we can get in terms of the better mix of products, selling planters and sprayers and combines, along with our tractor lineup and getting the costs right in those product lineups, we feel like we've got a road map to improve margins. And we don't think that's an overnight fix. We think there'll be steady improvement over a number of years, but we feel good that we're making good progress this year.