AGCO Corporation (AGCO) Earnings Call Transcript & Summary

Good afternoon, and welcome to the eighth Annual Credit Suisse Industrials Conference. My name is Jamie Cook, and I'm the machinery and engineering and construction analyst at Crédit Suisse. In terms of the format for today's fireside chat, I will be moderating Q&A. [Operator Instructions] Today, I'm very pleased to introduce the management team of AGCO. With us today, we have Andy Beck, who's the Senior Vice President and Chief Financial Officer; as well as Greg Peterson, Vice President of Investor Relations. So thank you both for being here. I just want to make sure you can hear me. We're all live.

All good. Thank you, Jamie.

We're good. Okay. Great. So I guess I'll kick it off, Andy. I guess following the announcement of AGCO's succession plan for the retiring -- for Martin retiring as Chairman and CEO, one of your largest shareholders, TAFE, has expressed their opinion regarding the preference for splitting the Chairman and CEO role as well as some other governance changes. Yesterday, I think AGCO responded to TAFE's concerns with an SEC explaining your rationale for keeping the roles combined. So I guess, because I think it will be topical, can you just sort of summarize the company's position on this just to start?

Yes, I'd be glad to. Just for everyone's background, TAFE, as you say, is one of our largest shareholders, they're a privately held farm equipment manufacturer in India, they're the #2 player in India. And they have a relationship with AGCO going back really through Massey Ferguson back into the 60s. There is an important commercial relationship between TAFE and AGCO, where they supply us low horsepower tractors, and they sell their equipment in India, primarily using the Massey Ferguson trade name. We have a historic ownership in TAFE of over 20%. And TAFE has accumulated a stake in AGCO and the recent history of AGCO, and they have about a 16% stake in AGCO. Because of our various reasons, we have a standstill agreement with TAFE, which prevents TAFE from acquiring additional shares of AGCO stock. Also, TAFE -- as you point out, TAFE's CEO, Mallika Srinivasan, has been on our Board since 2011. And by nature of our commercial relationships with TAFE, Mallika Srinivasan is considered to be a nonindependent director of AGCO. And as you pointed out, they've made some public statements about some of the decision -- governance decisions the Board's recently made, in particularly about the split or nonsplitting of the Chairman and CEO role. Let me first point out that TAFE has made it very clear that they do support Eric Hansotia, who was announced to be our new Chairman and CEO. They support Eric as the new leader of our -- of AGCO. So this is not about his capabilities at all. It's more about other governance issues. And our Board, uniformly, is very confident in Eric's capabilities, and Eric looks forward to his leadership as he takes over the company at the beginning of next year. The Board completed kind of a thorough review of the pros and cons of splitting or keeping the Chairman CEO position, which included the feedback and position of Mrs. Srinivasan. Ultimately, the Board chose to maintain its current structure of a combined Chairman and CEO, all along with -- and this is very important, with a very strong and lead independent director structure. And that structure has been even improved and enhanced with some recent changes of the Board policies that we just announced. Under that structure, the independent directors hold separate meetings, led by the lead director, and the lead director has very clear defined roles and communications with the CEO and is involved in a number of communication approaches with the directors and with the CEO. The Board also felt that this structure was sufficient and would be in the best interest of shareholders to maintain that approach. And it didn't really feel like there needed to be any further transition period from Martin to Eric because Martin has done such a great job in preparing Eric for the role over the last 2 years as Eric has been the Chief Operating Officer. With all that said, we've been working with a number of shareholders, meeting with our major shareholders over the last months to get a lot of feedback on where they see AGCO could improve in terms of all sorts of areas and compensation and governance. And we've taken that to our Board to make a number of changes. With respect to TAFE's recent filings, we want to highlight that our primary goal or the Board's primary goal is to act in the best interest of all of our stockholders, not just limited to TAFE. And it should be understood that in any business relationship, we -- our interests are not always aligned with TAFE. And for that case, the Board and the independent directors, particularly, want to make sure that their governance structures and approaches enable them to make sure that all shareholders are served with the decisions that they made. As we -- as you mentioned, Jamie, we announced some new governance changes yesterday. I'd like to go through those real quickly. First of all, we've appointed a new lead independent director beginning January of next year. Mike Arnold, who's been on our Board since 2013 as a very strong director, very engaged director, and we look forward to working with him in that capacity. This was a overwhelmingly supported choice of our independent directors for Mike to take that leadership role. And also, we have also enhanced the robust duties of the independent lead director as well. We've also rotated a number of board leadership roles, including a lead in a director role as well as Chairmans of audit, finance and governance beginning -- as the beginning of January 1. And we've adopted 5-year term limits for all the Board leadership positions as we listen to a number of our shareholders wanting to make sure that we continue to refresh the perspectives of the company and our Board leadership, and we've put in mechanisms to ensure that happens going forward. And lastly, we've adopted some new other policies about hedging and pledging policies that we put in place. So we, our Board, and particularly, the independent directors of AGCO are continue to be engaged with our shareholders and really believe that they've taken a number of the considerations and feedback we've gotten from shareholders with these actions that we took yesterday.

Okay. I appreciate that. And then, Andy, I guess, one of the trends that we've heard over the first 2 days of the conferences, relative to the second quarter, when everyone was concerned demand would fall off a cliff. Now things are starting to improve. But the other side of that as demand improves, I think they're concerned about with COVID spiking again, potential risk going forward, whether it's supply chain or getting your employees safely to work. So can you just comment on sort of what you're seeing in the channel -- sorry, at ACGO?

Yes. We have had issues already this year. As everyone knows, we had to shut down our European factories early in the -- early in this pandemic in late March and during the month of April as we couldn't get parts supplied into our factories and just had to shut down, even though we've been an essential industry and have the right to keep our production going. And a lot of times, we weren't able to do that in the early part of the pandemic. So that really affected our second quarter results, particularly in Europe. And then we were -- had the opportunity to get things back going and operating at normal levels. And you saw a nice recovery in the third quarter, where we had built order boards in the second quarter and really were able to fulfill a lot of those orders with increased production in the third quarter and had a very solid third quarter results, as everyone saw. So now as we enter into the fourth quarter, we already talked about in our October conference call that one of our factories in North America, our Hesston, Kansas factory that makes harvesting and hay equipment, had a COVID outbreak and had to suspend operations. We're happy to announce that over the course of November, we were able to get all those assembly lines back up and running in Hesston. So they're back running in normal fashion now. So that's good news. We are right now, in Europe and a little bit in Brazil as well, as really having issues with supply chain on a number of components, getting those parts into our factory so it can complete the assembly process. We've run a lot of products down the line. But in order to get them ready to ship, we still are missing a part or component that needs to be -- complete the unit. We need to get through quality testing before we can ship the units. So we're behind and really working very closely with our supply partners in order to get these parts in by the end of the year. But it's for certain that our fourth quarter production and sales have been impacted by this so far. And we've got a lot of work to do in December to get these products out the door as we intended. So it's going to be a challenging [ quarter ] for us.

Okay. I appreciate that. And understanding the short-term challenges. But Deere reported earnings last week and they gave their first glance at their fiscal 2021 outlook saying North America was up 5% to 10%; south America, I think, was plus or minus 5%; and then Europe was flat to up 5%. And they actually reported a fairly strong water book, too, if you listened to the -- I'm sure you listened to the call. But anyway, sort of how do you think your forecast compare? What are you seeing? Do you sort of -- does this view make sense to you?

Directionally, I think we're in the same ballpark as they are and see a lot of the same factors that they do. If we break it down, North America, we think, small ag has been on such a high run. It's at really record levels of demand. We think at some point, there's going to be a reversion back to more normal levels. I've been saying that for a couple of years now and been wrong every year. So I guess we'll wait and see, but there should be, at some point, some exhaustion of some of this demand and see that come down. So we think that, that's still likely for 2021. Large ag, we've got stronger commodity prices. We have an extended fleet age. Those -- and dealer inventories are low, used inventories are low. So a lot of positives going into next year, and particularly where the commodity prices are, that adds a lot of confidence and improves the sentiment of farmers, and we're certainly seeing that. We're seeing that in the demand here in the fourth quarter. The one offset to that or balancing to that is that this year in 2020, they're getting a lot of government support payments. And so their farm income is going to be benefited by the recent commodity price increases as well as all this government support. And so if you look at the income levels going into next year, they're likely to be flat or coming down. So it would depend on where those commodity prices end up and what their yields are, of course. But also, we don't expect the same level of government support. So in a normal circumstance, you see the crop prices go up, you're going to see their income go up. But because all this government support, that adds another factor to it. So if you look -- if you think that farm income is the real key gauge of farm equipment demand, you're not going to see really an increase in the income levels. But where they're deriving their income through higher commodity prices, earning their profits through their work. It's really going to help their sentiment. So I think we're in line with Deere that the market's improving, sentiment is improving. I think we might be a little slightly below, probably on the lower end of where they are in terms of how much impact that will have into next year.

Okay. That's helpful.

And then in South America, I think we're in line. South America has got favorable commodity prices. They've got improving farm conditions, government support is pretty stable. The only issue is with financing availability with the FINAME program, that the funds will be exhausted going into next year. So there is going to be alternative financing sources. And as long as farmers are willing to use that, that market should continue to be strong. And so we're in line there. Western European, we're probably maybe on the bottom end of where they are, but directionally see the same indications. Higher commodity prices certainly will help them, too. They've struggled with having good weather conditions and yields. So it will be a little bit dependent on -- always is dependent on those kind of factors. The government support seems to be stabilizing. The one factor that we have to keep in mind is that the German market provides [indiscernible] tax incentives for buying equipment in 2020. So that market is the only market that's really up right now in Europe. And so obviously, it's creating an impact in 2020. So will we see a reversal or some switch there? We think that some of these other markets will recover in 2020, probably offsetting potentially a little bit of a decline in Germany. That's what we see right now.

Are there other markets that you're more -- within Europe that your -- countries that you're more bullish on that would offset the potential risk to Germany?

Yes. I think some of the other big markets, France and U.K., should see some recovery back up. And so those would need to be the ones that will drive that offset.

Okay. And then just shifting gears a little bit. Obviously, we talked before with regards to TAFE on some of the leadership changes. But with Eric taking over as CEO, understanding he has to give his sort of speech to the investment community. I guess from your perspective, do you have any insights on how you think Eric can potentially be -- what his areas of focus will be relative to sort of Martin? Martin sort of focused on operations more, he invested organically, did a good job improving the margins. I'm just wondering, is Eric sort of more of a growth guy versus return guy. Or how to think about capital allocation as well?

Sure. I think we're going to continue to head in a lot of the same directions. And Eric has his fingerprints on the company's direction already in a heavy way in terms of the focus on our Precision Ag investments, the growth in our Precision Planting business the investments in new technology, smart machines like our IDEAL Combine, Precision Planting equipment, a lot of the innovation that we're working on is certainly driven by Eric's leadership and direction. So I think those are really key areas that we're going to continue to focus on. We still want to be bigger and stronger in our high horsepower sector of the market. We're taking a lot of our premium high horsepower tractors, the Fendt tractors and working to supply them into the U.S. and Canada, supply them into South America as a growth opportunity, an opportunity to really provide and serve those premium sector of the market in a more direct way than we have been able to in the past with our product lines. So a lot of those things are ones -- areas that there will be no -- those directions will continue, and Eric's really been behind a lot of that -- those strategies and growth initiatives already. I think those will be the focus areas, investing in technology, growth in our high margin businesses, kind of the key areas of focus for Eric and our team as we move forward.

Okay. That seems like the right place to focus. And then just maybe -- I'll ask you anyway, if it's unfair, Andy. But like do you think -- obviously, you guys have laid out the longer-term financial targets that you've had in place for some period of time. Do you think we'll start to revisit those? Or that's sort of the way to think about things? Or do we need to wait till Eric is -- wants to communicate?

Yes. Well, we're going to have -- as Eric assumes leadership, and we'll get more granular on some of these things and more specific and so want to hold off probably is -- a lot of that. But generally, the goals are the same in terms of margin improvement, capital allocation is going to be the same in terms of wanting to invest into our company as much as possible to drive growth and margin improvement. And then obviously, acquisitions is more opportunistic, probably more of a kind of bolt-on type things, typically focused on technology in the future. And then certainly continue to want to have dividend and share repurchase programs in order to continue to bring cash back to shareholders if there's excess there. So not a lot of changes from that perspective. But we're all very excited to have Eric be our new leader and really looking forward to the next years under his leadership.

Okay. And then just shifting gears to South America. Margins had been under pressure. We're seeing some improvement there. But how do we think about -- so first of all, some of the issues have been centered on some local content. So can you tell us sort of where it is today versus where it needs to be? And then I'm just trying to gain an understanding over the medium term, where can margins go in this business. It used to be one of AGCO's higher-margin businesses. And I guess, with the globalization you talk about with Fendt, you talk about introducing the IDEAL Combine, and I just think of your market share, even where it sits today, why shouldn't this be one of your higher return businesses for those reasons?

Yes. We've obviously made a lot of progress this year, Jamie, in South America. We're in a loss position last year, and now we'll be back in a positive position by the end of this year for the full year. And so we're satisfied with what we've accomplished so far, but we've got a long way to go to your point. Our -- we need to get those margins back up. What I've said recently is the first step is try to get them back in kind of our corporate average, and that's where we need to get those. We have suffered because of kind of the weaker market, but that's starting to come back. And it certainly helped us what you've seen so far, like in the third quarter, and hopefully, we'll see that in the fourth quarter as well. So the market's improving, that gives us more throughput and scale advantages, but there's a lot of other work we need to do in terms of growing our nontractor business, so planters, sprayers, combines, as you mentioned, are going to be important aspects of improving those margins. And then on the tractor side, growing in the high horsepower sectors. You mentioned Fendt and some of the other higher technology equipment that we want to sell into the big farm markets of South America. That's where there's more margin in kind of the small tractor area that we have a very strong share in. So a lot of areas of growth, a lot of areas to improve the mix and then we need to get our cost structure of some of these new products in line. We've been localizing more of the content and working hard at that. But that takes some time. So again, this is going to be -- if we're successful, steady improvement. It's not a one thing fixes the margins. We got to improve in all aspects of the business. And so that will take some time, and we hope to be able to prove that we can make steady improvement year-over-year.

Okay. And then shifting, I guess, the other real bright spot when you think about 2020 and considering the environment that we're in, is the North American margins, the improvement that you've seen there. I mean I've been covering AGCO in some way, shape or form for 20 years, I never thought you'd have double-digit margins in North America. So can -- just because you have market there, right? So can you help us understand sort of how the margins are performing in the core business, how much Precision Planting is helping versus sort of GSI? And I'm just wondering if this double-digit margin trend that you're seeing is sustainable assuming the markets, I guess, if North America improves where the margins can go, I guess. If demand outlook improves on grain and the equipment side.

Greg, do you want to take that one?

Sure. So Jamie, you're right. The first 3 quarters of the year, we have seen margins in low double digits. So an improvement from where they have been. And Andy touched on a couple of things that has helped us in North America. Number one has been the growth of our Precision Planting business. And I should say part of our margin profile was that we have a fairly highly seasonal, at least a couple of our product lines are highly seasonal. So the Precision Planting products that Andy talked about, which, essentially, is a retrofit business and has been our opportunity to really move our planting business forward, and we've seen that -- we've owned that business for, I guess, going on 3 years, and we've seen that grow nicely. That business is going to grow probably 20% or 25% this year. Because it is a retrofit business, the margins are more parts-like, more aftermarket-like than traditional equipment. So that's been helpful. And that business most -- well, about half of the business is in the first quarter. So between the first and second quarter, we recognize essentially all the margin we will for the year, and then the rest of the year is kind of a breakeven business. So that definitely helps our margin profile in the first part of the year. The other highly seasonal business we have that you touched on was our grain storage business. That, as you can imagine, if a farmer is going to get and add storage capacity to his farm, storage and handling and conditioning, he's got to do it in most cases before harvest. So for us and for that part of the business, that's second and third quarter. So that business helps us in North America in the second and third quarter from a margin perspective. And we have this year, it's -- year-over-year, we've seen some improvement. If you remember, last year, we had a big spike in steel prices as a function of the tariffs that were placed on Chinese steel initially and then impacted essentially steel from all sources. But we didn't have the ability to price for that nearly as much as we wanted to last year, and we've done a much better job with that this year, recovering that steel cost. So this year, that part of the business is up a couple of hundred basis points for us in North America. So that's also helped our margins. And then the last, I guess, major item in terms of improvement has been another thing that Andy touched on, and that's our efforts around globalizing our Fendt tractor into the North American margin -- or into the North American market. So that has been going on really for the last almost 2.5, almost 3 years. What we've done is essentially make the Fendt tractor row crop compliant in North America. So that means because of the wider row widths we have here in the States, it requires the rear axle to be configured differently. So starting 3 years ago, we came out with our first Fendt tractor that had that capability to be adjusted for the North American market. That was the Fendt 1000, which is at the very high end of our product range, 500-plus horsepower. Last year, we came out with the Fendt 900, which is kind of more of the sweet spot of the row crop market, which is kind of in the 300- to 400-horsepower range. And then late this year, so in the fourth quarter, but more next year, we'll be launching the 700, which is the 200- to 300-horsepower version of that Fendt tractor. So we now have kind of the big farms covered with the row crop compliant Fendts, which is a big step forward for us. And so now that business is starting to be -- to mean something. It's -- now our Fendt tractor sales are over a couple of hundred million dollars a year in North America. And that business is going to be up 20% to 25% this year. So really a number of things that have helped our margins, especially in the first part of the year. And I will say that because of the seasonality, this year and most quarters we would expect to be more breakeven-ish in the fourth quarter. So put all that together in, we're looking at high single-digit margins for the year this year. Should be a couple of hundred basis points better than last year on really not much sales growth. So that's good news. And I think we're positioned then to continue to grow market share as we, next year, bring the Momentum planter to the U.S. That's the OEM version of our Precision Planting products. So between the Fendt tractors, the Momentum planter, and the IDEAL Combine that we introduced last year in North America, we have a really, I think, interesting product lined up for the big farms that we think will really help grow our business and continue to move the margins in the right direction.

Okay. One more, if I could sneak it in, and then I'll let you go. Just can you guys talk to the adoption rate you're seeing in the order book on Precision Ag? And then I guess, Andy, you and I have always gone back and forth, is Precision Ag market share or is it really sort of a margin-enhancing pricing opportunity here. I'm just wondering if this is more additive to margins or mix going forward relative to how we used to talk about Precision Ag, and maybe Eric brings a different view to that as well.

First of all, our adoption rates are going up. A lot of our equipment now at certain levels of the product ranges are all -- it's standard equipment. They're all connected right out of the factory. And so we're really seeing big increases in the adoption and the use of all this technology. It's certainly important going forward, and customers are demanding it. To your point in terms of how does this affect the P&Ls of the company. It's going to impact it a number of ways. In most cases, it will be, as you say, a new feature component into existing products. So you're going to see it hopefully enhancing the margins of the products in terms of be an additional price and cost against it, but with better margins. So I think that's going to be the main way you're going to see it. There are some isolated individual revenue components, service contracts and things like that. But I don't think that's going to be as significant or predominant as new componentry features that go on your existing equipment.

Okay. Great. And I think we're already above our allotted time. So both Andy, Greg, I really appreciate your time and support. I wish you and your families both a very healthy and happy holiday. Take care.

Thank you. Same with you.

Thanks, Jamie.

Take care.

Bye.