AGCO Corporation (AGCO) Earnings Call Transcript & Summary

Welcome, everyone. I'm Courtney Yakavonis, Morgan Stanley's U.S. machine analyst. Before we begin, please note that for important disclosures, please visit the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. So next up, we have AGCO, a global manufacturer of agricultural equipment, who is best known for their Fendt, and Massey Ferguson Challenger agriculture brands. AGCO has been making several investments in precision technology over the past several years, including its acquisition of Precision Planting in 2017. And then just this morning announced the acquisition of Faromatics. And we're very fortunate to have with us today, Andy Beck, AGCO's CFO; and Greg Peterson, IR. So Andy and Greg, thanks both for joining us today.

Thank you, Courtney. Good to be here.

If we can maybe just start off talking about end market strength. You've talked about how the ag equipment cycle this year is beyond mid-cycle, but it's not quite a peak yet. Can you talk a little bit about the main drivers of the current up cycle and how durable it is?

Sure. Yes. Obviously, we've seen a nice increase in our industry demand in 2021. The main driver of that is farm income and farm income levels. So as commodity prices have improved, so do the farm income prospects for our farmers. And as they see that farm income growing and feel like they're going to have a good year, they're much more confident about buying equipment. And so for really the end of 2020 and now in 2021, we're seeing much higher demand for our equipment really across the world. So North America, significant improvement, particularly in the row crop sector. We're seeing very high demand in South America as income levels are very high there for our farmers. And then in Europe, which is typically a more steady market with less defined cycles, the market is also up and doing quite well this year. Our orders are much higher than a year ago. And so we feel very good about where the market is. So as you pointed out, it's really above average demand that we project now for the full year 2021. And again, that's because of where conditions are for farmers and their need to and want to acquire equipment and replace some of the aged equipment that they have. We've been in really a more of a down cycle since 2013 or '14 in both North America and South America. And farmers have been delaying purchases over that period of time. So we really have an extended down cycle and now that results in kind of an aged fleet of equipment in those markets. And for that reason, they're taking advantage of these better conditions to start replacing equipment and to try to get some of the newer technology in their fleets. So if you look at both North America and South America, I think both of those markets had more of an aged fleet than maybe Europe did. And so there's going to be a tendency for them to want to continue this cycle and to replace equipment, so they can get their fleets back to a kind of more normal age. And so for that reason, I think we feel good about this market as long as the commodity prices stay where they are and farm income levels stay where they are.

Got you. Maybe on the back of that, you mentioned farm income levels and commodity prices staying where they are. We have seen corn and soya bean retreat from some of their more recent highs, but still at very supportive levels. Are you concerned at all that some of this weakness will be reflected in ag equipment demand next year? Or are the fundamentals in terms of inventory and fleet age to over -- counterbalance that?

Well, I still think, again, you've got to look at where these new commodity price levels are. We also need to really focus on where input costs are, some of the inputs are coming up. So maybe the margins that they would have projected earlier in the year, the margins now are tighter, but they're still positive and quite good. So I think farmers still believe this is good conditions for them, and their confidence level is remaining high, and I don't see this recent retreat in some of the commodity prices as significant enough to change buying behaviors.

And then maybe just lastly on the cycle, how would you compare this cycle to the last cycle during the '08 to 2013 time frame, given some of the dynamics that you just talked about?

Well, yes, they're similar in that the improvement in the cycle, all is driven by when commodity prices went up. And so that, again, relating back to farm income and farmer confidence. The '08 to '13 was driven a little more by some weather issues, some droughts that drove commodity prices up significantly, and they were up in the -- corn was up in the $7 range, really extreme values there. The good thing that I would have observed in that cycle was that there was more aggressive [indiscernible] activity. So we saw a lot of quick turns of inventory, which created more used equipment in the market. And we're not -- obviously not very far along in this cycle -- up cycle, but we're not seeing those kinds of activities this year. And so I think the situation where we're in right now is farmer income is strong. We have very low inventories at our dealers, our used equipment is low and the prices are strong. And so we're -- all the conditions are still favorable for continued demand in equipment right now.

Maybe we can switch over to margins. You have a goal of achieving a 10% mid-cycle margin in the '23 to '24 time frame. And -- versus currently in '21, I believe your guidance is for about 9%. So how much of the improvement that you've seen in margins has really come from optimization initiatives versus productivity versus product mix? Maybe if you can just help us think about what the main buckets have been to get us to this 9% margin? And then what still needs to be done to hit that 10%?

So as you pointed out, we're looking and targeting about a 9% margin this year. Last year, we were at 7%. So we've got a 200 basis point improvement from '21 to '20. A lot of drivers there. First and foremost, is the higher sales volume by the industry growth and being able to increase our volumes in our facilities, get more leverage over all of our fixed costs, whether it be in our factories, or in our engineering and SG&A costs. So that's driving a lot of the improvement. And we said our 10% goal would be at a mid-cycle and 2020 was below mid-cycle. Now we've actually moved above mid-cycle. So it's now instead of a hurting factor, it's now a helping factor. So that certainly is helping us get to the 9% that we've enjoyed today. But I think there are other factors as well in that improvement. What we talked about in our strategy for the next 5 years is trying to grow our high-margin businesses. And those are the Fendt premium products that we sell. It's growing our Precision Planting business, which is part of our Precision Agriculture product lines along with our Fuse product line. It's growing our replacement parts business. All our aftermarket and retrofit businesses are typically at much higher margins. And so we're seeing growth in all of those sectors in our results this year. So for instance, Precision Planting is up 40% this year. Parts business is up very, very strongly this year as well. And that's also driving some of that margin improvement that we're seeing. So we're off to a good start in the acceptance of the Fendt product in North America and South America is also going quite well. So we're seeing a lot of those strategic factors come through in the results in the year of 2021. As we move forward, we also want to see improvement in our overall cost structure. And so we still have initiatives that we think have good traction in terms of purchasing, where we want to create more scale with our purchasing supplier base. This year, I think our purchasing team is more focused on expediting parts and just dealing with a disruptive supply chain. But as we get hopefully more stable times, we can move back to a real focus on driving cost savings through our supply chain. And also our manufacturing facilities, we continue to invest in new technology, we believe that will create labor productivity and cost savings as well. So we have a lot of areas where we still believe there's a lot of room for improvement in terms of margin from growing some of our higher-margin businesses, improving some of the businesses that run at lower margins today and also some operational improvements as well. So we're focused on all of those and just getting the benefit of the volume this year, but all these other initiatives should provide margin enhancement in any market condition.

You talked a little bit about how your above mid-cycle is helping that margin today. Do you have any sense of what -- how high margins could look like at peak?

Well, I guess you have to define peak. So I don't know if I could give a number out. As the volumes grow, they're going to help drive margin within the company. It's -- we have good incremental margins and leveraging our cost structure is certainly a really important aspect of margin improvement. But we're, again -- want to make sure that we're improving the overall core margins of the company. So wherever we are in the cycle, we want to see that where our margins are better than where they were the last time we were at that point in the cycle. And so that's more of our focus than picking at a certain point in time and try to hit a target just at that point, but we want to perform well in any condition and any point in the cycle.

Maybe just thinking about South America, you went from losing money a couple of years ago to now 6% margins this year. How sustainable do you feel like the margin improvement in South America has been? And I think part of the issue there were some supply issues. Has that been completely resolved?

Yes. We had some leaner periods in South America. We are going through a major product transition moving in a variety of new products into the market. That created a lot of instability in our margins and our production and our cost structure and things are settling down there. The other thing that's factored into the margin improvement is really growing some of the higher-margin business units there or product lines. So for example, we've grown substantially our market position in planters, which is a good high-margin business. We're selling the Precision Planting retrofit products in South America. Those are high margins. We've been improving our Parts business quite well as well. So a lot of the complementary products outside our core tractors and combines have really contributed to the margin improvement. And we continue to work on growing the margins and improving the cost structure for our core tractor and combine products as well. Now certainly, the volumes helped a lot, Courtney, in terms of how fast we've seen the margins improve. So the up cycle and the strong market conditions helped us get to where we are to the margins that you've already pointed out. But certainly, we believe we've really turned the corner and contributed a lot to the progress that we've made so far. And I hope that we can see even further improvement in the future.

Maybe flipping over then to some of the supply chain issues and price costs. Obviously, there's been significant disruption to the supply chain over the past couple of quarters. Where the pressure has been most acute for you? And what steps have you been taking to mitigate some of those pressures?

Well, it's -- the uncertainty is the hardest part of this. So it's really been a wide variety of parts and suppliers that have created issues for us, and I think they're continuing to be challenging. So we're just taking it day by day and expediting and working with our supply base to get the necessary parts to complete our production, so we can get our customers the equipment that they have on the [indiscernible]. So it's really, I would say, unchanged from where we were in the first and second quarter. We continue to have challenges, but our teams are working really hard to mitigate those and to get the products out as quickly as possible. And as we fix one issue or correct one [indiscernible], then another one comes up. So it's hard to know when things are going to stabilize, and we just continue to deal with them as they come.

Just as a follow-up question that we did get a question from the audience. Has anything materially changed on your expections of inflation or the supply chain since you last spoke last quarter?

No, no major changes. Again, most of this, the disruption in supply chain's really timing related. It's whether we can get the product out this month or next month. I don't think it's really affecting overall demand levels or anything like that. Our customers are waiting for their equipment. And we're working with our customers, make sure that we can get them a demonstration model or something if they're really in need of that equipment. So we're doing everything we can to support our customers and obviously, this is just more timing. So I don't think it's really impacting the overall market or anything like that, and customers are just going to have to be a little more -- hopefully, they're a little more flexible when they're getting their equipment. In terms of our costs, I would say, you can watch what's happening with commodity costs right now. Steel prices are probably the ones we're watching most carefully. And so yes, there's not a whole lot of change from what we've commented before. In terms of our cost structure, usually, a 3- to 6-month lag of when the cost changes and when it will kind of hit our results. And so what we said in the first half of the year, we didn't really get a huge impact from the cost, and it gave us some time to get some pricing in to offset the expected cost increases. And as we move into the second half of this year, we're going to see more of those costs really impact our results and -- but the fact that we've got the pricing in place, we think we'll be able to offset those cost increases in pricing in the second half of the year.

Has anything changed in terms of when you expect to see some relief in these supply chain pressures? Is that time line being pushed out at all?

I think my expectation is -- well, first of all, no, I don't think we've seen any signs of any light at the end of the tunnel or whatever you want to call it. I think as we correct 1 or 2 issues, we think, okay, well, now we're -- we've got that solved and then 2 more issues come up. So it's waiting on something that turns out what is going to happen. So we'll have to -- it's something that we'll let you know when that happens, I think. So we're certainly working with our supply base. When it's a capacity-related issue, we know we're working with suppliers to build up their capacities. And so that can be something that we can have visibility of correcting. When it's something related to a COVID delay or shut down, then obviously, it's very hard to predict those types of things. But -- so I think there's part of this that we can see how we're going to correct it, and then there's parts of it that are much more difficult to predict.

You mentioned steel costs earlier. How much exposure does that AGCO have to steel? And what type of hedging do you have that was in place for this year and then going into next year?

Yes. So what we do with steel, again, as we say, it's usually a 3- to 6-month lag. So we're not -- in most of our businesses, we're not a big buyer of raw steel. Most of the time are -- we're buying components that have a lot of steel content, whether it be a casting or an engine block or something like that. And so for that reason, there's a little bit of a time lag between when the supplier is going to start to feel those higher costs and when those costs get to us, that gives us some a little bit of runway to get the pricing back in place in order to offset those costs. When we are buying raw steel is -- I'll give you a good example is like with our GSI business with our grain bins and some of our material handling equipment. And so that is where it's -- the steel price increases are a little more immediate. And so as we want to lock in contracts with a lot of those steel providers to give us a little more room and comfort. And when we can't lock in advanced pricing agreements with the steel suppliers, then we're doing hedging. So we're -- we've just -- this is really the first year we've done any hedging, but with the conditions where they are, we moved to that kind of strategy. And it's paid off for us in terms of trying to match the order prices that we've accepted with the cost of the equipment as we get it produced. Now in some cases, we're still misaligned to some extent, but it's accretive. It's already been a benefit for us [indiscernible].

You mentioned taking some pricing earlier in the year. I think you took about 4.5% pricing in the second quarter. Can you just comment on how much additional pricing you would need to keep margins -- to maintain margins in the second half of the year? And how do you think about pricing for 2022 in terms of the inflation that we've seen and also competitors seeming to have taken more drastic pricing at this point?

Yes. So we're -- as you say, we priced ahead of some of the cost increases that were coming and we put in more pricing in the second half of the year to offset what we think is going to be the cost increases that we get in the second half. So we're still projecting that our pricing loss at the cost throughout this year. It will -- we had a better margin in the first half. Second half, it will be much tighter, because of that really getting ahead of it. But we do think we've still got enough pricing to offset cost. And as we move into '22, it will be the same approach to continue to add pricing as needed to offset the cost increases, and hopefully, to deliver some margin improvement as well. So it's something that we're monitoring very closely and trying to manage our order boards along with what's happening with our costs and when it's going to roll into our cost structure. So the biggest risk for us is when you get such a large order board and you got some protected prices in there, do we have enough pricing to offset the cost. The 1 advantage that we have in our business model in a way is that there's also a lot of promotional discounts in it. So it's not just 1 list price, and then that's what you're charging. There's a lot of promotional discounts also that we've been reducing over the course of the year in order to get some additional pricing in. So there's some flexibility beyond just the quoted price and the price books.

That's helpful. And -- this is another question from the audience. Are farmers in Europe any more sensitive to equipment price hikes than farmers in other regions?

I wouldn't say there's a difference in terms of sensitivity to price. What we've seen is more stable cost structure in Europe. The cost of steel, increase in steel prices in Europe has not been as big as other markets. So they're not seeing that the pricing that we're needing to charge is the lowest in Europe compared to other markets around the world. So I don't think we have to test that question at least at this point. But I don't -- I think behavior wise, it would be very similar in terms of that. I wouldn't say there's a big difference between European farmers from a price sensitivity. As I said before, the European farmer has kept their fleet at kind of a normal age. So there's not as much pent-up demand there. But other than that, buying behaviors are the same. They buy when their profits are strong, and they have high confidence in the future.

How about GSI, I mean that's a segment that really hasn't reached a lot of the financial returns that you were hoping for over the past couple of years. Can you talk about what actions you're taking there? And then I think last quarter, you commented that demand was muted, because the price increases were so -- given the steel exposure. So can you just give us some color in terms of how big were those price increases and why you wouldn't expect something similar on the tractor side?

Yes, the grain storage business and our protein production business are -- continue to be in weaker industry conditions. Overall the market was much stronger 5 or 6 years ago in those sectors at the kind of the peak of the market that we've described in the cycle that ended in '13 and '14. The grain storage business was much stronger than where it is today. So we've been focusing on doing some cost reduction activities. We've reduced our footprint quite substantially in order to get -- be more profitable at the current market conditions. And most recently, our market conditions and both grain and protein were really heavily affected by COVID last year and very weak. We're seeing a nice increase in sales in grain storage and protein production equipment, more on the grain storage side this year. And as that -- as those markets recover and improve, I think we'll see some margin recovery. We've done a number of footprint activities. We've taken and simplified the product line and we're investing in some of the higher-margin product lines. We announced an acquisition today in our protein production segment, where we're going to put some more technology, so that it's not as much commoditized products where we want to do precision agriculture and protein production equipment as well, and give those growers more information to improve their quality of -- and the welfare of the animals that they're raising. And so there's a lot of things that we're doing in that sector to not only stimulate demand, but also improve our overall margin profile.

Maybe just a good segue into Precision Ag for the last couple of minutes. Can you just talk about the transformation that you've had at Precision Planting since the acquisition. I think it's still about half of your Precision Ag sales today, but like you said, up 40% in the first half. How much of that is being driven by expansion globally versus increased penetration in North America? And how do you see that business growing going forward?

Yes. So Precision Planting, as you pointed out, was a business we acquired in 2017. It's doubled since we bought the company. It's growing not only in the U.S., but outside of the U.S. Now the U.S. is about 75% of the sales. So we still have a lot of opportunity for growth, particularly in Europe where we've just started building a sales force and some infrastructure to offer those products in Europe. Precision Planting is this unique line of business, where it's a retrofit products where you don't have to buy a new machine to get the new technology. We can adapt your existing planter and get all the yield production capabilities that you could get on a new planter. And so that -- those sales are going very strongly. And the key to Precision Planting's growth is innovation, and we're -- they're innovating not only in the planting cycle, but we're starting to look at other parts of the ag cycle. Precision Planting just recently bought a company call Headsight, which has sensor controls on combines. So we're now starting to look at harvesting part of the ag cycle within Precision Planting and expanding retrofit capabilities in that part of the market as well. So a lot of opportunities for growth, because of the innovation that they continue to generate.

And then lastly at Farm Progress, I believe you shared how your new Fendt 9 horsepower lineup can improve farm income by up to 20%. Can you just walk us through the build up to that number and how that's going to help the OE set of your precision -- or Precision Ag business grow?

So when we talk about improving farmer income, there's 2 ways to do that, improving yields and also improving costs. And so in all the products and all the innovations, Precision Agriculture, or Precision Ag portfolio of products that we're developing, it's to solve the farmer issue. It's how can I increase the yields, how can I reduce costs, and we're step-by-step automating, providing more data, making -- helping the farmer make better decisions, use more precise technology in order to create cost or yield advantage. And so that's the overall goal is through our -- all our innovation, all our Precision Ag technology that we put either on Fendt products or Precision Planting equipment, whatever -- wherever the farmer is looking at it. It's bringing that cost improvement and that yield improvement, so that farmer income can grow by the 20% target that we've given.

Great. Well, we're just about out of time. So Andy and Greg, thank you so much for joining us today, and thank you to everyone listening to them on the line. Have a good rest of the conference.

Thank you Courtney.

Thanks, Courtney.