AGCO Corporation (AGCO) Earnings Call Transcript & Summary

All right. Great. Good morning, everyone. My name is Dillon Cumming. I'm the Machinery and Construction Analyst here at Morgan Stanley, and I'm very pleased to have with me up here today. AGCO Corporation. We've got Damon Audia, the incoming CFO; Andy Beck, outgoing CFO; and Head of IR, Greg Peterson. So guys, thanks for being here.

Sure.

Just to start off, I'm going to read one quick disclosure. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representatives.

So with that, guys, I just wonder if you can start the conversation in the broader kind of thought around the ag cycle, right? I think that's given all the end-market strength we've seen over the last few years. A lot of questions in the market about where we are in terms of mid-cycle peak, past mid-cycle, et cetera. As you sit here today, what are your thoughts around that already past mid-cycle, approaching peak? Where do you see that kind of trending right now?

I think, Dillon, every cycle is a little bit different, as you probably know. Even by region, they tend to operate quite differently, with Europe usually being a less cyclical end market. I think if we look at our industry right now, what we would tell you is all of our regions, North America, South America, Asia Pacific, Europe, are all above what we would call our mid-cycle schedule if we look at how they compare over the last 10 years. And each of them are sort of in a different stage. If you look at the Europe here, obviously, that's been challenged by what's been going on with Russia and Ukraine. But overall, a good, stable market. We're seeing good growth there and good demand. If you look at South America, a very strong market. I think we'd say it's probably about 20% above mid-cycle. We've seen good growth there as we've been able to really grow our brands, especially the premium high-horsepower brands like the Fendt brand, but again, very strong market conditions there. And then here in the U.S., again, above mid-cycle and relatively strong market conditions as farm income -- if you think about our farmers with commodity prices, farm income has been strong this year. We would expect it to be strong next year. So even though input costs have been increasing for them, they're still generating relatively good income, which is facilitating strong demand for our products. And I think the biggest challenge that we've seen across all of the regions is supply availability. We've been dealing with supply chain constraints, there's more demand than we've been able to supply that's lending itself to a good backdrop as we enter 2023. And you've heard us and others say, our order board is into the second quarter for certain product lines next year. So we're feeling good as we come through the balance of this year. And we look at the macro backdrop, it's lending itself at least to a relatively solid '23. And again, I would say, I don't know the exact number, but we would expect it to be above that mid-cycle average as we look at '23, at least initially here.

Yes, makes sense. That's a helpful overview. I definitely want to touch on the order board. So maybe just thinking fundamentally about European market for a second, right? It's your biggest exposure, obviously. It's a region where we've seen some of the [ sensitive ] indices kind of moderated a bit in recent months. I mean I think it's a surprise, given the pressure of the situation. But when you see movements like that, does it change the thinking at all about the market into next year?

No. Again, I think when you look at the backdrop in Europe right now, there's a lot of concern about the overall macro, the energy-related activities for us. But as we think about that, and I'm sure you'll want to talk about the energy issues, but again, it hasn't changed the underlying demand. Again, that market, historically, is a much less cyclical market. And so again, we still see good orders, good pricing and good overall demand from -- for the European end market.

Yes, makes sense. And then thinking about North America, you mentioned some of the farm P&L dynamics, I want to touch on it as well. But it's a market where I think most investors still kind of recognize more structural growth drivers over the next few years, things like [ dealer ] restock materializing in the future years, things like an elevated North American farm fleet age. Are those all factors that you see as well in supporting a growth outlook kind of into next year or 2?

Yes, well, I think you got to look at it two ways, specifically for AGCO. One is, I think you're touching on the macro backdrop. And so we still see good, strong macro indicators. Things like, dealer restocking, the age of the farmers' equipment, all of those lending themselves to a good macro. But if I think about what we're looking at AGCO, call it, more of the self-help narrative for us, there's 3 incremental pieces on top of that macro. One is we've talked about Fendt, right? The global -- expanding the portfolio to be more than just traditional tractors. So sprayers, combines, adding in some of the other the planters, giving it a more holistic offering to the dealer network, we're seeing good growth in North America, right? We've talked about [ this Fendt ] experience, where we're bringing dealers on in a very selective fashion because those farmers get to experience the Fendt tractors or the other products, that overall experience where they have 3 years of warranty covered, the dealer relationships. We want to make sure that they're getting that experience the right way as we introduce this brand into North America. That's going to help us capitalize share gains agnostic of what the market does there. So we feel really good about what we're doing with Fendt on top of the market backdrop. You layer on the continued focus on our parts sales, where we're really working hard to improve the availability, the fill rates for parts, that will help dampen even as we see equipment sales fluctuate here over the next several years, building up that part revenue stream, continuing to grow that to help dampen the downside has been a strong focus for us. And then you layer on that third leg of our growth pillar, which is the Precision Ag side of the house, seeing great demand, great growth on that side by the team, especially here in North America. As we've expanded what would be traditionally this planting or the precision planting, now looking at other applications in the crop cycle, whether that's spraying and other applications, really trying to offer the farmers a more fulsome suite of Precision Ag-related technology, and we're seeing good growth there. And again, given the input cost and some of the things on sustainability, again, we continue to see great growth potential there beyond just that macro backdrop you touched on.

Yes, makes sense. And maybe sticking with North America. You guys have, obviously, had up farm progress a couple of weeks ago. Can you kind of contextualize sentiment at the show, anything notable to call out relative to prior years? How farmers [ are faring ] in general trends?

Sure. As Damon indicated, there's still a lot of positive sentiment out there with farmers. So crop prices remain high on the positive side, on -- but there is some concern about cost coming up. You've got higher fertilizer costs, higher fuel costs. So those are concerns that farmers have right now. And they're also worried a little bit about their yields. In some cases, we've had some challenging weather, and so yields look like they're coming down. But that also will somewhat guarantee that crop prices will stay high for the foreseeable future. So overall, the profitability of the farmer is going to be very strong this year. And I think they have confidence that it looks like it's going to be very strong for next year as well. So that leads to -- that confidence leads to still wanting to replace equipment and refresh their fleet. So the fleet age is still extended. It hasn't -- we haven't gotten to the point where with this stronger demand that we refresh the fleet back to kind of normal levels. We still see that as an opportunity. And so we think, again, as Damon talked, that there's -- opportunity in this market will stay strong, going into next year, because of that. The other thing going on at the farm show is technology and innovation, and that's what we're trying to show customers in terms of when they're buying equipment, buy equipment that's going to provide strong return on investments for them. And so if they're looking at Fendt tractors with strong ROIs from the fuel efficiency that it provides, if you're in our Precision Planting area, the yield enhancement that we can provide. And so farmers are very interested in this environment as well to find ways to improve their conditions, to improve their yields, lower their costs, especially with fuel prices high. And so very, very -- a lot of interest that you see in terms of the technology side of what's going on in our industry.

Yes, absolutely. Damon, I want to go back to a comment you made on the order book for a second. You mentioned it kind of extended in the second quarter of next year. I think on last quarter's call, you noted it was up 40% [ NIM ], which, I mean, pretty high, kind of coming off of a strong year as well. Can you talk about how that would compare to a normal year in terms of the length of the order book at this point? Whether or not it's kind of informally more positive for you next year? And then related to that, are you able basically the supply chain to actually take up production rates to work that down over time?

Yes, and I think the -- if we look at how far the lead time out, we're definitely up above traditional levels. I think some of the things that we've done, Dillon, is try to curb this a little bit, and you've heard us talk about this on our last quarter call, is we're limiting the order book, for example, in South America, to only 1 quarter. Because if we look at material costs, we look at inflation, we want to make sure that we're pricing for the cost that's coming through our cost of goods sold. So we've limited -- in certain areas, we've done that as others have done it in the Americas or North America as well, periodically pausing for certain product lines, just to make sure. So the order board is much longer. Again, the demand, as Andy just touched on from Farm Progress, is farmers are feeling good. They got cash. They know that they need to get in line. Again, if you look at where commodity prices are, they're willing to put their orders in, understanding that this is going to take some time. So for us, it's definitely giving us the ability to book, get sort of a certain retail demand. But again, we're trying to ensure that we have the right cost structure and then the pricing. So we're going to balance the two for sure.

Yes. So that's actually a great segue to kind of next question. So for the orders that you are taking for '23, what is the approach to price cost, right? Are you putting in higher-than-normal price increases to get yourself on the safety net? Or how are you thinking about that?

I guess, two comments. One is one where we -- especially where there's higher inflationary type challenges, we're limiting those orders, right? South America, certain product lines here in North America, rather than committing to a price to the end farmer, limiting the order board to give ourselves more visibility. I think the other one is we're looking at our cost basis, looking at the run rates and trying to reflect that in some of the other product lines as we put the pricing out, trying to make sure that we're covering price, recovering these cost increases. And if you look at what we've done this year, we'll come in pricing at around 10%. Again, relative to historical standards, that's a big number. We've been very successful in pricing in excess of the material cost, mainly on a dollar basis. As I said, last quarter, we didn't quite cover on a margin, but we're more than offsetting on a dollar basis. We're continuing to look for those opportunities to drive pricing to more than cover those material costs, going forward.

Yes, makes sense. So really a question on the kind of cost side. I'm sure it's one of the biggest [ FACs ] you guys have been getting. European energy dynamics, right? What you're seeing on the ground with regards to gas availability? European electricity cost inflation, what are you seeing on the ground? And what kind of mitigation actions are you will to take to kind of offset that?

Sure. Let's touch on the availability first, and then we'll come to price here in a second. But if we think about our footprint in Europe, obviously, we have a large exposure. We have factories in Finland, in France, Italy, Germany. I think the one that's probably most visible is the one in Germany, given its reliance -- or given Germany's relating on gas from Russia. If we look at what Germany said, they're building their reserves. They feel like they're ahead of schedule. They should be able to weather the winter with a couple of months supply. So we use that as a macro backdrop. So I think that's a positive for us. Inside our German factory, we're being very proactive in trying to mitigate the risks. And what does that mean? Adding LNG tanks on site, looking to shift to more electricity, and that factory in is already more driven by electricity than gas, but trying to see are there opportunities to move it to even more, adding or changing some of the furnaces to be more on wood fire. So we have a lot of crates that come in that we can't really recycle, using the wood source as a source of energy instead. So trying to be as proactive in addressing different ways to generate the energy for the factory. Again, as I said, most of that is electricity. There are parts of the factory or lines that would be focused on gas, but really trying to dampen or reduce our specific risk to our factory. I think the bigger question for us is our supply base. So what we're doing there? One, we're looking at suppliers who have multiple factories. Can we shift our source of supply from a Western European factory to a different factory? Trying to do that where we can. If we're dual sourced, how do we look at the exposure between those 2 or 3 suppliers and make sure that we're mitigating our risk that way? And then third is the continuity discussion with those suppliers. As you would guess, certain suppliers are going to be much more [ cash-intensive ] than we are. Castings and things like that are going to consume a lot more gas. So trying to understand what their continuity plans are. Again, everyone is going to be a little bit different, but trying to work with them, understanding what they're doing to mitigate the risk. So I guess, we're being as proactive as we can. I think the one variable that we don't know about right now is, if you go back in the peak of COVID, we redeemed a critical industry. We were able to run through the pandemic. If we get into a point where there's allocations, do we get a disproportionate share, given the importance of the ag space? I don't know. But these are all the things we're looking at and trying to make sure that we're sort of mitigating the risk as much as possible. So we feel like we're in as good a position as we can be. And hopefully, it's a non-event.

Yes, got you. And maybe you can just kind of contextualize the challenges you have experienced on that front relative to all the kind of material and supply chain disruption and inflation you've seen over the last 18 months, right? I mean, is this just another challenge to deal with, but has it been worse than the kind of steel inflation that we dealt with over the last year or so? Or how are you kind of conceptualize it?

I'm glad you came back to the question. I forgot the cost side. So I think if you think about the energy cost, for us, it's a relatively small part of our of cost of goods sold. What we'd tell you is energy cost, those factors are very low single-digit percentages in the overall cost of goods sold. So to the extent we see these prices go up 5x or 10x, not to minimize the incremental cost, but these are things that we think we can effectively pass through with pricing. So again, we don't see again. I think availability is the bigger question. We'll deal with pricing, if it does -- if the cost increases, we should be effectively passing that through.

Got you. Maybe on the more optimistic side of the margin discussion, right? This year, the closest that you guys have got essentially to the 10% margin target, which has been a long-term goal for the company. How much of that improvement this year was more structural versus cyclical? When you think about longer term, if we do go through a downturn, how sustainable is that level of margin that you're at today?

Yes. In terms of our margin, we've talked about advancing that and growing that margin over the last few years. And we can see if we somewhat adjust our sales and our business back to kind of mid-cycle margins, we can see that we're making step changes in our overall margins. So -- and how are we doing that? I think it's growing our Precision Ag business that we've talked about, the growth of Fendt globally, growing our parts business. Those are all things where our mix is improving, and we can see that we're really improving the overall margin profile. So those -- that margin improvement should be permanent. It's not just because the market is up. Now some of our improvement that we've seen in the last 2 years has been because of the cycle improving -- markets improving across the world. So as markets, at some point, come back down, we are going to see -- we're on -- certainly on a sliding scale of what happens with our margins, based on where the industry is. But if we normalize those, we can see step changes in our margins. And so going forward, we think we've got a lot of runway to improve our margins going forward. Again, when we went through our strategy, the key -- that was a key element of it, was to improve margins. And first of all, it was by growing our high-margin businesses. So our premium Fendt brand, taking that global, expanding the product line, selling more complementary products like sprayers and planters, which also carry strong margin, growing our Precision Ag business, we -- as we talked about, we had a goal -- we increased our goal of growing the sales up to $900 million. We're at about in the $600 million range right now. So there's growth opportunity there. That's a strong-margin, aftermarket-type margin business. And then within the parts business, we've been growing quite rapidly. And we think there's a lot of opportunity to continue to get a bigger share of the dealers' parks, wallet and demand, also with predictive maintenance with our digital tools, we think we can grow the parts business. So all of those are high-margin businesses. As we grow that, that should expand our margins. And then there is the traditional improvements in our manufacturing and purchasing. Certainly in manufacturing, we have not been efficient in the last few years because of the supply chain, just has created inefficiencies. And we should be able to bring those back into to more normalized conditions over time. And then there are some business units that we think we can improve. We talked about improving our Massey Ferguson margins by simplifying the product line, getting more focused in certain geographies. And we think that will help us improve our margin profile there. And our Grain & Protein business has gone through some challenging conditions. We've done a lot of restructuring there, and we think that we're poised to see some improvement in that business as well. So all of those different areas that we've got opportunity give us, we think, a lot of runway to keep margins growing. And regardless of where we are in the cycle, we want to see step changes in our margins going forward.

Yes. And I think the one of the reason that we didn't call out there, I think, has been a big contributor to margin growth year to date in South America, right? It's been a huge outperformance on market side really for the first 2 quarters. Can you just talk about, first of all, what the drivers of that margin improvement were, first of all? And how sustainable that is into the back half when we think about next year as well? Is that a structurally stronger margin business than it was before?

Yes. So I think -- yes, I think, Dillon, we've structurally changed our whole go-to-market strategy in South America. And if you think about what we've done over the last several years, and historically, I would tell you we were more of a lower-horsepower tractors in the south. Over the last several years, the team has made the decision to migrate up to the Midwest region, these more large mega farmers, and really doing so and bringing the Fendt with a larger horsepower tractors to the farmers. And what you're seeing there, again, is those are farmers who are driven more -- professional farmers. They're looking for efficiency. They're looking for productivity. And as we've introduced things like the Fendt brand, which is a much more fuel-efficient tractor versus the competition, they're seeing the savings translate from lower diesel fuel and the cost of that to their bottom line. So we're seeing a significant change not only in where we're approaching it, but what we're offering those dealers or what we're offering those farmers, we've been growing that -- our dealer network there in that part of the region. So you're seeing a significant mix up in the type of [ processing ] that's structural. You see us gaining share with these larger mega farmers. Again, structural changes there. You layer that in a very strong market environment, what we'd say is the South American market, it's about 20% above mid-cycle right now, which is lending itself to good volume, but probably also incremental pricing opportunity versus a mid-cycle margin. So again, overall, really strong structural changes in what we're doing with our Fendt brand and attracting a different segment of the Brazilian market, coupled with good pricing dynamics in a relatively strong market environment.

Yes, makes sense. Maybe to bring the conversation a little bit near term on the price cost and kind of supply chain backdrop, maybe putting Europe aside for a second. It does feel like you started to see some levels of moderation, some of the cost items, things like steel, premium freight, right? Have you seen that improvement in your own kind of cost profile? Or is this kind of a whack-a-mole situation?

No, I mean we're -- again, we watch the spot prices. What I would tell you is we're going to see that flow through our cost of goods sold usually 3 to 6 months from now. So our cost for the back half of the year, we certainly knew where that was going to be, and we're addressing that with the price as we said, 10% pricing. What you see with [ Kirk ] Steel today will likely affect more in the 2023 sort of cost of goods sold. The good news for us, as we said, there's more demand than we have supply, given supply chain constraints right now. And so our order boards are strong into the first half of '23, which may lend itself to this opportunity, at least as material costs come down, to sort of help facilitate a slightly stronger margin. Again, I wouldn't say it's permanent because at some point, as capacity aligns with demand, you're going to see discounts in sort of realigned dealer inventories. But at least in the first part of '23, we're feeling good about where we see our pricing relative to where the cost is apparently going to flow through.

Yes, makes sense. And just on the kind of production capabilities and supply chain state, right? Last quarter, you guys had a cyber incident, impacted production for a couple of weeks. Can you speak to, first of all, how that played out -- how the recovery played out towards the back end of the quarter? And then related into the back half of the year, does the supply chain, as you see it today, still have scope to kind of make up for that lost production in the back half?

Yes, so when the cyber event happened, obviously, we shut everything down around the globe. We selectively started to bring things off one by one. I think, within 2 weeks, we had all of our operations running. What we said at the time of the event and what we reaffirmed at the second quarter call is we expected to make up that lost production that we sort of saw in May in the back half of our fiscal year. So in Q3 and Q4, our July run rates, as we talked about on the call, we're in line with what we thought we needed to do. And so for us, it wasn't -- it was more of a timing within the course of the fiscal year rather than something flowing into '23. So again, we'll see our production schedule come up here in the second half of the year. And again, July was in line with that. So again, we're feeling good. Again, you hit on it, the question mark of the wild card is still the supply chain, right? That's our biggest bottleneck. What we've said is things have gotten modestly better from where they were. So we're feeling good to meet our demand. But again, supply chain continues to be the biggest question mark and a wildcard for us to deal with.

Yes, absolutely. So with last few minutes we've got here, I wanted to ask a few questions on the Precision portfolio, right? Obviously, one of the more secularly attractive elements of the AGCO story as well. You took up your 2025 sales target from $800 million to $900 million. Can you discuss, first of all, what products are kind of driving that more optimistic view in the near term? And as you look out over the next few years, were you most bullish on adoption across that portfolio?

Yes. So Dillon, we're approaching the Precision Ag world a little bit differently than our competitors. We're taking a retrofit-first approach. So that's important in a couple of different ways. Number one, it opens up the addressable market pretty significantly for us if you think about kind of the normal replacement cycle for farm equipment, typically 3 to 5 years. So depending on which end of that spectrum you're looking at, you're looking at 20% to 30% of the market that's addressable typically. But if you're selling retrofit kits, which we're doing now, in a number of different areas, doubles or maybe even triples the addressable market every year. So we're -- we started that effort with our Precision Planting business, which I think a lot of folks know about, but it's arguably one of the most successful ag tech companies in the world, right? So it's a company that addresses retrofit planting capabilities, essentially turning dumb planters into smart planters. And it does that -- it allows farmers to actually incrementalize their investments in planting. So they can spend tens of thousands of dollars on a kit in a particular year.

They get the benefits of whether it's higher-speed planting or better yields and then add another kit the next year and get more benefit. And so from that retrofit approach, we're attacking a good part of the market. So initially, Precision Planting started with, obviously, planting. The good news for us is that now we're broadening their horizons and soon, they'll be providing that same retrofit benefit for sprayers. So there a lot of talk about minimizing the use of herbicides and pesticides by using optical scanning capabilities and we're going full board to do that on a retrofit basis. So a lot of work on the retrofit side. At the same time, we're focused very heavily on our Fuse portfolio. So that's the portfolio of products that provide those Precision Ag capabilities across new tractors and combines and sprayers. One of the big things we've done over the last 5 years is to develop a common electronic architecture across our portfolio of products. So being a multi-brand company and multi-platform company, we had some differentiations across that architecture. And so over the last 5 years, we've developed that common electronic architecture, which is now allowing us to layer on applications, if you will. So things in the past that we worked with outside partners, things like simple as GPS, autoguidance, autosteering. Historically, we've partnered with outside folks. We've -- with the launch of our FendtONE application, for instance, now we've in-sourced a lot of that capability. So instead of buying a full solution from a third party, we're doing most of that ourselves and maybe just adding on a component or something. So it's allowed us to in-source, which means we're keeping more of that margin ourselves. So we've taken that now also telemetry, allowing our customers and our dealers to closely monitor and manage equipment. So there's a lot of proactive maintenance opportunities as we do that. So all the way across the crop cycle, we've layered in that those Precision Ag capabilities. From the planting we talked about on the Precision Planting-side retrofit, we're also now selling our Momentum planters and the OEM version of that Precision Planting technology. When you think about harvesting, that's obviously a key part of the farm economic situation, and we launched our IDEAL Combine several years ago, and we continue to refine that. But it has significantly more sensing capability than anything we had done in the past, and it really puts us into the market for the big professional harvester businesses. So now we can offer a full range of Precision Ag capabilities all the way across the crop cycle, both retrofit and OEM.

Yes. It's definitely one of the more exciting parts of the story. I think just to put in the last question here, AGCO has really focused a lot of its M&A on the Precision part of the portfolio in recent years, right? You had [ Perio], Headsight, JCA, you were doing a lot of deals on that front. When you look at the next leg of acquisitions that you're looking to make, is it fair to assume that's going to be focused on the [ Precision ] part of the portfolio related to that? Which parts of the overall Precision landscape are you looking to fill out via M&A?

Yes, and I think if you look at AGCO as a company, we're a company that's been built through acquisitions. And so we've demonstrated our willingness to do inorganic opportunities. Again, we'll always look at that to see if there's parts of the portfolio that we can help serve the farmers better that we don't have. And again, a buy versus build mindset has served AGCO well over its history. If you look at the last couple of years, it's been very technology-focused. We'll continue to focus our efforts there. Our Precision Ag team wakes up every day trying to figure out how do we make the farmers more profitable? How do we service their needs better? And again, for us, the team that we built with these software-type engineers are constantly looking to make the improvements internally. But again, if there's ideas in this crop cycle that can help accelerate our plan to help make the farmers more profitable, we're going to look at it. There's no one specific area to say we're going to go all in on X or Y, but it's looking across the whole crop cycle and figure out how do we help improve the farmers' yields and productivity, their profitability and making sort of us their primary choice. So I'd say, we're going to continue to look. But where? Again, TBD.

Yes. Sounds good. I think we're at the top of the time. So guys, I appreciate the time, and thanks for being here.

Thank you, Dillon.

Great. Thanks.