AGCO Corporation (AGCO) Earnings Call Transcript
June 8, 2020
Earnings Call Speaker Segments
Thanks. Yes. Good morning, everybody. My name is Stanley Elliott. Welcome to the 2020 Virtual Cross Sector Insight Conference. We are very pleased to have AGCO with us today. From the company, we have Andy Beck, Senior Vice President and Chief Financial Officer; as well as Greg Peterson, who runs up -- heads up their IR group. I appreciate everybody's patience in trying this virtually for the first time through, but I think we have a lot of the kinks worked out. For those listening on the webcast, we do have a feature for you to be able to send in questions to me. I will moderate this in a pretty informal kind of fireside chat sort of event. Feel free to shoot me those questions through the webcast, and I can ask them on your behalf. But with that, gentlemen, thank you guys very much for participating.
Thank you.
Andy, I guess, we'll start off, kind of what are you currently seeing across the various marketplace in the various markets? I guess what have been the major impacts that you're seeing right now from COVID on AGCO's businesses?
Yes. Obviously been a very dynamic situation that we've been working with over the last few months. Things seem to be settling down in almost all of our markets at this point. So as you recall from the discussions we had at the end of the first quarter, the overall situation for AGCO was driven by supply chain issues. And so we had talked about that in the month of April, we were going to have a number of our factories in Europe and in Brazil shut down not because of specific government regulations, but because of the indirect issues, with workforce issues, with our supply chain where we couldn't get parts to our factory. So we were basically shut down from late March and through most of April in Europe and South America. Our factory in China was down early in the year but had been up. And our North America factories had been running and never had any disruptions. So to update that, as we discussed on our call, we were back up in May, and we've remained up. So from a supply chain standpoint, the work that our team has done has been very good, working very closely with our supply chain partners and getting the visibility ready to work through any issues that they have, but everything has been working well and -- where basically the month of May was kind of a ramp-up period to get production back up and running. And so we've been running with no issues since those shutdown periods. The other factor we had was we had our Valtra tractor facility, which is up in Finland, it had incurred an incremental issue where we had a major supplier have a fire. And because of that, the Valtra plant was going to be also down in May, and we were working very quickly to resource those. They were casting components that we needed for the factory, and we've completed that, and we're back up and running now in our Valtra facility. So all of our factories are up and running normally now, certainly working with kind of new working rules in terms of making sure that our employees are distanced, have as many safety precautions as we can put in place. For instance, in our factory in Germany for our Fendt products, we're running 2 shifts rather than 1 shift in order to keep the social distancing and safety measures in place and also give us a chance to catch up to some extent as well. So we're operating, I think, fairly well and kind of the month of May was kind of a catch-up period. In terms of the overall market conditions, not a lot of change there. We're seeing in North America, the market is overall down. I'd say the one surprising element is that the low horsepower business still stays relatively strong. That business is more tied to the general economy rather than the agricultural economy, but it's still staying fairly buoyant. And then the ag-focused products, which are more in the high horsepower sector, we're expecting those markets to be down this year with commodity prices lower, issues with the ethanol industry being one of the main reasons why we expect farmers to delay purchases again. But as we've spoken for a number of years now, the demand to replace equipment, to refresh the fleet is becoming stronger and stronger in North America. The last big surge in demand was back in 2013. And so farmers want to replace equipment sooner than that. So the fleet age is getting larger. And so there are a number of farmers that with the conditions right, they would certainly replace equipment. So we're in a situation where there's a need to replace equipment, but the economics for the farmer are challenging. And so a lot of uncertainty there, a lot of wait-and-see attitudes amongst the farmers. I think on the positive side, the government support that's out there, there's going to be price support for a number of crops that the farmers are producing, and that should offset some of the real market price that we see in the spot prices or the market prices that farmers could get aside from that. So that will support, I think, a reasonable market this year, but expecting it to be down. In Europe, the market was down about -- only about 4% in the first quarter. But certainly, in April, with most of the factories down around Europe, and as we described, our factories were down, and I think most of our competitors' factories were down, the month of April was going to be quite low. And so we saw that from a market standpoint. We'll start to see it come back here in May and June. The main factors for the European market are simple economics for the farmers. So they're heavy in the wheat markets. And so wheat prices are performing the best of the major commodities, and so that's a positive. However, we're seeing the dairy prices start to come down a little bit. And so that's a concern because dairy is an important sector in Europe. So some positives and negatives going on. We're also following the yields for the farmers this year very closely. They've had consecutive years of dry weather, and there was some dry weather earlier this year. So we're hoping to see some improvement in the conditions for the farmer in order to see their yields improve this year. So all in all, kind of a mix situation. In terms of countries in Europe, they don't all move the same, and so we're seeing a mix of outcomes. The markets that were more heavily impacted by the pandemic, like Italy and Spain are performing weaker than some of the bigger agricultural markets like France and Germany. And so I think that's something we'll be watching very closely for the rest of the year. And then moving down into South America, the market was down in the first quarter, but relatively flat in Brazil. We've seen some further declines moving into the second quarter in Brazil, again because the factories were shut down in the month of April. So that should start to improve a little bit as we move forward. The Brazilian farmer is -- from an economic standpoint, is in good position right now. The weakness in the reals will help their margins when they export their crops. A lot of their input costs are in local currency. And so that gives an advantage when they're exporting their crops and selling them in dollars. And so from a margin standpoint and a yield standpoint, for the most part, the Brazilian farmer is in good shape. They did have some drought in Southern Brazil, which is impacting some of those markets. But overall, they expect a good production year. What's holding back? I think demand in Brazil is overall confidence and kind of a sentiment-type situation where farmers are remaining concerned about the impact of the pandemic in their market and also the social and political uncertainty in the market as well, which I think is holding back confidence because really, they have some pent-up demand. Their equipment is aging as well. And there should be a stronger market in Brazil. So we're looking forward to getting a little more confidence in the market, we think that would help the market going forward.
That's a great overview. With -- it sounds like production levels are picking up kind of post this COVID and as economies are reopening. How should investors think about margins? And kind of generally, how do you feel about inventory levels at the retail channel kind of as we finish through the rest of the year?
Yes. In terms of our margins, obviously, when your production is down or production is limited in any way, that's an impact to the margins because we're not able to offset the fixed costs that we have in our facilities. We do everything we can to reduce costs during those periods in terms of furloughing employees, cutting back on investments and other expenses and things like that. But still, there's an element of those fixed costs that impact our margins. So the level of production that we have for the rest of the year will be very important to dictate what our margins would be. Our incremental margins as we discussed end of our first quarter are highest in Europe. And so with that market down, that will be impactful. So our incremental margins should be probably in the low 30s for Europe and then maybe 25% to 30% in the other markets. And so that's the level of sales, and market conditions for the rest of the year will be very important in terms of dictating how our margins will perform in the rest of the year. We're doing as much as we can to control expenses, delay and defer expenses that we can until we see these markets recover. So we're doing what we can to keep those margins as high as possible. The second quarter will be the market -- the period where we'll have the most impact, again, with the production down. And then everything stays as it's going today, we'll see improvement from the second quarter into the third and the fourth. In terms of inventory levels, obviously, we had some disruption with our production. And so that -- we had a lot of inventory unable to get shipped out. And so we had higher inventories for a period of time. We're working those down now. In some cases, we're carrying a little more safety stock of some suppliers that we think might be at risk and sort of make sure that our production can keep running, but we're working that down and hopefully get those back into normal levels as we work throughout the year. In terms of dealer inventory, with the production down, there was still retail activity. And so our dealer inventories were reduced during the month of April. We do have solid order boards, particularly in Europe and in North America, and so we should be able to rebuild those dealer inventories through the rest of the quarter. Our overall target for dealer inventories is to really try to take this advantage of the situation with our production being down, trying to run our dealer inventories at a very efficient level for the rest of the year. And so we're targeting strict management of dealer inventories as we monitor retail activity and our production for the rest of the year.
I think that's encouraging, especially thinking about in the out years in terms of matching production with sell-through at the dealer level. You mentioned replacement demand kind of not really a whole lot since 2013. Can you talk about your expanded portfolio that you will have now particularly on the combine side, and I guess on the globalization of the Fendt product as well? To me, it seems like an opportune time to catch, hopefully, a tailwind of some replacement demand with a more complete portfolio serving the professional farmer.
Yes. I think those comments are most accurate as we relate -- look at our North America position to serve those large professional farmers in North America and compete against our strong competition in that market. We really felt like we needed to up our game in terms of the product offering that we had. And so over the last number of years, we've worked on having a stronger product offering for those North America farmers. They -- the product requirements are different than Europe. And so we've had to adapt the row width -- mainly the row width spacing for the North America farmer. And the Fendt product that you mentioned is the premium product in the market in Europe. It's our product that we sell that has the most technology, and we're moving that market into North America. So we offer the 2 highest horsepower ranges of the Fendt Tractor now in North America with the North America requirements in terms of row spacing and other features, and we're working on building up a distribution network for the Fendt product. So on top of that, bringing in more advanced high -- technically stronger product into North America. We've introduced a new range of combines, which we call the IDEAL Combine, that's also branded in North America and has very innovative features, self-correcting features, trying to improve the yields for the farmers through -- and improve the output and as well as fuel economy. So a lot of innovative features in this new combine. And so that's available to North America farmers now. And then on the planting side, we -- as you know, we had the opportunity to own the Precision Planting business for a couple of years now, and we're introducing a new planter this year, which has a lot of those features on the planter. And we think that the packaging of the planter, and we already have very good sprayer products in North America, with the combine and the Fendt tractors, really provides a great package of products for the North American market. So we're excited with our product portfolio in North America and looking forward to aggressively marketing that for the next few years. When we look at Europe, we've had very strong acceptance of our products over the last few years. I think we're doing quite well with all of our brands, both the Massey Ferguson, the Valtra brand has really done well recently, as well as the Fendt, which I think is growing in popularity in Europe over the last number of years. So we feel good about our product portfolio in both North America and Europe. In South America, we talked a lot about refreshing the whole fleet of products. In South America, we brought in a lot of products that were from our North America or European designs in order to upgrade the technical features that we had. And we've also kept in the portfolio, some of the more simple products, lower cost for the farming market in Brazil as well. So we feel like our product portfolio in South America is very strong as well.
And you mentioned the dealership piece here in North America. How far along are we in finding these consolidated larger dealers that you will want to have representing the Fendt brand?
Greg, do you want to cover that one?
Sure. So we have taken a very deliberate approach with the distribution, Stanley, for the Fendt brand. Andy mentioned that it's a premium brand. We've established it as a premium, high-tech brand in Europe. And we wanted to make sure that, that carried over as we introduced it really into the North American market. We've sold Fendt in pockets, but now that we've essentially Americanized a lot of the products, we wanted to make sure that we brought with those products the kind of service level that the Fendt brand has kind of stood for over the years. And so that process has been very extensive in that we developed a very complex playbook for our dealers. It's several inches thick, and it really outlines every single touch point that the dealers have with our customers in terms of, here are the 2 or 3 things you need to do, the very first time you talk to the customer. The second time you talk to them, here are the 5 or 6 things you need to do. When you sell a product, here are the training requirements that you need to do. And by the way, before you even start to sell, your service and your sales folks need to go through very extensive training courses. We've added sales support and service support folks here in the North American market to support the dealers. So as we've gone through that training process, we've added -- and by bringing the Fendt brand, specifically now, we've given ourselves the ability to kind of cherry-pick our best dealers around North America. So in a lot of cases, it will be our CAT dealers that are already selling our Challenger brand. Many of those have -- now have the Fendt franchise for their local selling area. In some cases, it's a larger Massey Ferguson dealer that has gotten the Fendt franchise. And so we'll have roughly around 200 dealers that are selling the Fendt brand. And so with that, in addition to the sales and service, they are required to stock certain parts. And we're being very deliberate with not only the initial context, but also with the service and warranty work that we do and the warranty that we provide. So we're very much promoting the brand and the products as a premium technology product, very -- not interested in competing on price. Really, it's about the features, the technology and the service level. So it's been an interesting couple of years, as Andy talked about, as we've brought the products in. And now that we've got the distribution ready to go, we've been very pleased with the volumes that we've seen in the early going. So it's been a good experience for us.
Perfect. And then kind of as a follow-on to that and the larger dealers. Certainly, Precision Ag has been a big focus for you all. You covered a lot of things at the December meeting, also very evident at the trade shows. How does AGCO's technology differ from peers? Where are you seeing the most success? Talk about how you're integrating that into your complete system now?
Great. Andy, I'll start out with some comments, and then you can add to that. So yes, you're right, Stanley, that our Precision Ag approach is quite different. It really starts with a focus on the smart products themselves, and Andy touched on a number of those already, but really all the way across the crop cycle. So starting with that Precision Planting technology that Andy talked about at the very beginning of the crop cycle, including some of the advanced features on our tractors like the Fendt products, Andy talked about, and our sprayers, through the new IDEAL Combine that has twice the number of sensors that we've had on any other combines before that. We actually, with that IDEAL Combine, started with a clean sheet of paper and did all the work, sat down with farmers and did the focus groups and found out what it was they wanted and tried to really tick all the boxes in terms of enabling the combine to do a lot of the self-adjustment on phone, the quality of the grain that gets harvested, the speed at which the combine operates through the field. So really introduced a significantly improved harvesting capability. And then it extends through the grain storage and handling products that we provide. So -- and then on top of that or maybe underneath that, we've layered on some important infrastructure. So we have a mixed -- or we have a -- we sell under a multi-brand product offering. And so with that, we have -- can and do have a mixed fleet in our customer locations. And so we -- it's very important that we have connectivity, not only across our brands, but across the competitive brands that might be found on our farms. So we focused a lot on that connectivity. We've provided a number of convenient mobile tools that allows our customers to access data and information that allows them to make important changes to how they're farming. So our truly open approach has allowed us to develop partnerships with people like Climate Corp here in the United States and in South America, Brazil, particularly a company called Solinftec. So we feel like that open architecture has been a real benefit and a real help for our customers. And then in terms of infrastructure or in terms of the connectivity, we've established a common electronic architecture that goes across nearly all of our platforms. So this serves a strong foundation to enable the integration of all of our Precision Ag features. And we're complementing those smart products that I talked about with some machine control features, things like guidance and rate and section control. And so these products are really helpful to farmers today. And the good news is that as we sell them, it's a nice additional feature that we charge for. And of course, the margins on those vertical features are quite attractive for us. We've also focused on connectivity in terms of our fleet. We've been offering that connectivity for many years. But really, starting last year, we ramped up our focus. And now we have connectivity virtually all across our large ag products. So that essentially everything over 150-horsepower that rolls out of our factory has that connectivity as part of the base feature set. So we're leveraging that, and that allows our customers and our dealers to monitor equipment wirelessly and remotely, allows us to diagnose as well as our dealers to diagnose machines remotely, helps with part availability, part stocking. And finally, Andy talked a lot already about our Precision Planting business. So that part of it is a little bit different in that, that is a retrofit business and -- most of that business. And so that allows us to compete very effectively in terms of cost for farmers and deliver a very quick payback. Because they can upgrade existing products, essentially turn dumb planters into smart planters, and so we've been offering that retrofit product for a number of years. And then, as Andy talked about, we're now offering an OEM version of that planting capability. That should allow us to grow that business, not just here in North America but broadly across Europe and South America as we extend into those markets.
Perfect. And then what's interesting is, too, is with kind of the more capable parts and services, the distribution. Do you envision the kind of the ag machinery market -- or to what extent do you envision the ag machinery market kind of changing as a result coming out of COVID? I know that it's kind of a harder thing to put a finger on, but I was just curious with some of the high-level things that you all have seen.
Yes, it's something that we're really talking a lot about right now is how have these changes that we've been forced to make in terms of how we interact work with our dealers and end customers, how will those extend on past the crisis and the pandemic. And we think there'll be a number of things because once a customer or a dealer gets used to using digital tools and technology, you usually don't want to go backwards. So I think we're going to see a lot of that. So how we interact with our customers and our dealers through digital means, the use of our platforms in terms of ordering, reviewing inventory levels, reviewing product specs. We're also doing a lot of things in terms of virtual demonstrations of equipment and things like that. So how we sell, how we service, how we communicate with our customers has changed. And we are finding it to be very effective and very efficient. And so it will be very interesting to see how all this evolves over time. I think, for sure, it tells us that we've started a project to work on our digital aspects of our business, making our whole customer experience a digital experience. And we know that, that's going to be even more and more important than what we consider maybe even 6 months ago. So we think we're moving in the right direction with all those investments. And certainly, we think they're completely necessary at this point.
Perfect. And we're almost out of time. So just to wrap it up, you talked a little bit about capital allocation. I mean it seems like just a couple of weeks ago, everyone is focused on liquidity, obviously, not a concern for you all. But how are you going to thinking now as the economies recover about M&A versus returning cash to shareholders. What would you be looking at as triggers to maybe resume repurchase activity at some point?
Yes. In terms of M&A, it's an opportunistic thing. So if the right project came available, it's something we would obviously consider. There's really nothing we can do to -- except for just monitor and watch for opportunities. In terms of returning cash to shareholders, we've maintained our dividend and all we've done is postponed share repurchases for the time being. But as things normalize and we get good visibility in terms of our cash flows and things like that, then I think we'll go back to more normal activities there.
Perfect, guys. But with that we are just about out of time. So Andy, Greg, thank you very much for your time today. We sure do appreciate it.
Thank you for the opportunity. Appreciate it.
Thank you.
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