AGCO Corporation (NYSE:AGCO) Q3 2023 Earnings Call Transcript October 31, 2023
AGCO Corporation beats earnings expectations. Reported EPS is $3.97, expectations were $3.27.
Operator: Good day, and welcome to the AGCO Third Quarter 2023 Earnings Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Greg Peterson, AGCO Head of Investor Relations. Please go ahead.
Greg Peterson: Good morning. Welcome to those of you joining us for AGCO’s third quarter 2023 earnings call. This morning, we’ll refer to a slide presentation that’s posted to our website at www.agcocorp.com. The non-GAAP measures used in the slide presentation are reconciled to GAAP metrics in the appendix of that presentation. We’ll make forward-looking statements this morning, including statements about our strategic plans and initiatives as well as our financial impacts. We’ll discuss demand, product development and capital expenditure plans and timing of those plans, and our expectations with respect to the costs and benefits of those plans and timing of those benefits. We’ll also discuss future revenue, crop production and farm income, production levels, price levels, margins, earnings, cash flow and other financial metrics.
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All of these are subject to risks that could cause actual results to differ materially from those suggested by the statements. These risks include, but are not limited to, adverse developments in the agricultural industry, including those resulting from COVID-19, supply chain disruption, inflation, weather, commodity prices, changes in product demand, interruptions in supply of parts and products, the possible failure to develop new and improved products on time, including premium technology and smart farming solutions within budget and with expected performance and price benefits, difficulties in integrating the Trimble Ag business in a manner that produces the expected financial results, reactions by customers and competitors to the transaction, including the rate at which Trimble Ag’s largest OEM customer reduces purchases of Trimble Ag equipment and the rate of replacement by the joint venture of those sales, introduction of new or improved products by our competitors and reductions in pricing by them; the war in the Ukraine; difficulties in integrating acquired businesses and in completing expansion and modernization plans on time in a manner that produces the expected financial results; and adverse changes in financial and foreign exchange markets.
Actual results could differ materially from those suggested in these statements. Further information concerning these and other risks is included in AGCO’s filings with the Securities and Exchange Commission, including its Form 10-K for the year ended December 31, 2022 and subsequent Form 10-K, 10-Q filings. ACCO disclaims any obligations to update any forward-looking statements except as required by law. We’ll make a replay of this call available on our corporate website. On the call with me this morning is Eric Hansotia, our Chairman, President and Chief Executive Officer; and Damon Audia, our Senior Vice President and Chief Financial Officer. With that, Eric, please go ahead.
Eric Hansotia: Thanks, Greg, and good morning. AGCO has consistently delivered record results over the last two years, and I’m pleased to tell you that the third quarter of 2023 is no different. AGCO delivered $3.5 billion in third quarter sales, nearly 11% higher than the third quarter of 2022. Operating margins in the quarter were 12.3% and 12.6% on an adjusted basis. That’s 190 basis points better than 2022. This marks the fifth consecutive quarter with operating margins above 10.5%, which is evidence of how we have structurally transformed our business and further demonstrates the progress we are making towards our mid-cycle 12% operating margin target. This strong financial performance reflects the continued success of our Farmer-First Strategy, focused on growing our Precision Ag business, globalizing a full line of our Fendt branded products and expanding our parts and service business.
Our North and South American Fendt sales are ahead of our growth targets as we expand our distribution networks in the regions to give more farmers access to the industry’s best equipment, and we continue to have the best parts fill rates in the industry. Our strategy is generating strong growth in each of these margin-rich businesses, providing the foundation for 2023 to be another record year in sales, operating margin, earnings per share and free cash flow. Our expanding tech stack is taking our products to new levels of performance and efficiency, putting us in a winning position as farmers’ most trusted partner for industry-leading smart farming solutions. The recently announced joint venture with Trimble is truly transformational for AGCO and for farmers.
It also aligns perfectly with our strategy of focusing on a greater percentage of our business and the high-margin, high-growth Precision Ag segment of our industry. We’ll talk more about the planned JV in a few minutes. Slide 4 details industry unit retail sales by region for the first nine months of 2023. As harvest draws towards completion in the Northern Hemisphere, higher production is driving up grain inventories, weighing on prices. Farm income is still relatively strong. And with positive cash flow for most growers, demand for our equipment is at a relatively high level. What is retreating from the highs seen in 2022 in earlier this year. While still supportive, lower commodity prices and the fleet age trending younger are causing farmers to become more selective about their equipment and technology investments.
North American industry retail tractor sales were down approximately 2% through September year-to-date versus 2022. Smaller tractor sales continued to decline from higher levels in 2022, as higher interest rates and overall economic conditions have slowed demand. Strong demand for greater than 200-horsepower in drive units helped partially offset the decline. Industry retail tractor sales in Western Europe decreased approximately 2% through September compared to 2022. Farmer sentiment continues to be negatively influenced by the ongoing war in Ukraine, as well as input cost inflation. However, forecasts for healthy farm income in Western Europe are expected to support good retail demand for equipment throughout the remainder of 2023. In South America, industry retail tractor sales decreased 8% for the first nine months of 2023 compared to 2022.
Retail demand in Brazil was negatively affected by the depletion of government-subsidized loan program prior to the June 30 fiscal year end. But with loans now being processed, we are hopeful this will help drive improved retail sales for the balance of the year. Although, there are increasing signs of caution, retail demand in Brazil and Argentina remained at above average levels in 2023, with particular strength in the high horsepower segments. However, weaker commodity prices from strong crop yields, concerns about dry weather are creating concern for some farmers. The combine industry was up 23% in North America, and 30% in Western Europe, through September versus 2022, due primarily to improving supply chains. Combines in South America declined 20% in the first nine months of 2023 compared to the prior year.
Although, market conditions continue to soften off the extremely strong conditions over the last couple of years, we remain positive about the underlying ag fundamentals supporting long-term industry demand for several reasons. First, stock-to-use levels are higher than recent lows, but they remain supportive of profitable commodity prices versus historical levels. Second, as the demand for clean energy grows, the need for solutions like renewable aviation fuel and vegetable oil-based diesel will grow strongly, driving demand for our farmers that will further support commodity prices. And third, input costs such as fuel and fertilizer are down from their peaks last year. We expect farm income to be down modestly in 2023 from the record levels of 2022.
In aggregate, we believe that it will remain at attractive levels in 2024 and be supportive for industry demand. AGCO’s supply chain has improved significantly over the last year. Our suppliers’ on-time delivery performance to AGCO’s factories has gotten better, and our on-time product delivery to our farmer customers has improved every month since March 2023. Another benefit of this more normalized production environment is lower inventory. We have been able to reduce our raw material and work-in-process inventory by 14% since September of 2022. AGCO’s 2023 factory production hours are shown on slide 5. Our production decreased in quarter three by approximately 2% versus 2022. Recall that last year’s third quarter production was exceptionally high as we were recovering from the cyberattack in the second quarter.
Given this phasing and our focus on managing 2023 inventories, we are planning for relatively flat production levels in the fourth quarter versus last year, resulting in a 5% increase in production hours for the full year. As of the end of September 2023, demand for our farmer-focused products remains strong, and our order boards remained higher than historical average across all regions. In Europe, tractors have six months of order coverage, taking us into the second quarter of 2024. Dealer inventories are up approximately three-quarters of a month versus September of 2022. We’re now at our targeted level of around four months on average with certain products like Fendt high horsepower tractors, still below the optimal levels in certain areas.
In South America, we have order coverage through December 2023, where we continue to limit our orders to around one quarter in advance, giving ourselves more pricing flexibility. We opened our fourth quarter order boards for all brands in South America and they filled up within a matter of days. In North America, our orders for tractors, planters and application equipment are fully booked for model year 2024 as the demand in the big farm market continues to be strong. We continue to limit order intake on some products to improve our on-time delivery rates, though other products are returning to a more normal order bank management. We currently have approximately seven months of order coverage for both large and small ag. Moving to slide 6. At our Investor Day in December 2022, we discussed our three high-margin growth levers that would help AGCO achieve its margin aspirations and outgrow the industry by 4% to 5%.
To reiterate, those three levers are; globalization and full-line product rollout of our Fendt brand, focusing on global parts business and increasing the market share of genuine AGCO parts, and the third is growing our precision ag business, which supports not only factory fit technology but also significantly focuses on the mixed fleet retrofit solutions. These three growth engines will help AGCO achieve 12% operating margins at mid-cycle by year 2026 and will drive AGCO’s growth above the overall industry performance. Slide 7 recaps the planned transformational joint venture between AGCO and Trimble that we announced a few weeks ago, in which AGCO will acquire an 85% interest in Trimble’s portfolio of agricultural assets and technologies.
By layering Trimble Ag on top of our already strong portfolio, we will fast track AGCO’s technology transformation. The joint venture will allow AGCO to be a key player in guidance by offering advanced hardware and correction services. It enables us to automate even more activities for the farmer through Trimble’s automated steering system and enable farmers to connect with all of their data via Trimble’s farm management software, all of which will be controlled by AGCO. This combination provides a full suite of advanced technologies for farmers everywhere regardless of the brand. With our combined solutions, we further expand our mixed fleet offerings throughout the entire crop cycle and are able to put technology on more than 10,000 different models from almost any OEM.
This JV announcement, combined with our existing Precision Planting business, reinforces our commitment to brand-agnostic retrofit solutions and will help position AGCO as the hub of the mixed fleet solutions. Lastly, AGCO’s multi-channel distribution approach will drive increased adoption of Trimble’s portfolio of technology across the machinery population, allowing farmers more locations to access next-generation technology. This multi-channel access is a key lever to doubling the EBITDA in five years. Looking at slide 8, the business combination will create meaningful commercial growth opportunities for AGCO through access to expanded geographies and channels. Through September, AGCO’s precision ag sales have increased 16% on a year-to-date basis, putting us solidly on track to hit our long-term 15% growth target and taking AGCO’s precision ag sales to $1 billion by 2025.
When we overlay Trimble Ag’s 2023 expected revenues, the effective pro forma sales would be approximately $1.3 billion already in 2023. With the combination of revenues from AGCO’s Precision Ag and Trimble Ag JV, we expect to deliver over $2 billion in combined Precision Ag revenues by 2028. To conclude, we would likely expect this deal to close in the first half of 2024, subject to regulatory approval and customary closing conditions. With that, I’ll hand it over to Damon.
Damon Audia: Thank you, Eric and good morning everyone. I will start on Slide 9 with an overview of regional net sales performance for the third quarter. Net sales were up approximately 7% in the quarter compared to the third quarter of 2022 when excluding the positive effects of currency translation. Pricing in the quarter, which was in the high single-digit range, was the primary contributor to higher sales. As you may recall, the third quarter of 2022 was a very strong quarter, partially due to a catch-up in sales related to the cyber event in the second quarter, which had a bigger effect on our European and North American operations. By region, the Europe/Middle East segment reported an increase in third quarter net sales of approximately 9%, excluding the positive effects of currency translation compared to the prior year.
The improvement was driven by increased sales of mid- and high horsepower tractors, strong part sales, along with favorable pricing. In South America, net sales in the third quarter grew approximately 19% year-over-year, excluding the positive effect of currency translation, driven by the continued strong sales growth in Brazil and Argentina. Higher sales of tractors and momentum planters as well as favorable pricing drove most of the increase. Net sales in North America increased approximately 3% in the quarter, excluding the favorable impact of currency translation compared to the third quarter of 2022. The growth resulted primarily from increased sales of high-horsepower tractors, sprayers and tools, along with the positive effects of pricing that more than offset inflationary cost pressures.
On a constant currency basis, net sales in our Asia-Pacific/Africa segment decreased approximately 15%. The most significant declines occurred in Australia, Japan, and China, driven by lower farmer confidence and dry weather. Finally, consolidated replacement part sales were approximately $468 million for the third quarter, up 10% year-over-year or 5%, excluding the effects of positive currency translation. Turning to Slide 10. The third quarter adjusted operating margin improved by 190 basis points versus 2022. Margins in the quarter benefited from higher sales due to a richer mix and positive net pricing compared to the third quarter of 2022, significantly offsetting high input costs and approximately $35 million of increased engineering expense year-over-year.
Price increases in the quarter more than offset material and freight cost inflation on a dollar basis and contributed to the improvement in margins. For the full year, we are still projecting approximately 8% pricing. By region, the Europe/Middle East segment reported an increase of approximately $57 million in operating income compared to the third quarter of 2022 and margins improved 230 basis points. Higher sales due to strong net pricing and a healthy product mix contributed to the improvement. North American operating income for the quarter increased approximately $27 million year-over-year, while margin improved by approximately 250 basis points. Operating income benefited from higher sales due to positive net pricing and a favorable mix based on significant growth in Fendt products year-over-year.
Operating margins in South America exceeded our expectations again this quarter and were over 20%, a 200 basis point increase over the same period in 2022. Operating income improved almost $42 million versus the third quarter last year. The improved South American results reflect the benefit of a favorable sales mix. Finally, in our Asia/Pacific/Africa segment, operating income declined approximately $14 million in the quarter due to lower sales, reflecting much weaker market conditions year-over-year as well as lower product mix. With the margin expansion in the last two years in our North American and South American regions from our strategy execution and disciplined pricing, we expect AGCO’s margin profile to be more balanced across the globe in the years ahead.
Slide 11 details our year-to-date free cash flow for 2022 and 2023. As a reminder, free cash flow represents cash used in or provided by operating activities less purchases of property, plant and equipment, and free cash flow conversion is defined as free cash flow divided by adjusted net income. Through September year-to-date, we have used $155 million of cash, approximately $411 million or 73% less than 2022, despite increasing capital expenditures by almost $90 million year-over-year. This was a result of higher earnings and improved supply chain that enabled us to improve our manufacturing flow and get products into the hands of our farmers more quickly. We typically sell down our inventory over the back half of the year and anticipate a strong fourth quarter to hit our targeted free cash flow range of $900 million to $1.2 billion for 2023.
For 2023, although things continue to improve, we still expect our raw material and work-in-process inventory to remain somewhat elevated, given supply chain challenges earlier in the year, but we still expect it to be a modest source of cash versus a use in 2022. We expect our free cash flow conversion to continue to range from 75% to 100% of adjusted net income, a significant increase from 2022, consistent with our improved financial outlook. We remain focused on direct returns to investors during 2023 with a regular quarterly dividend that we increased last quarter by 21% to $0.29 per share and the payment of a special variable dividend of $5 per share in the second quarter. Slide 12 highlights our 2023 retail market forecast for our three major regions.
While still at supportive levels, the recent reductions in commodity prices are resulting in slightly softer demand across all regions in 2023 relative to 2022. For North America, we now expect demand to be 2% to 3% lower compared to the healthy levels in 2022. The high-horsepower row crop equipment segment continues to be strong, but it’s offset by softer demand for smaller equipment after several years of robust growth. Current interest rates are expected to continue to slow smaller equipment segment of the market. In South America, we expect industry sales to now be down 2% to 3% in 2023. This is a result of softening demand and higher dealer inventories we have seen emerge last quarter. However, this region remains one of the stronger end markets, especially in Brazil, where the farm footprint is increasing.
Although, down from 2022 high, we expect healthy farmer profitability in the region, which should continue to drive demand for large ag equipment. For Western Europe, we now expect the industry to also be down 2% to 3% compared to 2022. Farm fundamentals in the region are still generally healthy, but sentiment has weakened a bit in the region and order flow has slowed. Slide 13 highlights a few assumptions underlying our 2023 outlook. In addition to focus on meeting the robust end market demand, we will also make significant investments in the development of new solutions to support our Farmer First strategy. Our sales plan includes market share gains, along with price increases of approximately 8% aimed at more than offsetting material cost inflation.
With the weakening of the euro last quarter, we do not expect currency translation to have effect on sales year-over-year. Engineering expenses are expected to increase by approximately 20% or approximately $100 million compared to 2022. This increase is targeted at investment in smart farming and Precision Ag products. Given our strong performance through September, we are raising our full year operating margin to around 12% versus our prior outlook of 11.7%, driven by the sales mix, table of pricing net of material cost and improved factory productivity, partially offset by increased investments in our engineering and digital initiatives as well as inflationary cost pressures. Other expenses are expected to increase approximately $105 million year-over-year, most of which has been incurred year-to-date.
Half of this increase is tied to the sales and receivables to AGCO Finance where we’re being affected by higher sales volume and higher interest rates compared to 2022. The other half is related to increased volatility in the Turkish lira and Argentine peso where we saw additional FX losses in Q3. With more clarity on our full year, we are now updating our effective tax rate to 27% for 2023, which is the low end of our prior estimate of 27% to 28%. Turning to slide 14. Despite the slightly weaker currency outlook versus last quarter, we have maintained our full year net sales outlook of approximately $14.7 billion. We are increasing our earnings per share estimate, which should now be approximately $15.08 or on an adjusted basis, $15.75 in 2023 versus our prior target of $15.25, given the strong year-to-date performance and our confidence in the fourth quarter.
We’ve also increased our CapEx targets to around $450 million to include additional investments in our CBT capacity and to further enable Precision Ag growth. As I mentioned earlier, even with the increased capital expenditure target, free cash flow conversion should be in the range of 75% to 100% of adjusted net income, consistent with our long-term target, which based on our improved outlook, should deliver an additional $60 million to $80 million in free cash flow from our prior outlook. With that, I’ll turn the call back to Greg for our Q&A.
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