AGCO Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 2, 2023

There are 12 speakers on the call.

Operator

Good day, and welcome to the AgCo First Quarter 2023 Earnings Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. In consideration of time, please limit yourself to one question and one follow-up. Please note this event is being recorded.

Operator

I would now like to turn the conference over to Greg Peterson, AGCO, Please go ahead.

Speaker 1

Thanks, Jason, and good morning. Welcome to those of you joining us for AGCO's Q1 2023 earnings call. We will refer to a slide presentation this morning that we posted on our website

Speaker 2

atwww.agcocorp.com.

Speaker 1

The non GAAP measures used in the slide presentation are reconciled to GAAP metrics in the appendix of that presentation. We will make forward looking statements on the call this morning with respect to Strategic plans, demand, product development and capital expenditure plans, production levels, engineering expense, exchange rate impacts, Pricing, share repurchases, dividends, interest rates, future commodity prices, crop production, supply chain disruption, Inflation, component deliveries, sales margins, earnings, cash flow, tax rates and other financial metrics. We wish to caution you that these statements are predictions and that actual events may differ materially. We refer you to the periodic reports that we file from time to time with the Securities and Exchange Commission, including the company's Form 10 ks for the year ended December 31, 2022. These documents discuss important factors that could cause the actual results to differ materially from those contained in our forward looking statements.

Speaker 1

These factors include, but are not limited to, adverse developments in the agricultural industry, including those resulting from supply chain disruption, weather, exchange rate volatility, commodity prices and changes in product demand. We disclaim any obligation to update any forward looking statements except as required by law. A replay of this call will be Available later today on our Corporation website. On the call with me this morning are Eric Kansodia, our Chairman, President and Chief Executive Officer And Damon Adia, Senior Vice President and Chief Financial Officer.

Speaker 3

With that, Eric, please go ahead. Thanks, Greg. Good morning. It's great to be with you. We started 2023 incredibly well from both an operational and a financial perspective.

Speaker 3

Slide 3 highlights the results of quarter 1, 2023. We posted a record Q1 in terms of sales, Operating margin and earnings. The combined efforts of AGCO team has helped deliver 1st quarter sales growth of 24% With adjusted operating margins expanding by 260 basis points to 11.7%. This makes 3 consecutive quarters with operating margins above 10.5 percent, sustainable progress towards The mid cycle 12% target. These results are a testament to the tremendous value we are adding to farmers as we revolutionize the crop cycle.

Speaker 3

This success is playing out with the backdrop of a continuing strong industry. AGCO's precision ag sales were up 30% and ideal combine sales increased 70% in the Q1 compared to a year ago. Development is underway on targeted spraying, Autonomy and dozens of smart precision ag features. We are making solid progress towards our ambitious technology deployment goals we set in December. These results and forward looking focus stem from our commitment of being the most farmer focused company in our industry.

Speaker 3

Our customers' growing interest in AGCO's Precision Ag Solutions is supporting extended order boards. We expect healthy market conditions to continue and our improved financial outlook for 2023 reflects this optimism. We've increased our sales and earnings forecast and expect to generate significant cash flow this year. The strong performance supports our technology related investments aimed at advancing our digital capabilities and growing our precision ag sales. We will also continue to return cash to our shareholders.

Speaker 3

Last week, we announced Special variable dividend of $5 per share as well as a 21% increase in our regular dividend given the strength of our business and our confidence going forward. Slide 4 details industry unit retail sales by region for quarter 1 2023. Supportive farm economics resulted in robust demand for large agricultural equipment as farmers continue to replace aging machines. While dealer inventory of smaller equipment has increased versus 2022 levels, larger machinery is still below historical averages. North American Industry Retail sales were down approximately 3% for quarter 1 versus 2022.

Speaker 3

Smaller tractor sales declined from a high level in 2022, while increased sales of greater than 100 horsepower units help to offset the decline. Industry retail tractor sales in Western Europe decreased approximately 3% in quarter 1, 2023 compared to 2022. Farmer sentiment has been negatively impacted by the war in Ukraine as well as input cost inflation. The forecast Healthy farm income in Western Europe are expected to continue to support solid retail demand for equipment throughout 2023. In South America, industry retail sales decreased 3% during quarter 1 2023.

Speaker 3

Positive farm economics, supportive exchange rates and continued expansion in planted acreage in Brazil Our driving increased investments in high-tech farm equipment and resulting in an outlook of modest growth for the South American tractor industry in 2023 compared to strong levels last year. Across all regions, the combine industry was up significantly compared to Quarter 1 of 2022, given the relatively low level in the Q1 last year due to significant supply chain constraints. We are very positive about the underlying ag fundamentals supporting strong industry demand in 2023. Box to use levels remain at low levels supporting elevated commodity prices. While there's been some pullback in commodity prices over the last 6 months, They are still well ahead of historical averages.

Speaker 3

Equipment in the field is aged and increasingly due for replacement. New dealer inventory of large ag equipment remains below targeted levels, while small ag dealer inventory is up from last year. Input costs like fertilizer and fuel are down significantly from their peaks last year. While farm income may be down modestly in 2020 From record levels in 2022, we believe it will remain at very good levels in 2023 and be supportive for industry demand for 2023, assuming normal crop production. And at the same time, we don't see that changing much 2024.

Speaker 3

Our team did a great job maintaining focus on our strategy, while continuing to deal with supply chain challenges. While the supply chain has improved over the last couple of quarters, we continue to experience some component shortages that are affecting our production volumes. The encouraging news is that even with global supply bottlenecks and inflationary pressures, farmer economics remain healthy Global end market demand remains strong, especially in the large farm segment. AGCO's quarter 1 2023 factory production hours Are shown on Slide 5. While some supply chain shortages linger, we grew our production in quarter 1 by Approximately 8% versus 2022.

Speaker 3

We are planning on higher production levels in quarter 2 versus 2022 and we are planning for relatively flat production levels in the back half of this year versus 2022. Based on our industry And market share forecast for 2023, we are projecting a 3% to 5% increase in production hours for the year. As of the end of March 2023, demand for our farmer focused products remains very strong and our order boards remained elevated across all regions. In Europe, tractors have order coverage through the end of the year with large ag orders up double digits And small ag orders down double digits compared to last year. In South America, we have order coverage through September of 2023, where we continue to limit our orders to around 1 quarter in advance to give ourselves more pricing flexibility.

Speaker 3

To give you an idea of the strength in this market, when we open the system to receive Q3 orders, the order board was filled effectively in one day. In North America, our orders for tractors, combines and sprayers extended into 2024 as the demand in big farming market Continues to be extremely strong. As we outlined last quarter, orders remain below last year's levels as we have elected to limit order intake to improve our on time delivery rates. Normalizing for the new order intake rules, large ag orders are up and small ag orders are down. This next slide highlights our 3 growth vectors to outpace the industry by 4% to 5% per year.

Speaker 3

Our FEMP Global Full Line Business, our Global Parts and Services and our precision ag product offerings, All 3 provide significant growth potential at higher margins with less variability during cyclical downturns. This morning, I want to focus on our efforts on our FENT initiative. We continue to grow the business along two paths. First, we're expanding the FENT product line beyond tractors to now include key products like sprayers, planters and combines. 2nd, we are taking this full line of FENT products global.

Speaker 3

As you can see on our results, interest continues to grow For our premium FENT product lines in both North and South America. In the Q1, our FENT branded sales in those markets increased by 139% 94%, respectively. Our FENT and Challenger sales in North and South America are expected to double over the next 4 to 6 years. As part of our FENT globalization efforts, we are launching the FENT 200 Vireo in the North America market. This segment leading tractor has been successful in the European market for many years and now we are bringing it to North America where it launched in February at the 2023 World Ag Expo.

Speaker 3

The tractor will serve customers with vineyards, orchards and other high value specialty crops. The lightweight and maneuverability combined with the high performance of the machine enable premium pricing and high margins. At the World Ag Expo, dealers and potential customers were impressed by the cab space, front 3 point features and variety of widths offered. We expect the Fendt 200 Vireo to continue to provide our farmers with exceptional results they have come to expect as part of the Fendt experience. With the introduction of the 200 to North American market this year, the globalization of our Fent Tractor product line is nearly complete.

Speaker 3

We will have brought to the market models ranging all the way from the largest 1,000 series down to the 200 series. Our technology rich products are enabling more sustainable farming practices and outcomes for our customers. We are also in a much stronger position from a sustainability perspective. Slide 7 shows a couple of highlights from our 2022 sustainability report, which was issued in March. We are delivering on our sustainability commitments from industry leading innovation to improved sustainable outcomes for our farmers Decarbonizing our products and operations to offering our talented diverse employees a safer, more engaging workplace.

Speaker 3

I am proud of the progress we're making, which includes achieving our Scope 1 and 2 targets 3 years ahead of schedule by reducing the emissions intensity of our manufacturing operations. Other impressive achievements include Our renewable electricity usage is now 63% of our total. Our renewable energy usage is already at 36% of our total. Improvement in health and safety metrics like reducing our incident rate by 14% helped in part by increasing the number of sites that are ISO certified and taking employee feedback from our voices survey to help make AGCO a great place to work. With that, I'll now hand over the call to Damon, who will provide more information about our Q1 results.

Speaker 2

Thank you, Eric, and good morning, everyone. I will start on Slide 8 with an overview of AGCO's regional net sales performance for the Q1. Net sales were up approximately 30% in the quarter compared to the Q1 of 2022 when excluding the negative effect of currency translation. Pricing in the quarter, Which was over 11%, contributed to higher sales along with strong growth in high horsepower tractors, combines application equipment and precision ag products. By region, the Europe Middle East segment reported an increase In net sales of approximately 30%, excluding the negative effects of currency translation compared to the prior year.

Speaker 2

The improvement was driven by increased sales of high horsepower tractors, utility tractors and fused precision ag products Along with favorable pricing actions, strong growth in Turkey, Germany and the United Kingdom accounted for most of the increase. In South America, net sales in the Q1 grew approximately 42% year over year, excluding the negative effects currency translation driven by continued strong sales growth in Brazil, partially offset by lower sales in Argentina. Higher sales of tractors, combines and application equipment as well as favorable pricing effects drove most of the increase. Net sales in North America increased approximately 32% excluding the unfavorable impact of currency translation compared to the Q1 of 2022. The growth resulted primarily from increased sales of high horsepower tractors, application equipment and combines along with the positive effects of pricing to more than Inflationary cost pressures.

Speaker 2

On a constant currency basis, net sales in our Asia Pacific Africa segment Decreased about 4%. Delayed shipments from our European factories last quarter resulted in lower sales in most of the markets, partially offset by sales growth in Australia and China. Finally, consolidated replacement part sales We're approximately 5% during the Q1. Turning to Slide 9. The 1st quarter adjusted operating margins improved by approximately 260 basis points versus 2022.

Speaker 2

Margins in the quarter benefited from higher sales and production, a richer mix and positive net pricing compared to the first Order of 2022. Price increases of over 11% more than offset significant material and freight cost inflation on a dollar basis We're also positive on a margin basis. For the full year, we are still projecting approximately 8% pricing. By region, the Europe Middle East segment reported an increase of approximately $77,000,000 in operating income compared to the Q1 2022 and margins approved approximately 250 basis points. Higher sales, Product mix and strong pricing contributed to the improvement.

Speaker 2

North American operating margin for the first Increased approximately $47,000,000 year over year. Operating income benefit from higher sales and production, positive net pricing in a favorable mix. Operating margins in South America reached nearly 20% in the first quarter And operating income improved over $53,000,000 versus the same period in 2022. The South American results reflect the benefit Higher sales and production and a favorable sales mix. The continued strength in Brazil has resulted in strong price resiliency in the quarter, helping deliver robust results once again.

Speaker 2

Finally, in our Asia Pacific Africa segment, Operating income declined approximately $16,000,000 in the Q1, primarily due to lower sales and production. With the margin expansion in the last two years in our North American, South American and Asia Pacific, Africa regions from our strategy execution In disciplined pricing, we expect AgCo's margin profile will be more balanced across the globe in the years ahead. Slide 10 summarizes our precision ag business. As you can see, we are focused on expanding our addressable market From just traditional agricultural machinery spend, which today is in the low to mid teens. With our precision ag portfolio, Our sites are set around 70% of all non land areas.

Speaker 2

We believe that the investments in Precision Ag positions us well as it will play a major role in We recorded $199,000,000 in precision ag revenue in Q1 of 2023, approximately a 30% increase from 2022. Our current run rate puts us solidly on track to hit the $1,000,000,000 sales target by 2025 that we announced during our December 2022 Investor Day. Slide 11 details our free Cash flow for 2023 2022. As a reminder, free cash flow represents cash used in or provided by operating activities, Less capital expenditures and free cash flow conversion is defined as free cash flow divided by adjusted net income. In the Q1, AGCO used $682,000,000 of cash in 2023, 6% more than 2022.

Speaker 2

Remember, It's typical that we seasonally build inventory in the Q1 for the spring selling season. The year over year change is related to approximately $60,000,000 increase in capital expenditures coupled with a modest increase in working capital that more than offset increased earnings. For 2023, we expect our raw material and work in process inventory to remain somewhat elevated given supply chain challenges, While we expect to be a modest source of cash versus a use in 2022, we expect our free cash flow conversion to range from 75% to 100% of adjusted net income, a significant increase from 2022. We remain focused on direct returns to investors during 2023 with the regular quarterly dividend that we recently increased 21% to $0.29 per share last week and the declaration of a special variable dividend of $5 per share. Future returns of cash to shareholders will be based on cash flow generation, our investment needs, which include capital expenditures and acquisition opportunities, as well as our market outlook.

Speaker 2

Slide 12 highlights our 2023 retail market forecast for our 3 major regions. Globally, driven by elevated commodity prices, we expect healthy farm economics to support another year of Strong end market demand. For North America, we expect similar demand compared to the healthy levels in 2022. We expect continued growth in the high horsepower row crop equipment segment to be offset by softer demand for smaller equipment after several years of robust growth. Increasing interest rates are expected to continue to slow the smaller equipment segment of the market.

Speaker 2

In South America, we expect industry sales to be flat to up 5%, moderated by supply chain constraints. This region remains one of the stronger end markets, especially in Brazil, where the farm footprint is increasing and we expect another year of Healthy farmer profitability, which we expect to drive demand for large ag equipment beyond 2023. Shifting to Western Europe, the industry is forecast to be relatively flat compared to 2022. Farm fundamentals in the region are generally healthy With grain price continuing to outpace input inflation. Meanwhile, supply chain constraints over the last 2 years are Extending equipment replacement.

Speaker 2

Slide 13 highlights a few key assumptions underlying our 2023 outlook. In addition to focusing 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. Although we see strong market demand, AGCO's results will still be dependent on our supply chain performance in 2023. Our sales plan include market share gains along with price increases of approximately 8% aimed at offsetting material cost inflation. We currently expect currency translation to positively impact sales by about 1%.

Speaker 2

Engineering expenses are expected to increase by approximately 20% compared to 2022. The increase is targeted at investments in smart farming and precision ag products. Operating margins are expected to improve to around 10.9%, driven by higher sales In production, favorable pricing net of materials and improved factory productivity, partially offset by increased investments in our engineering and digital initiatives as well as inflationary cost pressures. With increasing interest rates and higher sales forecasted, we expect other expenses primarily related to the sales of accounts receivables to increase approximately $50,000,000 year over year with the majority of that in the first half of twenty twenty three. We are targeting an effective tax rate in the range of 27% to 28% for 2023.

Speaker 2

Turning to Slide 14. We've raised our sales and earnings per share targets from what we highlighted on our Q4 call. We currently expect net sales to be in the range of $14,500,000,000 Earnings per share should $14.40 in 2023. We continue to target CapEx of $375,000,000 And as I mentioned earlier, free cash flow conversion should be in the range of 75% to 100% of adjusted net income consistent with our long term target. With that, I'll turn the call back to Greg for Q and A.

Operator

We will now begin the question and answer session. Please limit yourself to one question and one follow-up. Our first question comes from Stanley Elliott from Stifel. Please go ahead.

Speaker 3

Good morning, guys. Thank you all for taking the question. Could you talk a little bit, I guess, kind of I guess, start off with the grain and protein business. How has that been tracking relative to expectations and just curious with that there. Thanks.

Speaker 2

Yes. Sure, Stanley. So I'd tell you, grain and protein, after a couple challenging years, the team worked really hard to do a fair amount of restructuring to really Consolidate the factories, improve the overall cost position of the business. Last year, Stanley, they were challenged with steel prices, Obviously escalating in the first half of the year, they were probably the most adversely affected by the cyber event that we experienced. And then the challenges that they saw in China, really on the protein side of the business there really sort of, I would say, masked The underlying improvement that we were seeing in their operations and so as we started the Q1 here, I would tell you grain and protein had a good first Quarter you saw on the appendix sales of $256,000,000 operating income was call it mid single digits, So improving year over year and I think what we're seeing is the sort of a year as steel prices have moderated Relative to last year, as you know, Q2 is a strong quarter season, especially here in the U.

Speaker 2

S. For them. So we're hopeful to see the improved performance sort of Continuing to raise that margin and we have expectations for significant improvement in grain and protein in 2023 versus 2022.

Speaker 3

Great. And I apologize, I had to hop on a little bit late. But can you talk about kind of where you think we are in the cycle more so for South America and then in North America and then how you're kind of managing the business and expectations there? Farmer fundamentals are extremely strong. Our order boards are higher now on all large ag all around the world than they were a year ago.

Speaker 3

Dealer inventory is low, used prices are high. So we see a very strong market all the way The year and we don't see what would change that significantly in 2024. We're not forecasting 2024 yet, but we still feel we've got a strong market in front of There's some more macro tailwinds that are going to play out. A few years back, we had the in North America, the big ethanol Demand contributor where it started consuming a large portion of the corn crop. Well, we see that a similar thing happening with vegetable oil going forward, where soy and canola will be demanded to convert that soy That vegetable oil into renewable fuels and other things.

Speaker 3

The renewable diesel capacity has Doubled in just in this year, in the last say 12 months. And by the end of the decade, we see it going up 4x globally and 9x in the U. S. So that's another demand driver. And then maybe the last one I would say in terms of macro themes is you're seeing all around the world countries Announcing that they're placing higher priority on food security.

Speaker 3

So they're, I'll call it hoarding or storing more food, more grain locally. Well, that means even if you look at the global ending stocks have been declining for the last 6 years in a row, they've gone from 650,000,000 tons to 580 from 2017 to now, but under that is even a more dramatic shift in that Those are in the wrong locations. They're being hoarded by certain countries. So not enough grain, machinery still tight And more demand coming. We feel like this market's got a lot of strength to it.

Operator

Our next question comes from John Joyner from BMO Capital Markets, please go ahead.

Speaker 4

Good morning. Thank you for taking my question. So I guess when looking at your outlook for operating margins for the year, you're basically assuming that profitability We'll moderate for the rest of the year, which I guess is contrary to what I would have assumed with some better volume leverage and supply chains improving and such. So Why would margins ease for the remainder of the year? I mean, is it greater planned investments or something else?

Speaker 4

Or is it just a little bit of conservatism?

Speaker 2

Yes, I think excuse me, John, I think it's a couple of things. One is we do have material cost increasing. If you think about The other thing is pricing in the first half or the first quarter of the year was our strongest part of the year. As we've talked about South America again outperforming even our expectations. We do expect that to moderate.

Speaker 2

And then the 3rd component is our engineering. We said engineering was going to be up around $100,000,000 Year over year, so you'll see that continuing to flow through here in the back half of the year. Those are the really the 3 big drivers Leading to the sort of the 10.9% outlook that we have now for the full year.

Speaker 4

Okay. I'll take it as being conservative. But then my next question, when looking at the age of the Shifting fleet in South America, I mean, I believe farmers there typically use equipment longer than North American or European farmers and probably beyond the kind of assumed So what do you think is driving the higher age of large ag machinery there? And particularly when grower economics are currently so strong?

Speaker 1

Yes. So John, you're right in the sense that equipment is used much more intensively in South America. So The actual useful life though tends to be shorter and we see equipment replaced generally faster, especially on the big farms in the Mato Grosso And the sugarcane mills that also are big consumers, that hasn't changed. And the used market isn't quite as Developed in South America, it's more especially on these big farms, that are in more rural regions. It's they tend to use until the wheels fall off, they have their own maintenance shops in a lot of cases.

Speaker 1

So we haven't really seen those dynamics change, Used equipment values to the extent there are used equipment on market are still very high. And even our New equipment inventory in our dealers while they're up a little bit still down from where we'd like them to be. And if you remember last year at this time, Inventory levels were almost dealer inventory levels were almost nonexistent. So, result continues to

Speaker 3

be a very strong market.

Operator

The next question comes from Dylan Cumming from Morgan Stanley. Please go ahead.

Speaker 2

Good morning, guys.

Speaker 5

Thanks for the question. Just wanted to ask first on the kind of production hour dynamics for the rest of the year. You were obviously guiding to flat in the back half. I guess, is there still a layer of growth that's being constrained on that front with regards to supply chain, labor, etcetera, such that as we look kind of beyond this year, you could potentially take that up a bit More as we go forward.

Speaker 2

Yes. I think Dylan for us as we look at the Q2, you see the big increase. If we look at the back half of the year, as we've said, we do expect some continuation of supply chain challenges. I think the other one is we'll watch As we look at the dealer inventory levels, as Eric just talked about, the market demands, if we continue to see the demand as robust it is right now, think like you saw last year, there may be opportunities to squeeze out a little bit more incremental production, but at least right now, We do have preventative maintenance that you would normally see in the Q3 and a little bit in the Q4. Some of that we've Given the demand that we've seen in the last year, and so we do have to do that at some point in time.

Speaker 2

But again, right now, our Forecast is sort of aligning with our revenue outlook and sort of the overall market demand that we see for the balance of the year and into early 2024.

Speaker 5

Okay, great. Thanks, Damon. And then just one kind of broader question, it was kind of early days, just with regards to kind of tighter financing conditions. First of all, have you heard that feedback dealer channel, heard that from many customers. I know you've got the JV with wrap up,

Speaker 3

I think that probably gives you

Speaker 5

a bit more flexibility, but just any concerns out there on the customer side with regards to tighter financing?

Speaker 2

No, I think as we pull between Agco Finance, DLL and our joint venture partners along with other customers, We really have not seen anything affecting the financing. Now we are seeing as we've talked in the past, Dylan, as small Ag is declining due to rising interest rates, but risk or things of that nature, we're really not seeing any challenges on collectability or loans Being made to the farmers, again, a lot of these are made by regional more ag centric banks that usually have a little bit more of a conservative lending policy. So we haven't seen anything affecting that policy, but more just a small lag coming down due to GDP and overall interest rate increases.

Operator

Our next question comes from Mig Dobre from R. W. Baird. Please go ahead.

Speaker 6

Thank you. Just to follow-up on that last question. Not so much a credit availability issue, but Just the outright cost to finance equipment has gone up obviously with interest rates and at least some of the things that we've heard in our conversations with dealers is that There are many of them are kind of hoping for more manufacturer support. So I'm kind of curious, do you think That this is an issue and do you have any tools available to be able to manage that dynamic?

Speaker 2

Mig, we do our AgCo Finance. I guess a couple Points I would make. One is for especially for these large farms, all of them are or most of them are usually bringing a trade in As they think about upgrading their equipment and if you look at the trade in values of used equipment, it's still staying at a relatively high level right now. And so the net Delta of what these farmers are financing, right now is still relatively small. And then when you think about the interest rates, Adco Finance tries to Stay very competitive in the marketplace and opportunities to incent the farmers to use AgCo Finance versus other alternative forms of financing.

Speaker 2

On the small ag, I know some of there are areas where we are doing 0% financing for a period of time on the small ag side of the house in order to encourage those Small Ag customers to make the purchase. And so I'd say the team is constantly assessing the market, understanding what the interest rate is, what the overall cost Of the tractor maybe or the combine would be to the farmer and trying to put it in an attractive rate that allows him or her to get what they need. So, but I think we're looking at that and constantly monitoring the situation.

Speaker 6

Understood. Then my follow-up back to South America. I mean, this segment has performed at least on the margin side Considerably better than I personally would have guessed. And sort of curious if you can level set our expectations here going forward, Regularly as we think about the second half of the year on both how you think about revenue, but also maybe more importantly, how you think about margin? Thank you.

Speaker 2

Yes. I think when we think about the South American market, it is our strongest market that we have relative to the mid cycle. We continue if you look at our outlook, we expect that market to stay strong for the balance of the year is what we've said is up sort of 0 So maybe 5%. So we still expect very strong market conditions, which will drive top line growth. When we think about the margins for South America, This quarter again, I would tell you it's outperformed even our expectations.

Speaker 2

The price resiliency that we're seeing in the markets Has continued to be strong now. What I would tell you is there's 2 pieces here as we do expect that to decline in the back half or in the second quarter and for the balance of the year Really for two reasons. One is the material cost inflation. We know that's continuing to increase. A lot of the product for our large horsepower tractors are input Or shipped in from Europe, so there's an elongated supply chain there.

Speaker 2

So we see that coming in. And then there's also what I'll call more of the traditional Dealer incentives that we would provide for volume orientated, given the strength of the markets over the last couple of quarters, We haven't been giving those traditional dealer incentives out. At some point in time, we do expect that to wane and that would Fall into the pricing dynamics. And so if you look at our outlook for the balance of the year, we're now in that 16% to 17% range, Really based on those two primary factors, but like we've said before, the team has done a really good job in staying disciplined on price, They're looking at the market and taking advantage if they see the strength to not provide any more incentives than we need to. And Eric alluded to on his opening comments, when we opened the order book for Q3, we filled that up within effectively one day.

Speaker 2

So very strong market fundamentals, Great product portfolio down there, all of that driving a richer mix and ultimately the high margins. But again, we're sensitive to the market dynamics that that may come down a little bit here in the balance of the year. And expect that may come down a little bit here in the balance of the year.

Operator

Our next question comes from Seth Weber from Wells Fargo Securities. Please go ahead.

Speaker 7

Hey, guys. Good morning. I guess another margin question. I was actually Pretty surprised by the strength in Europe, the margin strength in Europe, 14 ish percent was pretty Flat from the Q4 even though revenue came down a bunch. Are Europe is it just pricing or is there something else that has Kind of structurally changed in Europe that we should start to think about Europe margins now kind of in that low teen range going forward?

Speaker 7

Thanks.

Speaker 2

Yes. So I said a couple of things for Europe. Again, another a really strong quarter for them. To your point, strong pricing was very strong, More than offsetting inflation, on top of that, we saw a really rich mix, great volume growth, Fence, Valtra and Massey, all three major brands had significant growth year over year. A lot of this for the higher horsepower of the richer mix.

Speaker 2

I think the other thing in Europe is again very strong production year over year. Production was up double digits, so you're getting some of that incremental absorption And that was helping drive the improved profitability. As I said on my comments earlier, as we sort of see the Profitability with the richer mix, we're seeing a better balanced portfolio around the world. And again, Europe, we expect to see continued strong margins here for the balance of the year.

Speaker 7

Got it. Thanks, Damon. And then just maybe on the free cash flow guide maintained for the year, It's a pretty big leap from the Q1 to hit your full year target. I guess just your level of confidence In hitting the free cash flow number and what the levers are, what the big drivers to that are going to be, because it sounded like I think I wrote down that working some of the inventory is going to be still high. I think you said your with inventory at raws is So just trying to think through what's going to get you there for the full year.

Speaker 7

Thanks.

Speaker 2

Yes. So Seth, I guess my comments were more that were up relative to our historical standards. The supply chain inefficiencies that we're still dealing with Are creating some inefficiencies in the factories. We're getting more units out, but we're not running at an optimal level again. So for us, We don't see that necessarily being eliminated through the course of the year.

Speaker 2

We're hoping that it gets better. We still see a path to deliver on our full year targets of inventory. 1st quarter is a normal seasonal build as we get ready for that spring selling season And then we'll work through that here in the back half of the year. So we do see line of sight to improve. If you go back to where we were last year, We had a very strong second half where we had to work through that inventory.

Speaker 2

We delivered on our cash flow outlook for 2022. We're hopefully going to be more balanced than it all coming in the Q4 this year. But as we look at that inventory build, that seasonality and line of sight for the back half of the year, we feel confident in delivering that 75% to 100% of adjusted net income in cash flows.

Operator

Our next question comes from Jamie Cook from Credit Suisse. Please go ahead.

Speaker 8

Good morning and congrats on a nice quarter. Just Obviously, you have a very strong order book and visibility into 2023. But in the event that things deteriorate in 2024, Can you talk about how you think about decrementals or why margins will be structurally higher just Given some of the self help and precision ag margin stickiness. And then my second question, as supply chain Eases and customers and dealers get more comfortable with your ability to produce, how do you think The order trend set up for 2024, do you think dealers and customers are still going to rush to order? Or do you think you'd see a slowdown in order pace?

Speaker 8

Thank you.

Speaker 2

I mean, maybe I'll touch On the margins and then I'll let Eric maybe touch on the order trends for 2024. I think Jamie for us on the margin side, if you think about our 3 big growth engines, We've talked about the parts business growing high single digits, high margin. We said that usually grows every year, somewhat agnostic of the Cycle with our increased focus on that, especially improving our fill rates in areas like South America, continued strong performance in North America and Europe, We see that continuing, somewhat regardless of where the cycle is. Precision ag, again, if anything, we see that continuing to grow. If you look at our outlook, we reaffirm that $1,000,000,000 target.

Speaker 2

That's around a 15% CAGR Over between today 2025, we were up 30%. Again, 90 plus percent of farmers invest in retrofit or some sort of repairs in the course of the year. We see that continuing to grow again agnostic of where the whole goods cycle is. So both of that is we should Continue to improve both richer mix and then you think about the Fence market share expansion, right, not necessarily OE or the general economy, But just the growth in share as we go to areas like South America and North America, we still see white space opportunities to bring on new dealers To penetrate those markets and so we see those 2, those opportunities on Fendt continuing to play out even though if the cycle was to weaken. So We look at those and we've talked about outpacing the market 4% to 5%.

Speaker 2

We talked about that at our December Investor Day. Those 3 big growth engines are going to help us do that. That should help dampen the increment or the decrementals on the downside. Hard question for me to answer is given the speed, right. If the markets were to come down slowly, we're being very cautious on our dealer inventory levels.

Speaker 2

We're managing against this value creation line that we talked about, knowing where our costs have to be. So if things come down in a slow fashion, we're able to adjust our production, Adjust our cost structure, I think you'll see better incrementals. If we were to see a shock to the system that made us react quickly, that It takes time and may take a couple of quarters to work through the system. But I would tell you, we're watching the downside. We're trying to make sure we stay as variable as And you're seeing that on the upside with the margins, but hopefully you'll see it with improved profitability on the downside.

Speaker 2

And what we've talked about is Confidence level in improving that trough margin, we took that up at the December Investor Day. And what we told you is by 2026, If we're doing 12% mid cycle, we'd expect to see 9% at the equivalent level of 2016. And if I just sort of fast forward that to where we were last year, that would have put our trough margin at around 7%, so a lot higher than where we were in 2016, which was closer to 4%. Yes, we feel good. But again, a little bit will depend on the timing and the speed at which the cycle declines.

Speaker 2

Eric, do you want to touch on the order trends?

Speaker 3

Sure. And then the second half you can say, well, second half of your question, it's what's going to happen with the ag Anatomy, you've been around the same, so I'm not saying anything you don't know, but it doesn't move with GDP. It moves with is there enough grain in the world. And with the ending stocks being down 6 years in a row, more demand coming for grains either for wheat consumption is going up, But also vegetable oil consumption is going up for fuel usage. And so we don't expect demand to come down sharply by any means.

Speaker 3

If it does if the demand does moderate, which is the heart of your question, We still see dealers being undersupplied with used inventory. So there will be, I think, a shift. Right now, our order book is so Highly retail oriented. It's got a lot of customer names on it. I think in the midterm when the market does cool a bit, We'll see a bit more of a trend to historical norms where there's some dealer orders, more dealer orders mixed in with customer orders Back to a normal ordering pattern.

Speaker 3

And I expect that would take a whole year to normalize.

Speaker 9

Great. Thank you.

Operator

The next question comes from Kristen Owen from Oppenheimer. Please go ahead.

Speaker 9

Great. Thank you for taking the question. A lot we can follow-up in that last response. So maybe if we can start on Just unpacking the $199,000,000 of precision ag revenue in Q1, I think you mentioned both Fuze and Precision Planting results in the quarter, you talked about that being a little bit more evenly spread throughout the quarter or throughout the year. So just wondering If availability improved and that was maybe higher than you expected or if there's any change in that outlook for the full year on the precision ag revenue?

Speaker 2

No, I think we're still very confident on the precision ag revenue, Chris. I'd put us probably in the range of $800,000,000 to $850,000,000 for the full year. Year over year, if you remember, the 30% sales increase, there was chip availability issues last year this time that was really affecting The precision ag side of the house quite a bit, I think so as you look at that was the big sort of the year over year change that improved as we sort of went through the balance of the year, But we still feel very confident with our outlook, say somewhere in that 8 to 8.50 range for the full year for the precision ag business.

Speaker 3

And this summer, we'll be finishing up go online this fall. We're putting in a very large new distribution center, 500,000 square feet That will give us more capacity, more efficiency to handle the global orders, not only for Precision Planting, but we've got this constellation of companies that we've purchased Last year and a half and we'll be leveraging that new logistics center to be able to support the demand for those as well because they're all growing.

Speaker 9

That's super helpful. Thank you. And then if I could just ask you to maybe unpack some of the margin performance For the year, just help us understand on a production line rate basis, how that is performing relative To maybe 2019 or pre COVID levels and how we should think about the margin performance throughout the year Benefiting from either better throughput like we saw this quarter versus lower material inflation versus Just magnitude of price.

Speaker 1

Right. So it's a good question and kind of a complicated question. But if you go back pre COVID, I would say that And compare our current run rates, they're not as good or as efficient as we were in 2019 because we're still having to deal with Not as many, but still some manufacturers shortages and rescheduling and overtime, so that leads to inefficiency. The good news is that year over year we're definitely improved. And in fact, so much so that we've actually and I think Eric talked about it earlier.

Speaker 1

We scheduled kind of normal seasonal maintenance, especially in Europe in Q3. So that's a real positive sign that some of the efficiency that We would expect to improve as improved, but there's still I would say if you look at our production schedule for the back half of the year, There's still we've layered in some continued supply chain difficulty. So The good news is if things continue to improve, there could be some upside to that production in the back half. Thanks.

Speaker 9

Thank you.

Operator

The next question comes from Jerry Revich from Goldman Sachs. Please go ahead.

Speaker 10

Yes. Hi, good morning and congratulations on the strong results here. I'm wondering if you could just talk about margins heading into the 2nd quarter. So normal seasonality as you folks tend to be up 2 to 3 points margins 2Q versus 1Q and I see your production is up Significantly in the deck. So anything that would keep that normal seasonal cadence from playing out this year 2Q versus 1Q?

Speaker 10

Thanks.

Speaker 2

No, I don't again, Jerry, I think as we look at Q2, that is of our stronger selling seasons, our selling quarters, so we would expect to see sort of a continuous improvement. Again, I would caveat again as we look at the sequential Change from Q1 to Q2, I alluded to the South American margins, the retail incentives. Again, we're not optimistic that that's going to stay. So I do think that if you look at it sequentially, although we'll see stronger revenue, you are going to likely see some margin contraction as material cost increase in South America, Potentially some of those retail pricing discounts decline, but overall I think everything else would follow more of your traditional pattern.

Speaker 10

Super. Thank you. And can I just shift gears and ask you to talk about where new equipment inventories stand for you folks in North America and South America, I know with the Fed rollout, you folks are probably in a different position than the industry, but the industry data shows new equipment inventories building Over the past, call it, 2 to 3 quarters in North and South America, can you talk about where you stand? Thanks.

Speaker 3

Yes, more of that is in the small ag. The inventory is all growing in small ag. The large ag is still below What we would say is our healthy target and what the dealers would say is their healthy target. They would love more inventory for sure. And so that has not fundamentally changed at all.

Speaker 3

We don't think it will change much during the course of the year. Small egg is up and it's probably at or maybe even a hair higher Then our target is we're going into the selling season. So the dealers will work through that, but it's tied with this overall small ag market cooling off.

Operator

The next question comes from Tami Zakaria from JPMorgan. Please go ahead.

Speaker 11

Hi, good morning. Thanks so much for taking my questions. So I wanted to quickly touch on And I'm sorry if you already answered this, but in terms of incomplete or Red Tagged unit, I think at end of the Q4, you had some Are they all cleared by now or do you still expect some delivery in 2Q and later on in the year?

Speaker 2

Yes. So Tammy, you're right. We made a significant reduction in the, I'll call it, the semi finished units at the end of the year. Not uncharacteristic though as we go into the Q1 here, we build up inventory getting ready for that spring selling season. So if I look at the absolute numbers Semi finished or I think you call them red tag units.

Speaker 2

That number is up relative to the Q4 as expected. If I compare it to where we were last year this time, where we were dealing with a lot more supply chain disruptions, I would tell you the units of these Red Tag units is about half of Where they would be. So it's in a much more appropriate level given the timing of the year. So we're making again, Supply chain is not perfect yet, but operational performance is getting better and that number of Red Tag units is sort of in line with what we expect going into the Q2 here.

Speaker 11

Got it. Thank you so much. And then just quickly, wanted to clarify the sales guidance raise. I think you raised it by 500,000,000 FX is probably half of that. And then you're maintaining your price realization goal of 8%.

Speaker 11

So Is it fair to assume the $250,000,000 of revenue guide raised, That's entirely volume driven. And if so, is this more your supply chain getting better or you're also seeing Better than expected demand.

Speaker 2

Yes. Tammy, your numbers are spot on. And I would tell you that $250,000,000 It's a combination of richer mix that we're seeing and then a little bit more volume as well, but I would tell you more on the mix side.

Operator

Our last question comes from Chad Dillard from Bernstein. Please go ahead.

Speaker 6

Hi, good morning guys. Thanks for fitting me in. So just wanted to go back to large ag dealer inventories. I just want to understand like where do you expect to be at the end of 2023? And within your guidance or with the raise, do you embed any opportunity for restocking?

Speaker 2

Yes. I think Chad, I think as Eric has alluded on the call, large ag inventories are still well below what we would consider more The normalized level, we don't see that really changing here in the balance of fiscal 2023. We're not embedding any sort of a dealer restocking on the large ag side. This year that would still be opportunity beyond likely into 2024 depending on the cycle here in the commodity prices. But again, around the world, all of these large ag inventory levels Below the normal level and I think you can see that as well if you look at the residual values of used equipment, even those Are still very low.

Speaker 2

The number of used equipment on the dealers lots are very low. Residual buyers are staying high. All of those are sort of early indicators or indicators that The market is staying relatively strong. Farmers still see good crop prices, good income and driving the demand for the new equipment here for the balance of the year.

Speaker 6

Got it. And then you replied about your sales incentives helping South America. So was hoping we could kind of broaden out that question into just overall ag co. You guys have a 8% price increase for the year. I guess, how much of that is list price versus more sales incentives and I guess more and more of a temporary increase?

Speaker 2

Yes. Most of that is list prices and the vast majority of that was put in place in the latter part of last year. So If I think about that 8%, a lot of that is carryover pricing. And so when you see that will start to over that will start to lap itself in the back We do have a little bit of incremental pricing planned in 2023. That will be subject to the market conditions, new model years coming out, But most of that is list pricing.

Speaker 2

I think what you're hearing me talk about is the improvement in South America was the unexpected. We plan for these volume incentives If the team sees the ability to not do that, they're going to hold that back and that's the positive upside that we saw in the quarter. But think about most of that or almost all that 8% is list.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Eric Hans Sotia for any closing remarks.

Speaker 3

Very good. I'd just like to close by saying thank you very much for your participation and support of AGCO. We are really proud of how we started 2023. It's a record quarter in many ways and it's setting us on a trajectory to deliver another record year at AGCO. The key to our success is the continued execution of our Farmer First strategy.

Speaker 3

Our focus is on growing our margin rich businesses like Fent, Parts and Service And our Precision Ag Smart Machine business that Damon talked about earlier. We've been investing heavily in the last few years. And in 2023, we're making even bigger investments to continue to the development of these farmer focused solutions that are solving critical farmer problems with many of them delivering very short paybacks. We're using our precision ag tools to really engage strongly on sustainability, Putting more and more of our technology efforts there, capturing a lot more data, helping our farmers make the transition to not only more productive farming, but more sustainable farming. Lastly, the large ag markets are very strong globally.

Speaker 3

We touched on that a lot today. Farm fundamentals are healthy and supporting farmers' investments. We've touched on many of the factors supporting our markets, including growing populations, changing diets, lower stocks to use levels and healthy commodity prices. There's a couple of new trends that I mentioned earlier. The first is given the increasing geopolitical tensions, you're hearing more and more countries Talk about potentially increasing their safety stocks of grain for food security.

Speaker 3

This potentially significant increase in demand isn't being factored in yet the supply demand picture, but would only add to the existing challenges. In addition, the growing demand for oilseed groups, especially biodiesel, which will be critical for many industries like aviation, construction and ag could have similar impacts as the ethanol production has had on the consumption of corn. All these trends give us confidence that our industry could stay strong for some time. So we're excited about 2023 and beyond. We're convinced that the best days of AGCO are still in front of us.

Speaker 3

We look forward to seeing many of you at our technology event on June 28 29 in Nashville. Thank you and have a great day.

Operator

Thank you for joining the AGCO First Quarter 2023 Earnings Call. The call has concluded. Have a

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AGCO Q1 2023
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