Deere & Company — 2023 Q3
Transcript
Each turn shows the speaker, their inferred role, the section, and that turn's net sentiment (×1000).
Good morning, and welcome to Deere & Company's Third Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Brent Norwood, Director of Investor Relations. Thank you, sir. You may begin.
Hello. Also on the call today are Josh Jepsen, Chief Financial Officer; and Josh Rohleder, Manager of Investor Communications.
Good morning, and thank you all for joining. John Deere finished the third quarter with another strong performance, resulting in 22.6% margin for equipment operations. Performance exceeded expectations as a result of sustained demand for both farm and construction equipment as well as sound operational execution across all business units.
Thanks, Josh. First, our factories ran really well in the third quarter. We saw continued progress from our supply base, enabling our operations to hit production schedules almost exactly as planned. This precise execution from our factories is evident in our top line quarterly cadence, which will show a return to normal seasonality in 2023 when compared to 2022. And a return to normal seasonality is incredibly important to us because it means that we are delivering on our customer commitments to get them machines in season. Importantly, this is a real testament to our factory teams.
That's great. Thanks, Brent. With operations running much more smoothly, maybe we can flip to the other side of the equation. There's been a large amount of focus on industry fundamentals, both from a construction and an ag perspective.
Yes, that's great context, Josh. Earthmoving industry fundamentals remain quite strong, driven by construction job growth across most sectors, and in particular, large infrastructure project spending. Coupled with continued rental industry re-fleeting, demand is expected to remain steady throughout the remainder of the year. And while we see nice tailwinds from mega project spendings tied to government funds, most of these projects will primarily benefit 2024 and potentially even 2025, supporting an elongated cycle for construction equipment sales.
Okay. That's perfect. So near-term construction fundamentals remain resilient and the business appears to be very well positioned on the construction side heading into 2024.
Grain prices have definitely seen a large amount of volatility this year. But equipment demand has remained strong, particularly for large ag. While down year-over-year, crop prices are forecasted to be the third highest in over a decade. And in North America, farmers are projected to have another year of healthy net income. Additionally, farm inputs have trended back down to pre-COVID levels, providing a benefit to next year's farm margins.
Thanks, Brent. That's great color on the U.S. and Canada. If we look outside North America, how will we see these fundamentals impacting Brazil?
Yes, Brazil has been a real dynamic market this year. Earlier in the year, we saw some of the political uncertainty and the delayed government-sponsored financing plans weigh on sentiment. While profitability has been very good, some farmers generated lower-than-expected income due to lower grain prices, combined with a strengthening Brazilian currency relative to the U.S. dollar.
And Brent, this is Josh Jepsen. Just to add to that, Brazil still experienced record production this year. We're seeing continued acreage expansion and a supportive government-sponsored financing program is now in place. So long term, Brazil remains a key market for us that we'll continue to invest in for the future as we accelerate precision technologies in the region.
Thanks, Josh. Now switching back to the North American market. With order books full through the end of the year, how are new field inventory levels shaping up as we exit 2023 and begin planning for '24?
That's a great question, Josh. Starting from the top, all of our North America large ag production is sold out for this year. We expect ending year-over-year changes in new field inventory to be modest. In-season inventory increases have largely corresponded to our quarterly production schedules, which will come down in the fourth quarter. Combine inventory, for example, saw its highest level in the second quarter and is currently down from its peak.
Perfect. So we will expect to see inventories wind down further throughout the fourth quarter. Now what about used inventories? We've seen those rise pretty significantly year-over-year from their historic lows last year.
We have. But the key phrase here is historic lows last year. When you are starting with a historically small existing inventory base, like we had in 2022, even modest changes in units will reflect large percentage increases. That said, our dealers have been watching used inventories very closely and have been managing them proactively. Large ag equipment has roughly 4 to 5 owners over its useful life in North America. So for every combine or tractor we sell, a dealer will typically facilitate 3 to 4 additional transactions as used equipment works its way down the trade ladder.
And this is Josh, maybe one thing, too, to highlight. Just I think the important takeaway here is that by year-end, we expect both new and used inventory levels to be below historic levels on a unit basis, so really position us well as we exit '23 into '24.
Perfect. But how are we doing from an EOP perspective in North America?
At this point, we've kicked off, and in some cases, closed our early order programs for a few product lines. I want to caveat here that it is still early. And while we don't have a fully formed view, the early order programs are giving us some early data points. We launched our sprayer EOP back in May and the program ended July 31. The we have sold out all of our model year '24 production slots with unit sales up double digits when compared to model year '23 sprayers.
Thanks for the color on North America, Brent. Clearly, too early to tell here, but it sounds like preliminary data is supportive. To round out our discussion, can we focus on Europe and discuss how things are shaping up there for next year?
Yes, absolutely. And actually, Josh, I just want to amend my prior statement. Tractors are sold out through calendar year '23, not to '24. In Europe, however, order books are stretching into the second quarter of 2024, providing decent visibility. But with some early order programs having just kicked off, it remains too early to form a view on 2024 outlook. Expect markets in Europe to remain dynamic with outlooks varying a bit between Western Europe versus Central and Eastern markets.
And one point I'd add to highlight in Europe is our dealer network. We continue to see higher levels of sales flowing through dealers of scale. This has driven better market share, higher rates of precision ag adoption and overall stronger businesses for our dealers and Deere.
Perfect. That's great insight. I -- now I have one last question for you, Josh. Given the high level of cash flow this year, we've had an opportunity to execute on all elements of our capital allocation priorities. Can you walk through some of the decisions we've made this year with respect to funding further investments in our business, both organic and inorganic, while at the same time returning higher levels of capital back to investors?
Yes, great question, Josh. This is, first and foremost, a direct reflection of the strong performance this year, which is projected to yield between $10.5 billion and $11 billion in operating cash flow for the equipment operations. We're very proud of what we've been able to accomplish this year and are encouraged by our ability to both invest aggressively in the business while at the same time returning a significant amount of earnings to our shareholders.
Thanks, Josh. And before we open up the line for questions, do you have any final thoughts you'd like to share?
Yes, thanks. As previously noted, the team is executing at a high level in 2023, which is evident in our results. We're actively working to reduce some of the inflationary and disruption costs experienced over the past couple of years, and we expect to see that benefit continue.
Thanks, Josh. Now let's open up the line for questions from our investors.
[Operator Instructions] Our first question is from Jerry Revich with Goldman Sachs.
Josh, I'm wondering if we could just continue the discussion you just touched on in terms of higher value per unit. So in the past, you folks have been able to outgrow ASPs by 3% to 4% per year beyond price. Do you have a finer point that you can share on what that might look like in '24 and if you could just touch on precision ag take rates and how they're tracking as part of that conversation as well if you don't mind?
Yes. Thanks, Jerry, appreciate the question. I think we're seeing that continued trend of 3, 4 points on top of the inflationary price as it relates to technology and the appetite we're seeing to continue to drive technology into the machines. As we look forward and start to drive the business model shift, that may change a little bit as we see and build a little more recurring revenue. But I think all-in, we're continuing to see the benefits on the unit economics through what we're doing in technology and the value that we can create for customers.
Yes, Jerry, as it relates to take rates on technology, obviously, we just finished up our sprayer early order program and are near complete on planters. Those are two product lines that have a high degree of technology embedded in those solutions. And for some of those mainstay technology innovations, like ExactEmerge and ExactApply, we continue to see those take rates increase mid-single digits year-over-year.
Yes, Jerry, maybe one last thing I'd add, too, that bodes well in terms of the direction we're headed is we're seeing growth in engaged acres and we're seeing growth in highly engaged acres. So the interaction we're seeing, the value that we can create with our digital tools and having that all in one place in the John Deere Operations Center for our customers is continuing to drive value. And we're seeing that continue to aid in our business.
Our next question is from Jamie Cook with Crédit Suisse.
Congrats on a nice quarter. I guess, my first question, as it relates to -- it sounds like supply chain is getting better, which probably bodes well for 2024. So as you're thinking about supply chain getting better and you're looking at your -- what you're seeing so far in terms of this early order program, can you talk to your approach with inventory next year, both for Deere and both at the dealer level, whether you think you will -- would overproduce retail demand to achieve some more normalized inventory levels? I guess, that's my first question.
Jamie, thanks for the question. I'll start with some comments on supply chain and what that means for our inventory position next year. And Josh can comment on the margin progress. But I think you've been able to see from our results that our factories ran really well in the third quarter. We've got a robust cost agenda still to come in next year. But we're really pleased that the progress we've made on reducing production cost inflation, particularly in the third quarter-to-quarter.
Yes, Jamie, if you think about reducing volatility, I think there's some near-term things that we're working on. Brent mentioned what we're doing as it relates to cost management, continuing to take some of the cost that we've seen through inflation and disruption out of the system. That's an important one. Continuing to drive technology into our machines, driving, as I just mentioned, more value per unit from an economics point perspective will be beneficial.
Our next question is from Tim Thein with Citigroup.
Maybe just on ag, coming back to the comments on Brazil, if you can just maybe help us frame that up a bit just in terms of you mentioned some of the production cuts you made, where you're, I guess, targeting in the second half of the year. How do you think that -- obviously, again a lot of moving parts in a volatile market. But how do you think you'll end the year from an inventory perspective in Brazil as we go into '24 and obviously the dealer inventories? That's the question.
Yes. As it relates to Brazil, as we noted in our opening comments, it's been a really dynamic year, I think a lot of puts and takes. At this point, the order book is full for the rest of '23. And managing the year has been interesting. We've seen record production for corn soy and near-record production for cotton and sugar, really healthy profitability for customers there, down from 22%. And again, to refer back to our opening comments, probably a little bit less than expected from our customers there as they had lower levels of forward selling this year and I think some difficulty marketing the sizable the crop that they had in 2023.
Our next question is from Steven Fisher with UBS.
So the year-over-year step-down in pricing in production and precision ag from Q2 was a bit bigger than the kind of headwind you had from tougher comparison in the year before. I guess, were you expecting such a big step-down in pricing? I mean, you didn't change your pricing forecast, so maybe it's really not any surprise. But I'm curious if the environment and what you're seeing in the order activity is still supportive of a 2% to 3% pricing, including incentives? And how is the need for incentives kind of shaping up here?
Steve, as it relates to pricing, I would say that the second quarter came in almost right on the forecast for production and precision ag and construction and forestry. Small ag and turf probably fared just a shade better as they're retaining a little more price than we had in the forecast. But all of this is largely in line with our expectations. Particularly as we lap some of the mid-year price increases that we took in '22, we would expect from a percentage basis to see that price realization come in.
Our next question is from Kristen Owen with Oppenheimer.
Wanted to ask about the construction margins. You lifted the target once again and really narrowing the gap with your ag businesses that what is arguably a different point in the cycle. Just given some of the comments of normalization in pricing across the portfolio and what you talked about in the prepared remarks for 2024, how we should think about the sustainability of that improved margin performance in the construction segment?
Kristen, as it relates to construction and forestry margins, I would kind of refer back to some of the comments we made in our opening remarks around the structural things that we've been doing in construction and forestry for really the last 4 to 5 years that have really reformed that business into a more sound and solid business that, to your point, has closed some of the gap between large ag over the last couple of years.
Yes, Kristen, one thing I'd add is as we look forward and you think about what -- is there another leg in this journey for C&F, and we believe there is, and it's around technology and how do we integrate technology to help do the jobs that our customers do and do them better and more efficiently, more productively and more sustainably.
Our next question is from Rob Wertheimer with Melius Research.
And actually, I wanted to follow up on what [ Josh ] was just talking about, where construction pricing, what you've achieved to date, is that largely market-related? Or do you feel like you've had enough technology flow in to sort of support a rising price overall?
Yes. Rob, as it relates to -- I'll first start with the comment around pricing and then we can talk about technology more broadly. But as it relates to the pricing that we've achieved, I mean, I think you've seen that broadly in the construction equipment markets. We work hard to lead in price as best we can. We try to be one of the most disciplined industry players as it pertains to price. I think we're still early days in terms of getting higher average selling prices on account of more technology, more innovation in the equipment.
Rob, I'd say time line-wise, if you think about this journey we went on, on the large ag side in 2013/'14, when we began, I would say we're probably similar to that time frame, so maybe not quite a decade, but I think behind. But we're in those early days of starting to drive more of that technology in.
Our next question is from Steve Volkmann with Jefferies.
I wanted to go back. I think a couple of you have used the words robust cost agenda for next year a couple of times. And I'm just wondering if there's any way for us to think about sizing that. Is this like sort of a big deal, where we could see these sort of production costs in your waterfall chart could actually be positive next year? Or is this kind of continuous improvement a better way to think about that?
Steve, it's a great question. We've seen over the last couple of years, billions of dollars of cost inflation flow into our operations. Some of that is coming from systemic inflation. A portion of that though is coming from just, I would call it, COVID disruption cost, inefficiency cost, also associated with our deferred ratification of our UAW contract in '22. All of those things caused overheads to run higher than they normally do. So we're bringing a lot of those back in 2023. I think there's more room to run certainly in 2024. I would not probably characterize it as just a normal continuous improvement program here at Deere because we do have line of sight to specific costs that we want to take out.
Yes. Steve, the only thing I'd add on top of that is just coming through the last 3 years, which have been far from usual operating procedures in terms of pandemic, supply chain disruptions, et cetera, is continuing to root out that disruption cost that had come in and made its way in on top of we were seeing strong demand. So I think there's going to be work done certainly and I think ongoing, getting back to a cadence that we would expect in terms of continuing to take cost out and drive efficiency in the operations. So we're -- we think there's more room to go here for sure.
Now our next question is from David Raso with Evercore.
The comment earlier about the construction -- the demand backdrop, right, you were saying the 6-month rolling order book extends into the second quarter of '24. Can you give us a sense of that order book? Are your orders up year-over-year? Is that implying growth in construction and forestry through the second quarter? Is that what that comment meant? And any help on the pricing within that order book would be great.
Yes. David, let me start with the first -- the last part of that question on the ag side and then I'll let Josh comment on construction and forestry. If you think about the fourth quarter, we'll see revenues flattish to maybe down a little bit in ag. The big driver there -- and then to your point, margins will come in a shade from where they were in the third quarter. The big driver there is we are seeing a return to again this normal seasonality, which does mean that we will institute normal factory shutdowns, particularly at Harvester Works, which historically we've done factory shutdowns in the month of September and/or October. And so I think what you're going to see is the impact of shutting that down. We haven't done that the last couple of years as we've been running behind on delivering machines to customers in late in '21 and then all the way really through 2022. So that's really the big impact that we're going to see happen in the fourth quarter.
Yes. As it relates to C&F and if you look at the order book, I mean, I would say, comparing year-over-year is a little bit difficult because we were constrained last year, so probably not a good way to compare just total order activity. But what I would say is on the order book that we have, we're looking at similar production rates, '23 to '24, so not a significant change there and realistically, obviously, less disruption expected as well in '24 than we saw in '23.
Our next question is from Tami Zakaria with JPMorgan.
So I wanted to step away from the quarterly trend and ask you about your new battery plant. I think you do speak to a new battery manufacturing location. Can you tell us a bit more on that, when it will be operating at run rate, what volume you expect that run rate, what products you expect it to feed in to, any impacts on margins or potential cost savings? So any thoughts on this initiative?
Yes, certainly, Tami. Thanks for the question. So this stems from the acquisition we made a little over a year ago with Kreisel Electric. So this is really the next step as we continue that evolution to build manufacturing capacity for batteries and charging, which was announced here earlier this week in North Carolina.
Our next question, from Chad Dillard with Bernstein.
So I want to spend some time on the average age of the fleet. Can you just talk about where we will be ending the year versus normal? And I recall you're talking about how there are, I guess, 5 different owners within the fleet. I think where is the bulge in age in terms of the fleet?
As it relates to the average age of the fleet, I think what you're seeing is the impact of this replacement cycle really having a sort of delayed or deferred start, right? If you think about when demand really inflected, it was at the beginning of 2021. And you really had 3 factors conspiring to slow down the production really for -- not just for Deere but the industry at large, right? We had -- the industry was suffering from labor shortages, supply chain delinquencies, delays as well as significant inflation affecting production.
Yes, maybe one thing I'd add just on top of that is I think the important piece, too, is we are continuing to see demand for technology across the trade ladder in our equipment. We were just speaking with a dealer principal a couple of weeks ago. And he was talking about this very fact. It's not just demand for the latest technology by the first owner, but it's the second, third, fourth, the fifth.
So our last question now is from Seth Weber with Wells Fargo Securities.
I guess, I wanted to ask about the small ag business. Margin was a lot better than what we were expecting. I think I heard you say something about Europe. I'm just wondering, is that -- are those structural changes that we should think about as being in place going forward? And then just your comment about small ag inventory kind of coming off the peak, do you think that we're past the challenges there and things are going to start getting better or just less bad going forward?
Seth, thanks for the question. As it relates to small ag and turf, it's certainly a structurally sounder business today than we went back to prior cycles. As you think about -- and I'll talk a little bit more about some of the margin puts and takes there. Let me answer your question on inventory first, though. As it relates to inventory for small ag and turf, I know there's been a lot of focus on what I would call the small end of small ag and turf, so like the under 40-horsepower category of compact utility tractors.
Yes. Seth, one last thing I would add is just the deep geographic diversity of small ag and turf. So it's much broader in terms of global coverage. And we're seeing performance really strong across the globe. And to Brent's point on driving technology, we're seeing technology be driven into utility tractors in India, leveraging telematics and bringing connectivity to the farm there. So there's a lot of activity that we see that is going to both create customer value and also drive a different business in small ag and turf than you've seen in the past.
That concludes today's call. We appreciate everyone's time, and thank you for joining us today.
This conference has concluded. Again, thank you for your participation. You may please disconnect at this time.