Deere & Company — 2023 Q4
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 Fourth Quarter Earnings Conference Call. [Operator Instructions]
Hello. Good morning. Also on the call today are Josh Jepsen, Chief Financial Officer; Josh Beal, Director of Investor Relations; and Josh Rohleder, Manager of Investor Communications.
Good morning, and an early happy holidays to everyone. John Deere finished the year with an excellent fourth quarter, thanks in part to strong margins of 20.3% for equipment operations. Continued outperformance throughout the year resulted in 16% top line net sales and revenue growth for 2023.
Sure, Josh. That's a great question. Yes, let's start with the quarter, which was a tremendous finish to the year and really boiled down to solid execution as we delivered against the year's backlog of orders.
This is Jepsen here, maybe to add. I think the overarching takeaway here is that we're finally getting back to steady state of execution. As Brent mentioned, factory production schedules and customer deliveries have returned to traditional seasonal patterns, which has been very good for the business. And we expect that 2024 will be much the same, meaning we'll see the highest levels of production in the second and third quarter, aligning with the primary use periods for farm and construction equipment.
That's great color, Brent, and thanks for the reminder on seasonality, Josh. It's been a few years since we've been able to use seasonal trends as a guide for future expectations. And speaking of future expectations, this is a perfect segue into my next question, which is probably top of mind for everybody today.
Thanks, Josh. Definitely a lot to unpack here. Why don't we start with large ag in North America. Farm fundamentals are expected to remain sound in 2024, albeit down from record highs of the last few years. That said, customers are still profitable heading into 2024, with balance sheets bolstered by multiple years of record net income. Farm debt-to-equity ratios are forecasted to remain at historic lows, thanks in part to continued increases in farmland value. And while commodity prices trend lower, we still expect crop cash receipts to be the third highest in 2024.
Okay. So it sounds like EOPs are running the full gamut across our product lines. I guess that purports the next question. How are we positioned going into the year from an inventory perspective?
Our teams did a tremendous job in 2023 managing North America production in line with the retail demand. To put that in context for new equipment, year-end inventory-to-sales ratios are at 15% for 220-plus horsepower tractors, 9% for 4-wheel drive tractors and just 4% for combines. We are well positioned to produce in line with retail demand again this year for the North American market.
This is Jepsen. Just to add on here. While markets ebb and flow, we've learned from prior cycles and know how to manage through them and execute on the things we control, as demonstrated by Brent's comments on North American large ag inventory.
That's great to hear, Josh. And Brent, I'd actually like to pull on a thread you hinted at just a second ago. Our guide would imply that demand modulates in some markets for 2024. Could you compare how we're positioned today relative to prior replacement periods?
Absolutely. There are really a few different variables that make this replacement period distinct from prior periods in the North American market. First is large ag inventory levels, which we've already talked about. These remain significantly below long-term averages. In fact, new inventories for both combines and 220-plus horsepower tractors are 30% below 2013 levels and while 4-wheel drive tractors are 60% below that same year.
This is Jepsen. Two things to point out here. First is that we are a different company today versus a decade ago, and we have managed the replacement cycle better than the past. Certainly, we have work to do, but we know where we need to focus and we'll execute.
Okay. Thanks, Brent and Josh. That makes a ton of sense. We spent quite a bit of time now on North America. Can we shift over to South America? Josh, would you walk us through what's happening down there?
Of course. I think it's best to start with what happened in '23, which is driving much of our expectations for '24. And as we noted, Brazil has been a very dynamic market with a number of temporary headwinds. We experienced industry demand weaken much faster than expected in the second half of the year for the reasons, Josh Rohleder, you mentioned earlier. For example, we saw combine retail sales down about 25% and large tractor retails down close to 10% in the second half of 2023, demonstrating the volatility we experienced.
Okay. Thanks, Josh. And now let's finish up on the ag side with Europe. What are the dynamics over there, Brent?
While volumes will be down a bit next year, Europe remains more stable relative to the other markets we've already discussed. It's been a consistent story, and we expect 2024 to be no different. While large tractor demand finished strong, we did see moderation across mid tractors and combines. We were able to manage production accordingly and feel well positioned heading into 2024.
Thanks, Brent. That's really helpful. Let's shift now to C&F. With 2023 being a story of rental and dealer re-fleeting following 2 years of constrained production, what should we expect to see in 2024? And then secondly, we've heard a lot about mega project and infrastructure spending still to come, yet guidance is down for the next fiscal year. Can you walk us through what's going on there?
You bet, Josh. On one hand, you have strong end markets and infrastructure, as you noted earlier, which are offset by some caution in our guide around residential and the office and commercial sector, given elevated interest rates. On the other hand, you have these mega projects and systemic investment in U.S. manufacturing, which will be significant, albeit hard to predict on timing. Where we've seen the most consistency is in road building as U.S. government funding, both local and federal has driven expectations for another solid year for the Wirtgen Group.
That's helpful insight into the various end-market dynamics, Brent. The sound execution of our C&F business really looks to be paying off as we see another year of high margins and reduced decrementals relative to our historical performance.
Sure. We've made some big strides across our entire tech product portfolio this year, with much of the focus on our retrofit solutions or what we refer to as precision upgrades. With See & Spray, which is our down payment on Sense & Act technologies, we successfully launched See & Spray Ultimate for model year 2024 and have seen significant interest in our limited release of See & Spray Premium, the retrofit kit, which can be applied all the way back to model year 2018 sprayers. We are targeting a significant push for premium into the installed base in 2025, supported by our Solutions as a Service business model.
That's all really exciting, Brent. And it looks like we continue to demonstrate our commitment to the business strategy with stable through-cycle investments in innovation. To that extent, maintaining the gains in structural profitability we've achieved over the last few years requires diligent cost management across the business. We've already noted the significant effort we've put into reducing costs in 2023. But Brent, can you share how we're thinking about cost management for 2024?
That's a great question, Josh. 2023 was really all about getting the low-hanging fruit. From premium freight to declining raw material costs, we did a good job at wringing out a decent amount of disruption-related inefficiencies.
This is Josh Jepsen again. One thing to add to Brent's comments there is just the effort of our teams. These costs don't come out overnight nor do they come from the work of one lone group. It takes a lot of hard work across the board to make this happen. Part of our success over the past few years has been our ability to manage our business and run a lean operation capable of adapting quickly to changing environments, while maintaining the clear priority of taking care of customers. Our teams remain focused on cost management, and I expect we'll see the benefit of these efforts as we move forward.
Okay. Great. And my final question is back to you, Josh. We've had a significant year from a cash flow perspective. Can you talk briefly about our use of cash priorities and capital allocation in '23? And then what we might expect in 2024?
Sure. We saw excellent cash flow conversion in 2023, allowing us to execute on all of our priorities. Liquidity, along with our single A credit rating remains in good shape, which has allowed us to reinvest diligently in the business. This has never been more important than today.
Thanks, Josh. Now before we open up the line for questions, do you have any final thoughts you'd like to share?
Yes, that would be great. It's been a truly phenomenal year for us in 2023. Our teams executed well, recovering from some of the production challenges in 2022. As a result, we ended the year setting new levels of structural profitability on margins, net income and earnings per share while investing significantly in the business and returning cash to shareholders.
Thanks, Josh. Now let's open it up to see what other questions our investors have.
Now we have -- now we are all ready to begin the Q&A portion of the call. The operator will instruct you on the polling procedure. [Operator Instructions]. Sue?
Thank you.[Operator Instructions] Our first question is from Steve Volkmann with Jefferies.
Great. My question, I guess, is around kind of the cost side of this. I guess, historically, I've been through a few cycles with you guys, I might have thought that there'd be more opportunity on the cost side relative to the sort of top line guide that you're giving. I'm calculating kind of a 35% decremental. I guess that's kind of okay, but it feels like there should be some levers for you to pull to maybe mitigate that a little bit. So any thoughts around that? I'd love to hear.
Yes. Steve, thanks for the question. Regarding our cost management for 2024 and sort of the level of structural profitability embedded in the business, you'll see that some of our most profitable markets are down from a top line perspective. So production and precision ag will be down 15% to 20%, while at the same time, maintaining a 35% decremental. And as we look at sort of the execution in the fourth quarter, we're starting to see some of our disciplined cost management come into play. I mean that's the first quarter in a number of years where we've seen production costs actually become deflationary and serve as a tailwind for our business. And I would say there's a significant agenda that we'll be executing towards for the remainder of 2024, but we're pleased to see the progress we've made already in the fourth quarter of '23.
And just to be clear, you're expecting that within that 35% decremental, you're expecting kind of all those pieces of goodness that you just described?
Yes. Certainly, our guide would contemplate achieving further reductions, and that's already included in our 35% decremental. There's certainly going to be opportunities to continue to control decrementals with further supply management and cost activities for 2024.
Yes, Steve. One thing I would add is, I mean, if we compare back to periods when we've been at or around mid-cycle, which we're projecting '24 will be, our margins will be nearly double net income, about 2.5x greater. So I mean, if you think about being around mid-cycle, delivering this decremental and significant improvement from a mid-cycle-to-mid-cycle perspective in profitability, we feel good about where we're at. We have opportunities to keep working on, and we'll methodically work through those. And as we execute, we'll see those benefits come through. But we feel good about where we're at from a guide perspective. We know we need to execute. But really, structurally, see a significant shift forward even just, call it, the last 5, 6 years. Thank you.
Our next question is from Stanley Elliott with Stifel.
Can you just talk a little bit about the implied pricing as roughly kind of 1%, coming off of difficult compares? Help us with maybe the exit rate into next year -- or the end of this year or '24? Are we talking about negative pricing? Just any kind of help that you can provide there would be great.
Stanley, regarding our pricing strategy for 2024, we'll be at about 1.5 points for both PPA and CNF and then 1 point for SAT. We will see some carryover early in the year, but we would expect the entire year to remain positive for all 3 segments. Importantly, that forecast does include a return of some retail discounts. So that is a net price realization figure, again, inclusive of incentives.
The next question is from Seth Weber with Wells Fargo.
Happy Thanksgiving. I wanted to see if you could just give a little bit of context around your guidance for P&PA and the other segments, where your growth is expected to be -- your decline is expected to be bigger than the industry declines. If you could just maybe contextualize that for us, like why Deere would be underperforming, what you're calling for, for the industry end markets.
Yes. Happy Thanksgiving to you, too, Seth. Regarding our guide, our financial guide relative to our industry forecast, you'll notice a slight difference -- some slight differences between the segments, maybe starting with production and precision ag. In North America, we have positioned ourselves really well, and we will be able to produce in line with retail demand for 2024. Where you're seeing our financial guide a little bit lower than our broader industry guide is really due to Brazil, where we will be underproducing retail demand in 2024 as we work to bring inventory levels back to our targeted levels for that particular market. So that's really what's affecting our financial guide relative to the industry guide for production and precision ag.
Yes. Seth, this is Josh. Maybe one thing to add is just to reiterate the position in North America on the large ag side. We've managed that very well and very different than the prior cycle. I think both new and used, we're really well positioned, as Brent mentioned, both to build in line with retail as we go forward. But the work that's been done on the new-new side, we highlighted it earlier, but for example, new inventory on combines, inventory sales of 4% at the end of the year, 4-wheel drive tractors 9%, or something like 15% on row crop. So both the new side and then what the dealers have done working through used proactively, and we've supported that activity, has been really positive and positioned us well when you think about our biggest market. Thanks, Seth.
The next question is from Tim Thein with Citigroup.
Maybe just coming back to the comments on production costs and I guess it's a bit more of a clarification. But I thought I heard you say earlier that you expect that the production cost to be favorable overall for the company in '24. But then later, it sounded like maybe there are pieces of it that you expected to be favorable. So just so we're on the same page in terms of the EBIT bridge you provided by segment, that production cost for the company as a whole, you expect that to be on the plus side throughout '24? Is that correct? Or is that not? Did I mishear that?
Yes. Regarding production costs for 2024, our guide would contemplate production costs to be flat to a tailwind next year, a slight tailwind, I should say. There are some subcomponents within production costs that will still be inflationary. But net-net, we should be moderately positive in the year 2024.
Yes. I mean in short, Tim, you add up those bars for production costs, they should be green is our current expectation for production cost in '24.
The next question is from Kristen Owen with Oppenheimer.
Happy Thanksgiving. I wanted to ask on the broader capital allocation question, just given the outlook. You've got operating cash flow conversion greater than 100% guided in 2024. And so my question is twofold. First, on the internal investments, can you talk about the technology spend through the cycle and how you're prioritizing those projects? And then externally, maybe touch on the dividend given the 25% to 35% payout ratio at mid-cycle, how we should think about that influencing your dividend outlook next year?
Kristen, it's Josh. Thank you for the question. I'll start with the R&D side. So yes, we'll be up slightly from an R&D perspective. So we're talking $2.2 billion or more. A tremendous amount of that continues to be focused on what we're doing from a technology perspective and bringing Sense & Act technologies across our portfolio, across the enterprise. Autonomy, significant opportunities there. And as Brent mentioned, we saw good progress this year there as well. And we have significant opportunities there.
The next question is from Jerry Revich with Goldman Sachs.
Happy Thanksgiving. Nice to see the production cut in the business before used inventories got out of hand the way they did in prior cycles. I'm wondering if we could just unpack the 15% to 20% production cut in large ag and how you're thinking that will drive a balancing in used inventories because obviously, used inventories are at absolute low level but rising rapidly off the bottom. So what's the level of comfort based on your modeling that the 15% to 20% cut is going to get us where we need to be versus needing to cut production further if used inventories continue to build? Would love to hear how you're thinking about all of that.
Jerry, happy Thanksgiving to you as well. There's a couple of puts and takes as we think about production for next year. Certainly, we and the industry at large have benefited from some of the production constraints over 2021, '22 and '23. Certainly didn't feel like a net benefit during those years. But the constraints that we faced as an industry during that time period, limited the amount of new equipment that we introduced to the fleet in a short period of time. And I think ultimately, we'll see that have a dampening effect on the cycle itself.
The next question is from Rob Wertheimer with Melius Research.
I just wanted to circle back to decremental margins in large ag. I think the production and precision is more like 38% versus 35%, obviously, not a huge difference. But I was curious if there's any mix headwind within that segment or R&D? And actually curious how you interpret what sounds like a more negative kind of combine Early Order Program versus some of the others? Is there any shift in time? Is that a combine-specific cycle? Is that -- how do you interpret that differential, if there is one? And is that kind of what's dragging down on the margins in the outlook?
Yes. Thanks, Rob, for the question. Regarding our decrementals for next year, I think -- I mean, there's a number of things to consider. We are seeing a significant double-digit volume decline in our shipments, while, at the same time, we've held our R&D investment relatively flat to up a little bit next year as we intend to invest somewhat consistently through cycle here.
Yes. Maybe -- Rob, great question. This is Josh. One thing to add. At the same time, Brent mentioned R&D, and we're also investing in parts of the business like our business model transformation and how we build out the go-to-market plans there. Over time, we expect that will drive more stable business, better margin as we deliver on that and grow that at scale. I think in the near term, we're building that and investing in it, knowing the benefits that can deliver here as we go through the balance of the decade.
Thanks, Rob. And Sue, I think we have time for one last caller.
Thank you. Our last question comes from Mike Shlisky with D.A. Davidson.
Happy Thanksgiving. Mine's really a very simple one. Just a little more granularity on your comments about this being a mid-cycle year in 2024. I guess I want to know, are all 3 segments looking to be at mid-cycle for fiscal 2024? And are margin expectations for each segment also about where they should be at a mid-cycle as well? Just kind of your thoughts on whether any segment will be below or above mid-cycle and kind of balanced out by the other one.
Mike, happy Thanksgiving to you as well. I would say broadly segments are somewhat close to mid-cycle. I think production and precision ag is probably the closest. Construction and forestry running a little bit higher and small ag and turf a little bit lower, is sort of the directional breakdown there. And I think for us, as we think about structural profitability, we measure that at similar points in the cycle across a long period of time. And so for us, we look at 2024 as a good proxy for mid-cycle. We would compare that to 2019 would be the last year our businesses were running around the same level of volume, and so we're pleased that we can generate 2.5x the net income at these levels. And given the mix, as most of them are closer to mid-cycle than not, we feel like it's a pretty good example of what we can deliver at mid-cycle volumes.
Yes, Mike, this is Josh. I think just maybe to add on what Brent mentioned. I think importantly here, what we can deliver here at near mid-cycle is fundamentally different than how we performed in the past. So we're talking about roughly $8 billion of net income, $28, $29 of EPS. You can compare that back to 2013, a period we often get compared to, and we are significantly better than that point in time. And I think that's important because you're seeing a significant shift in terms of how do we perform mid-cycle. Obviously, you saw how well we performed in '23. I think the implication is at the bottom of the cycle, we would expect to perform significantly better than we have in the past as well.
That concludes today's call. We appreciate everyone's time and hope you all have a great Thanksgiving.
Thank you. That does conclude today's conference. Thank you all for participating. You may disconnect at this time.