Deere & Company — 2024 Q2
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 Second Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Josh Beal, Director of Investor Relations. Thank you. You may begin.
Hello. Welcome, and thank you for joining us on today's call. Joining me on the call today are Josh Jepsen, Chief Financial Officer; Cory Reed, President Worldwide Agriculture and Turf division, Production & Precision Ag Americas and Australia; and Josh Rohleder, Manager of Investor Communications.
Good morning. John Deere concluded the second quarter with solid execution. Financial results for the quarter included a 21.2% margin for the equipment operations. Trends in the end markets that we serve remain broadly unchanged from last quarter. Ag fundamentals continue to abate leading to more challenging market conditions in the back half of the year.
Yes. Absolutely, Josh. This is really a story of executional discipline across the organization. We were able to outperform on the top line as demand held up slightly better than we expected. In particular, we saw resilient earthmoving and road building market that exceeded our expectations despite a tough competitive environment.
Thanks, Josh. That's a great summary and a great point you bring up. It's clearly been a strong executional start for the year, but we've revised our full year guidance.
Right. The forecast change is really volume-driven, primarily in our ag and turf segments. Underlying the demand decline is a tougher backdrop in global ag, which as you mentioned in your opening comments, has continued to weigh on our customer base. Uncertainty has caused a decline in farmer sentiment. And as a result, we are seeing a softer retail environment today than we did just 6 months ago.
This is Jepsen here. Maybe a couple of things to add. First, I want to commend our employees for the work they've done to drive the overall decrementals for the business despite the velocity of declines we're experiencing this year. We're delivering value for our customers and driving operating margins that are structurally better at this point in the cycle than ever before.
Thanks for that additional color, Josh. And you make a great point about the decrementals. We're definitely being impacted by more definitely being impacted more significantly than usual by the unfavorable mix associated with higher margin products and regions declining more significantly.
Yes. Thanks, Josh. We are coming down from a period of high demand, and historically, we would have, as an industry, been slow to react to that change. Often, we would drive higher levels of field inventory to the detriment of the following years.
This is Jepsen. One other thing to highlight beyond the current environment, and where we see the long-term strategy leading us, is related to technology and how we engage with our customers. We're starting to think about market share, not only as the number of units sold but as the number of acres covered by Deere products and technologies as a percentage of total acres farmed.
Those are excellent proof points. But one thing we haven't covered yet is costs. A key benefit of proactive cycle management should theoretically be the associated cost savings. We're seeing another year of positive price cost.
Definitely, yes. That's a great point, Josh, and I'm happy to start. I'd begin by referencing back to what Josh Jepsen talked about earlier, along with structural cost reductions, we continue to prioritize managing to our structure lines, which essentially means as production and sales come in, we pull levers to bring in costs.
This is Jepsen. Maybe one thing worth mentioning is we also pull levers on assets. And that's evident when you look at our cash flow guidance change, which is now less in this guide compared to the change in net income. This is reflective of the fact we're starting to see our inventory come down following our production rate reductions in the first half of the year, creating a source of cash for the business.
Perfect. And in the spirit of inventory management, I'd like to briefly touch on new and used inventories. Josh Beal, could you give us an update on where we stand today and what to expect in the back half of the year?
Yes, absolutely. And I'll start with new equipment. In North America, large ag, we're seeing intra-season inventory build as expected, albeit below industry levels and inventory to sales ratios -- ratio increases in line with historical norms. That said, given our proactive underproduction previously discussed, we expect these numbers to fall by year-end with beginning 2025 inventory to sales ratios down significantly from where they stand today.
Josh, this is Cory. Just one thing to add here is as you look at the industry as a whole, we've been relatively disciplined. Our large ag new inventory in North America currently represents less than half of the industry's unit inventory and significantly below the industry on an inventory to sales ratio basis. This is reflective of the discipline we're showing in this cycle.
Thanks, Cory and Josh. That's a good reminder on intra-year seasonality swings and how those play into our larger production and inventory management.
Yes, happy to. And definitely a dynamic market to unpack. And I'd like to first start by extending our deepest sympathies to those affected by the tragic flooding you mentioned, Josh, including a significant number of our employees, customers and suppliers. We want to wish everyone well in the recovery, and I want to emphasize that the safety and security of our employees is our first priority as we assess and respond to the impacts of the event.
Perfect. Thanks for setting the stage, Josh. Now Cory, I believe you were just down there for Agrishow. Could you give us an update on what you saw there and the sentiment you were hearing from dealers and customers?
Absolutely. That sentiment was positive, Josh. This is not to say that we've reached an inflection point, given Josh Beal's comments earlier about retail activity. But I think the biggest takeaway was the excitement that we're seeing for our latest tech offerings. In fact, we're taking preorder interest for our StarLink connectivity solution and ended up oversubscribed by the first day of the show. We similarly sold out of our allotments for See & Spray Select and our Precision Ag Essentials bundle that was also a great success.
Awesome. That's really great insight, Cory. Now for the last topic, I'd like to briefly touch on Construction and Forestry, which is relatively stable this quarter. Earthmoving end markets remain largely unchanged quarter-over-quarter, while road building has seen some minimal shifts in North America, albeit remaining at strong demand levels. .
Definitely, Josh. The key takeaway for the quarter is what you noted, minimal change at healthy levels of demand. As we've noted on previous calls, we expected some decline year-over-year unrelated to end market demand as we build less inventory this year relative to 2023.
Thanks, Josh. That's a great update. And before we open the line to questions, Josh Jepsen, any final comments?
Certainly. It was a good second quarter with strong results to round out the first half of the year. Despite a dynamic global ag market and competitive construction environment in North America, we performed at structurally higher levels across the business. Given the pullback we've seen in ag markets, we now expect to end the year moderately below mid-cycle levels.
Thanks, Josh. Now let's open it up to questions from our investors.
We're now ready to open -- to begin the Q&A portion of the call. The operator will instruct you on the polling procedure. [Operator Instructions]
[Operator Instructions] Our first question comes from Jerry Revich with Goldman Sachs.
I'm wondering if you could just expand on the...
Jerry, we lost you. You've broken up a little bit. We can't hear what you're saying. Amanda, we might need to move back to Jerry. Jerry, if you can hear us, you're not coming through.
Our next question comes from Angel Castillo with Morgan Stanley.
This is Grace on for Angel. I think your updated guidance for Production and Precision Ag, I believe, implies 50% decrementals and high teens margins. So can you talk about the underlying drivers of that? And what you see as ultimately the normalized level of profitability for the segment? And as part of that, what gives you comfort that we will see margins move lower to the low to mid-teens range?
Yes. Thanks for the question. Yes. I mean really, what we saw in Production of Precision Ag in the quarter was, as we described in our comments, some further softening in markets really around the globe, and you saw that reflected in our industry guides.
Yes, Grace. This is Josh Jepsen, maybe just to comment around decrementals. I think full year, I think we expect PPA to do around 44%. I think the back half is actually pretty similar to that, so not materially different. And maybe important just compare juxtaposition terms of the structural profitability of that business is if we look back to 2020, the business was around, call it, 90% of mid-cycle, which is not terribly far from where we are today for Production and Precision Ag. And we did around 16% operating margin kind of adjusted for some onetime things that occurred during that time.
Our next question comes from Mig Dobre with Baird.
I'm wondering if you can maybe put a finer point and help us understand how large is this underproduction in both PPA and SAP? What percentage of revenue or the revenue decline, if you would, is related to this under production?
Thanks, Mig. Appreciate the questions. Yes, looking at total underproduction for the year, and starting with the large ag segment. Globally, Mig if you think about it, worldwide underproduction to complete good retail sales is going to be in the high single digits worldwide. North America, large tractors, it's probably in that range, maybe a little bit higher.
Yes, Mig, this is Cory. I'll just give a finer point to you on the inventory side. I mentioned that we're on a unit basis, significantly below -- we're below the total in terms of the rest of the industry. On a unit basis for row crops, as an example, we're sitting at half of the industry new inventory, but we're taking that down even further. So as Josh mentioned, we're going to go from that range of 15-plus percent down to 10% at the end of the year.
Yes. And maybe one thing -- just lastly to add, this is Josh Jepsen. I think compared to historical, we are ensuring that we're getting inventories in the right place, being as proactive as possible and not prolonging demand, not stretching out the potential to have higher demand a little bit longer, which is a lesson learned clearly from the past. So being able to do that more proactively, we think puts us in a better position. It also impacts I think duration of what we see from an overall cyclical impact.
Yes. Maybe a final point on that to support Josh is that actually in the month of April, we saw the industry actually peak in row crop tractors, and we're proactively pulling back at the peak before the decline comes. So I think that's another indicator.
You had asked about small ag as well. I mean, just maybe a couple points there. I don't have it for the whole segment, but if you kind of break down some of those subcomponents. Small tractors, has been high inventory, particularly in compact utility tractors. Pretty significant under production there. It's double digits.
Our next question comes from Kristen Owen with Oppenheimer.
Mine will be somewhat of a follow-up to the last, which is given the high level of underproduction in the back half of the year, and as mix implications being more toward this high-value large form factors, I'm wondering if you could talk a little bit more about those offsets, what you've done already to help protect that decremental margin? Arguably, that should be actually significantly higher given the mix. So what actions you've taken already? And how to think about the cost benefits layering into the back half of the year that's offsetting that under production.
Thanks Kristen. I'll start, and jump in as well here. I think a few things. I mean, certainly, I think as you think about 2024 and particularly underproduction, primarily shifted towards the back half of the year, we have had some adjustments in rates and things. And we've talked about that in terms of some of the overhead and efficiencies that have come into the business as we made those changes. You're seeing that in production cost.
Kristen, it's Jepsen. I would say definitely, we see the bigger impact in 4Q as seasonally -- you see a higher level of retail, but then also we get seasonal shutdowns and those sorts of things. As we work through the back half of the year, we're resetting production rates, as Josh mentioned. We're also getting the cost structure aligned. So that will benefit us as we go forward.
One thing I would add, I mean, one of the additional points I'd make is we're actually preparing for probably the largest new product launch going into 2025, we ever have. So while we're pulling production down, we're also readying to launch some of the highest, most productive products we've ever had. So all new combines, all new four-wheel drive tractors, all of that is taking place and included in what we're doing to prepare in terms of the cost structure as we head into '25 and bring value proposition even higher for our customers going forward.
Yes. And I think just building on that too Cory, excitingly, a lot of those new products are coming with great tech, harvest setting automation, predictive ground speed automation, exact shaft for vision. There's a lot of great solutions coming in '25 as well.
Our next question comes from Nicole DeBlase with Deutsche Bank.
Maybe just if you were willing to comment a bit on what you're seeing so far with the crop care Early Order Program, and I think that question may be quick. So I'm going to ask another -- little question, I guess. And that's the C&F decrementals were a bit high this quarter. Are you expecting that? It seems like in the guidance. Thoughts on decremental margins you see in the back half?
You're right that the answer is quick on crop care Early Order Programs. So that sprayer Early Order Programs just opened up at the beginning of the month. So we're about, what, 1.5 weeks, 2 weeks in now to that. It's early, and that tends to build throughout the course of the program. So really not enough to comment at this point just based on the very early stages of that program.
Nicole, this is Jepsen also on EOP. I think one thing important to note we've seen, as we get into times of uncertainty, order activity tends to probably push a little bit later through the phases of those programs as customers dealers exercise a little more optionality and want to have a little bit firmer view of how this planting season go and how is crop emerging, just another point of reference there.
Yes. I think maybe shifting, Nicole, to your question on C&F decrementals for the quarter. I think the 1 thing to point out there is we did have lower price realization than originally anticipated. That was due to a discount accrual that we put on some field inventory that will affect really sales for the balance of the year. So it's a little bit of a timing around price realization. That's why you see us keeping that full year guide at 1.5.
Our next question comes from Jairam Nathan with Daiwa.
I just wanted to -- if you could dig a little bit deeper on pricing. What are you seeing in that run across regions and segments. And just kind of also a primer on what we could be seeing next year on the pricing side?
Yes. I mean a bit early to talk about 2025 pricing. But I think as we talk 2024 and where it stands, and then we kind of do a walk around the world here, again, in large ag, we're talking about 1.5 points price realization for the year, as we kind of step through the different regions.
Our next question comes from Rob Wertheimer with Melius.
My question is kind of a big picture one on [ PP&A ] in North America. And just how you think about the trade down cycle? Your machines have gotten bigger, more capable, more productive, more expensive in some ways. And I'm curious if you see this as an unknown whether they all find homes in the second and third owners or whether you guys know the market better than anybody in the chain of buyers? Or whether you see enough of the moderate-sized farms, the second buyers, to kind of absorb the equipment? Just how you think about that playing into the overall cycle?
Yes, Rob, this is Cory. I'll maybe take a first stab. Look, I'll use tractors as an example. One thing we watch very closely is used inventory on row crop tractors. We've seen late model used above 300-horsepower grow, and we've watched it closely. But if I can give you the example, if you went back to the previous peak, 14,000 unit industry back in 2014, there have been about 14,000 units but only 30% of that industry would have been above 300 horsepower.
Yes, Rob. The one thing I would add is I think the other -- the piece that gives us confidence as well is no matter where the customer is in that ladder, whether they're the first owner or the fifth, there's a strong desire to keep upgrading technology, become more productive, more efficient and be able to execute those jobs in tighter time frames.
Our last question comes from Jerry Revich with Goldman Sachs.
Yes, I apologize for the sound issue earlier. I wanted to ask, you folks are hyper focused on used inventories just normally. Based on the actions that you've taken, rising use of full fund roughly $2 billion destock, what's your level of confidence that late model inventories will stop moving up from here? I appreciate that it's more of an [indiscernible], but I'd love to hear how you're modeling and thinking about it versus additional potential levers?
Thanks for the question, Jerry. Glad you made it back. I mean I'll start and Cory, Josh, feel free to jump in. I mean, I think it starts with our proactive management on the new inventory side as well. I think our decision to underproduce [indiscernible] row-crop tractors in North America in 2024. And to bring those inventory sales levels down as low as we're bringing them. We're significantly below where we ended last year, is really that opportunity, as Cory talked. We feel pull for the equipment. There's value there given where current environment is, given where rates are, it has slowed down, that equipment moving through the pipeline.
I used the planting example earlier, but I think it also applies in spring, and it applies in harvesting in the end. Those windows get tighter and the ability to both cover more ground more quickly at all levels and all customers, I think, helps us drive confidence together with the fleet age, drives confidence that we will consume that product. And we've got tools in place to be able to do it.
Thanks for the question, Jerry. Appreciate all the questions today. I think we're at the end of the list here. That's all the time we have. We appreciate everyone's time. Thanks for joining us. We'll talk soon. Have a great day.
That concludes today's conference. Thank you for participating. You may disconnect at this time.