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AGCO Corporation (NYSE:AGCO)

2013 RBC Global Industrials Conference Call

September 10, 2013 4:55 PM ET

Executives

Greg Peterson - Director, IR

Analysts

Seth R. Weber - RBC Capital Markets LLC

Seth R. Weber – RBC Capital Markets LLC

Okay thanks. Good afternoon everybody. Thanks for sticking around. [Music] AGCO. with us today, Greg Peterson, Director of Investor Relations representing the company. Welcome.

Greg Peterson

Thanks, Seth.

Seth R. Weber – RBC Capital Markets LLC

I think most of you probably know, just for overview, AGCO is really the largest pure play farm equipment company. It’s the number 3 by size, but the largest pure play, a big exposure to Europe, leading market share in Latin America and Brazil, and a growing share in North America. A big part of this story has been the operational improvements, the margin improvements particularly in North America that we’ve seen over the last couple of years, maybe that’s a good spot to kind of kick-off, I mean it seems that you’ve had a longstanding target of about 10% margin company-wide that’s been out there for a while. It seems like given some of the success you’ve had, that could be perhaps conservative. Maybe you could give us some color on some of the initiatives and sort of where you think we are in the process there.

Greg Peterson

Sure. Thanks Seth. As Seth said that have been – our operating margins have been our primary strategic target for the last few years, maybe helpful to step back a little bit and to think about where AGCO is in its company-wide for a relatively young company, about 23 years old, but the first 16 or 17 years that was spent buying other companies and accumulating scale and technology and products, and really it’s only been the last 7 or 8 years that we’ve been focused on being a global manufacturer.

Our Chairman, Martin Richenhagen joined us about 8 years ago, so his focus was to manage the company as the global manufacturer, and since then we’ve been focused as I said on doing what may seem like with the boring, blocking, and tackling things like global purchasing, global factory, labor efficiency initiatives, working on common platform initiatives, all those things that we’ve been working on for a number of years, but still we’re in, I would say, kind of maybe the middle innings on most of those.

So we have, what I think is a good bit of runway to continue to see improvement, as Seth said, a lot of the progress or some of the most significant progress we’ve made this is year in North America. We’ve gone from being essentially a break-even kind of operation to the last year, our margins were about 10%, operating margin wise, we were about 10%, so we are now kind of globally in roughly the high single-digit low double-digit range.

We want to be set at 10% by the end of 2015. This year, we think on a global basis, we’ll be somewhere between 8.5% or 8% and 8.5% and that’s up from a little over 7% last year. To get to 10% , we are saying we need relatively flat -- in terms of top line growth, are not looking to grow the business dramatically in order to make the 10%, we can do it with our flat volumes. If you look at our cost structure to be successful, a lot of the improvement is going to have to come on the material side. If you look somewhere more around 70% or 75% of our cost relate to material , so a lot of our focus has been on globalizing our purchasing.

We’ve created global commodity teams instead of focusing at the factory level now. we have commodity teams focused on tires -- big components like tires and castings and things like that that we can accomplish scale and develop a lot more expertise for these folks and are starting to see the benefit of that. So that’s global purchasing along with doing more from some of the lower cost markets like Eastern Europe and some Asian markets.

We expect to save somewhere around $50 million to $60 million in each of the next three years through more intelligent purchasing. Similarly, we have an initiative aimed at our factory productivity. Our direct labor makes up some more 10% or 15% of our cost to goods sold. We’ve implemented a program called AGCO production systems which not surprisingly is modeled after the Toyota production system’s scheme.

We expect then to generate by implementing on a global basis things like six sigma and lean, things that we’ve done individually now, we are doing globally and taking advantage of best practices. Employees now are helping us. We are being more intelligent about and realizing what a valuable asset they are and they are helping us become more efficient, and so we expect roughly $10 million to $15 million a year in savings. Going forward over the next few years, as a result of these efficiency programs.

So, roughly somewhere between 60% and 70% of our margin improvement is going to come from materials and direct labor. Over the years, through the different acquisitions we’ve done, we have a number of different platforms that we used to manufacture tractors and combines. We took our first step towards making common those platforms with our small horse power tractors. We are building a factory in China, that we’ll build a drivetrain that we are going to use in these small tractors, that’s global. Small tractor platform will go live starting next year.

We expect this more efficient operation to save us some more between 500 basis points and 600 basis points and about $1 billion of our sales, so we’re looking for another $50 million or $60 million a year in saving starting in 2015. And then, the last major piece of our stair step to get us to the 10% involves some new products that we’ve been introducing, primarily new high horse power tractors, and some additional harvesting products, so these bigger more technologically advanced products typically carry better margins. And so, the last piece of the puzzle is essentially improving the mix of our products. So, a number of things that we have in the works and we feel like we will have good visibility on that should get us to the 10% in the next couple of years.

Seth R. Weber – RBC Capital Markets LLC

Okay. When people look at AGCO, I think the first thing they think of is, probably Europe given the 50% or so revenue exposure. Is there any update to order books or anything trend wise that you are seeing there in Europe or any of your other markets that you can share with us?

Greg Peterson

Yeah. so on our second quarter call, we did talk about our order books, and we said that in Europe -- well, starting here in North America, we said that order books were up nicely from this time from June a year ago, also up year-over-year in South America. we said Europe was actually down a little from 2012 levels.

If you look at the European market, you really have to kind of focus at some of the individual markets, some of the bigger markets in Western Europe. the two biggest markets, France and Germany have been very healthy over the last few years. Our business is driven more by farm income and commodity prices than the general economy.

so a lot of the pushback we’ve gotten around our business and considering from the investment community has been that the overall weak economic situation in Europe is an overhang on our business. but in fact, if you look at some of the markets in Europe that have benefited from the drought for instance here last year, higher commodity prices in markets like Germany and France, have actually seen very healthy market conditions and we’ve seen nice growth over the last few years. so, those markets continue to be very attractive.

But then, if you move up into Northern Europe, places like the U.K. for instance had a very wet fall last year and a very wet cold growing season this year, so their wheat crop is down, farm income likely will be down again this year. And as a result, the market has been soft.

Similarly, Scandinavia and Finland, we’ve seen weak market conditions. So, the stronger – two biggest markets as I talked about, France and Germany have been strong. That strength has been offset by weakness in some of the Northern European markets, and also in Southern Europe where we’ve seen dry weather and also some credit, a little bit of tight credit related to some of the economic situations going on there. so, a very mixed situation in Europe, some of the Central European countries though have had a good year, and we’re continuing to see a good demand there, so Poland and the Czech Republic, those markets have been relatively strong. So, whereas folks are somewhat concerned about the market here in the United States, I think that it’s a much different situation in Europe, not so much a peak situation that’s actually an opportunity to maybe see some recovery in some of the markets next year.

Seth R. Weber – RBC Capital Markets LLC

And how does that match with your – you just recently spent a lot of money adding capacity at your German factory -- out of your Fendt facility in Germany. I think you took your capacity up 25% or so. How are you finding demand for the product that you’re producing there now?

Greg Peterson

So, in Germany at our plant in Marktoberdorf, we – as we say, we have increased the capacity there from probably somewhere between 15,000, 16,000 to close to 25,000. We make there our Fendt brand, it’s a hi-tech solution for big professional farmers and does very well in the bigger farms in Germany and France and some of the Eastern and Central European countries, which is where we’ve seen a lot of growth across Europe and similar to what we’ve seen here in the States, there has been a lot of consolidation over the last decade in terms of farm sizes, and as that continues -- as some of the subsidy programs change in Europe, we expect to see more of the production move to some of the Central European countries, and that’s good news for our Fendt brand, because typically the farm sizes there in those markets are bigger and very good customers for our Fendt tractors, and we’ve seen – this year, we expect to produce somewhere between 17,000 and 18,000 tractors this year versus about 14.5 last year. So a very nice increase given that the overall market is expected to be somewhere between flat and down about 5%.

So, we are benefiting I think a little more than the market is in terms of our Fendt growth. It is our highest margin product and will also benefit in the second half of the year from more efficient operations in our factories. last year, we had some start-up – a slower start-up ramp than we expected. So, we’ll benefit in the second half of this year, both in terms of volume and in terms of margins in the way of lower operating costs, right.

Seth R. Weber – RBC Capital Markets LLC

Then the Europe market, relative to North America, the Europe market is probably 15% below prior peak, and it’s been there for several years. I mean is there a scenario, is that a market that ever gets back to past peak you think or is it just kind of kind of bounce along here?

Greg Peterson

Yeah. as we talked about, it’s kind of a mixed bag in terms of demand, and I think if we saw more normal weather patterns in some of the Northern European countries and if you saw commodity prices hang in to may be where they are, we – it has been relatively good over the last few weeks. The harvest situation looks good in most of the markets, export demand looks to be picking up. I have seen some forecasts call for pretty increase in wheat exports out of Europe this year, so you can imagine that if we saw similar levels of farm income and maybe some improved production levels, you could see more normal kind of demand patterns and more normal conditions in some of the Northern European markets to go along with strong conditions in Germany and France. And then longer-term, some growth in Eastern Europe and Russia may be put us over the top there.

Seth R. Weber – RBC Capital Markets LLC

The other market I think people are – that people associated with AGCO is really Brazil. 50% plus or minus share of the tractor market, and that number has been coming down over the last couple of years as Deer frankly has been more aggressive there. Can you talk about the sustainability of the strength of that market that we’ve seen the tsunami, the government financing is sort of under review or maybe being rate raised next year, Deer commented this morning that they don’t really see any competitive pricing issues there. Any thoughts as to what’s going on there?

Greg Peterson

Yeah. Brazil is definitely one of the bright spots if you look long-term wise in terms of potential growth opportunities. If you look at the amount of land that is currently being farmed , Brazil copuld double their farm footprint without cutting down the rain forest and doing any major damage there. The big obstacle for Brazil is the lack of infrastructure, so their investments in roads and railroads is badly needed, and we have seen some of that happen over the last few years as a result of some of the Olympic activity and some of the World Cup activity that’s going on. But there is still a need to increase that and that’s kind of one of the things that we look for in terms of enablement of some of that growth, but the market itself we think will continue to be strong Brazil, I think Brazilian government realizes the importance of the ag industry to their economy.

They have been supportive as you’ve said with the [phenomenal] (ph) rates this year. This year, they are about 3.5% or looking for probably a modest increase next year. we don’t have any hard information from the government, probably won’t get a signal yet for another month, maybe two, but we believe that the rates will continue to be attractive. The other important factors in Brazil, the exchange rates, about half of their crop get exported and most of that is done in dollar terms.

And so with a weaker Real, which is where we are today relative to where it was a year or two ago, the margins on those export sales for the farmers are very good. So that again supports not just current levels of production but also some expansion. Then commodity prices are still at attractive levels, soybeans, which is probably the single largest crop. We haven’t seen as much price compression there and economics are still very good for the soybean farmers.

Sugar production is also important, and prices there continue to be good and our growers are profitable. So, a lot of positive dynamics around the Brazilian market. We have, as you’ve said, seen a little bit of share loss over the last few years, a lot of the growth that’s taken place in Brazil is in the North Central region. That (inaudible) in some of the areas up in that direction. Our strength in Brazil is around our two strong brands and our distribution. Our dealer network is not as mature up in that region. So, we don’t have the outreach like we do in some of the other parts of Brazil.

So that is part of the rationale behind some of the share loss. The economics for the farmers in that region are quite as good as they are in Southern Brazil, simply because it costs a lot of money to bring the crop, the processing facility or the ports, so the credit up in that region isn’t probably as good as it is, the credit size, I should say aren’t as good as maybe they are in Southern Europe. So we haven’t been quite as aggressive there.

And then lastly, we’re going to be a little more aggressive with bringing in some of the more current technology, some of the more – especially for the bigger tractors, we’re going to be aggressive with bringing some of our LRT models that we sell in the U.S., and Europe will continue to be localized over the next 18 months, and so that will help also in terms of capturing more of the share growth.

And then lastly, we expanded our product line in Brazil about a year and a half ago with the purchase of a small company that makes equipment for sugar producers, and a lot of the growth that’s taken place over the last couple of years has been with the sugar mills, and we’ve missed out on some of that business because of the fact that we didn’t have a harvesting product. And so now, we do have a sugarcane harvester that we did get through this acquisition, and we’re in the process of commercializing that. We’ll be launching it under our Valtra brand in Brazil early next year. We feel like that will help us in terms of packaging some of the sales to these bigger mills.

So a lot of things going on, we think will help us continue to grow that business there.

Seth R. Weber – RBC Capital Markets LLC

What about GSI, I mean I think the Brazilian government recently passed some support – financial support for storage, have you started to see benefit from that with the GSI business that you acquired last year?

Greg Peterson

Yeah. We’re really starting at a very low bubble in terms of the storage industry. There’s almost no on-farm storage in Brazil. so, it’s definitely going to be a long-term program, it was – I think it was a 5 billion real program that they announced. It’s definitely a very big program. We have a relatively young GSI business there we’ve kind of restarted it since we did the acquisition.

So we’re starting at a relatively small scale, but as we talked about earlier, our distribution there is very strong and feel like we can leverage that, and with our strong brands, we feel like we’ll be able to ramp the business up pretty quickly. We’ll do some colocation in terms of production and be able to leverage some of our purchasing capabilities down there. So, we feel like there is a pretty nice opportunity, probably not so much this year and next year, but hope the next three to five years, we feel like it will be a nice growth opportunity for us.

Seth R. Weber – RBC Capital Markets LLC

Just to understand, so you’ve raised your GSI guidance with your second quarter report?

Greg Peterson

Yes.

Seth R. Weber – RBC Capital Markets LLC

So, what was the basis for that then ?

Greg Peterson

Yeah. It was a combination of our original forecast assumed a pretty significant decline in the U.S. as a result of last year’s drought. Now we think that U.S. business will only have a modest decline. The biggest part of the increase came in some of the international markets; China and Brazil and Europe. So, international growth is a little stronger than what we expected and the business in North America is picking up. And we’re able to accelerate some of the storage business in the U.S. into the first half of the year, and so that gave us some capacity to handle some additional business in the back half of the year in the U.S. So, we are positioned to be able to do that if it materializes.

Seth R. Weber – RBC Capital Markets LLC

So within North America, you’ve always been kind of the third, maybe 10% market share or something like that. You have turned the business profitable, margins now profitable. I mean, where do you think that could go from both, I guess from a market share perspective, I know you’re adding some higher horsepower product, I mean there’s very well established competitors in those areas. They get very high margins in part because their dealer networks are so strong, you’re kind of coming out a little bit late, frankly. So how do you sort of make it get better from here?

Greg Peterson

So you’re right, we’ve made some important investments in our products, and all that’s from new high horsepower tractor products and some new harvesting products. In our business, as you know Seth, distribution is very important, it may account for as much as half of the purchase decision, and we’ve spent a lot of time working on our dealer network in the United States trying to improve that. A big part of that initiative has been around the Caterpillar dealers. We utilized the Caterpillar dealers. They sell our Challenger branded products, and we’ve seen that business grow pretty dramatically. The CAT dealers have embraced the opportunity to diversify their businesses. I think it has come at a very nice time for them in the sense that as the construction industry maybe soft, and they have had an opportunity to move more of their business into the Ag area.

We’ve seen our business that we take through the Caterpillar dealers grow from about a – when we purchased the Challenger brand from CAT in 2002, it was about $150 million business. Last year, we did about $800 million through that channel. And you can imagine that these CAT dealers that are very well capitalized and have very high levels of service, but they have historically been providing to the construction guys, probably among the best in the world that’s selling big pieces of the sophisticated equipment. So, we’ve been very fortunate that they’ve really made some significant investments in selling Ag equipment.

We’ve seen them in some cases by smaller dealers in some of the rural areas. They really seem to kind of figure it out. There are a lot of differences in selling construction equipment versus selling farm equipment. The farm equipment typically, there’s much more of a retail environment, and farm purchases– the farm equipment, the farmers like to go to the dealers and climb into the cabs and kick the tires, and actually it’s a place where they go to meet and talk to neighbors in the winter time.

So it’s a formula that the CAT dealers have kind of better understood over the last few years and have gotten engaged, and it really gives us a much stronger position to sell to these big Ag producers. And so, a combination of the bigger, more sophisticated products that we’ve come out with and now with our CAT partner dealers where we are doing a better job in the U.S.

Seth R. Weber – RBC Capital Markets LLC

Two parts, I mean do you think that your Ag gross margins on the bigger higher horse power equipment could eventually be similar to some of your competitors; and secondly, pretty consistently, we’ve been hearing about elevated used equipment inventories on the big tractor and combined products, and is that something that you’re seeing or you’re just not big enough to matter in that space yet?

Greg Peterson

Right. so I would say that certainly our margins have room to improve, and we have seen, as you’ve talked about, we have seen a good bit of improvement already. A lot of that – a lot of the future benefit will come with some additional scale. There is some good operating leverage that we can take advantage of, and as you mentioned, we’re probably about a 10% player in across a lot of the different products. We don’t have ambitions to collect 50% anytime soon, but if we’re able to add a couple of hundred basis points of share over the next few years, that’s a good outcome, 20% or 30% increase in volume would do very nicely in terms of our margins.

So yeah, I mean I think we do have some upside on our margins, and I think some of the global initiatives that we talked about earlier will certainly benefit our North American business. And then, in terms of current inventory levels, I would tell you that, I think on the tractor side, the industry in general, I think, is in pretty good shape, maybe at the high end of normal. I think we’re probably in that range.

We’re not a big player on combines. We have probably a mid-to-high single-digit kind of market share on combines, and our used inventory levels for combines are typical for us, so in a normal range. So, at this point, I’m not seeing channel problems with our North American inventory.

Seth R. Weber – RBC Capital Markets LLC

And do you think that in a scenario, there has been a lot of discussion about North American market. Farm income is going probably down next year a little bit. Are you – the theme that we heard that Farm Progress a few weeks ago was market could be down, but it’s probably not yet down cliff scenario, is that sort of AGCO’s view in North America?

Greg Peterson

Yeah, I think – our view would be that farm income at least at this point would be above historical averages, above the 10-year average anyway, in which case, farmers are going to be nicely profitable. So, it’s hard to imagine that some of the regular placement we’ve seen developed over the last five years, it is hard to imagine that they are going to completely abandon their method of managing their fleets, and I think given the (inaudible) profitability, you’re right; we’re not looking for the cliff event to happen next year.

Seth R. Weber – RBC Capital Markets LLC

Are there any questions from the audience? We have time for one. No, okay. Greg, thank you very much.

Greg Peterson

Thank you, Seth.

Seth R. Weber – RBC Capital Markets LLC

Thank you, thanks everybody.

Question-and-Answer Session

[No Formal Q&A for this event]

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