CNH Industrial NV (CNHI) Richard J. Tobin on Q1 2016 Results - Earnings Call Transcript

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CNH Industrial NV (NYSE:CNHI)

Q1 2016 Earnings Call

April 29, 2016 9:30 am ET

Executives

Federico Donati - Head of Investor Relations

Richard J. Tobin - Chief Executive Officer

Massimiliano Chiara - Chief Financial Officer

Analysts

Joel Gifford Tiss - BMO Capital Markets (United States)

Robert Wertheimer - Barclays Capital, Inc.

Monica Bosio - Banca IMI Intesa Sanpaolo

Ann P. Duignan - JPMorgan Securities LLC

Joe J. O'Dea - Vertical Research Partners LLC

Tyler L. Etten - Piper Jaffray & Co. (Broker)

Massimo Vecchio - Mediobanca Banca di Credito Finanziario SpA (Broker)

Larry T. De Maria - William Blair & Co. LLC

Ross P. Gilardi - Bank of America Merrill Lynch

Operator

Good morning, good afternoon, ladies and gentlemen, and welcome to today's CNH Industrial First Quarter 2016 Results Conference Call. For your information, today's call is being recorded.

At this time, I would like to turn the call over to Federico Donati, Head of Investor Relations. Please go ahead, sir.

Federico Donati - Head of Investor Relations

Thank you, Bertrand. Good morning and afternoon, everyone. We would like to welcome you to the CNH Industrial's first quarter 2016 results webcast conference call. CNH Industrial Group CEO, Rich Tobin; and Max Chiara, Group CFO will host today's call. They will use the material you should have downloaded from our website, www.cnhindustrial.com. After introductory remarks, we will be available to answer the questions you may have.

Before moving ahead, let me just remind you that any forward-looking statements we might be making during today's call are subject to the risks and uncertainties mentioned in the Safe Harbor statement included in the presentation material.

I will now turn the call over to Mr. Rich Tobin.

Richard J. Tobin - Chief Executive Officer

Good afternoon or good morning, everyone. I'll make some brief comments on the quarter and then we'll go through the financials and back to the segment information.

From an execution point of view, it was a good quarter. Given the overall market demand conditions, we're continuing to navigate the challenging trading conditions and execute on our channel inventory destocking in Agricultural Equipment segment. We are encouraged by the improved operating profits and margins in our industrial segments compared to last year, which has allowed us to offset a significant portion of the profit margin impact from Ag.

Revenues for the quarter were $5.4 billion with continued demand strength in Commercial Vehicles, which was up 18% in Europe buffering the impact of challenging trading conditions in the Ag segments and general headwinds in Latin America. Industrial Activities' operating margin was 3.5% with year-over-year operating profit and margin improvements achieved in all segments except Ag. In Ag, the margin was at an industry standard 4.2% for the quarter. We'll get into the details later, but positive price realization despite challenging market conditions, lower material cost offset significant decline in unit production in NAFTA and LATAM.

All three other industrial segment margins in Commercial Vehicles, Construction Equipment, and Powertrain were up 2% plus quarter-to-quarter, again with positive price realization in CE and CV, a richer mix in Powertrain, lower material costs, flow-through, and manufacturing footprint efficiency benefits in Commercial Vehicle and Construction Equipment.

Net industrial debt at $2.5 billion and net industrial cash flow improved by $375 million as compared to quarter one of 2015 as a result of lower production levels in Agricultural Equipment, available liquidity at $8.2 billion. As previously announced, we booked an exceptional charge of $502 million related to the European Commission investigation and related matters during the quarter. And in light of this performance and our confidence in our ability to execute for the remainder of the year, we've reaffirmed guidance that we had given in January.

Now that's it for the opening comments. I'll hand it over to Max and then come back and review the segments. Max?

Massimiliano Chiara - Chief Financial Officer

Thank you, Rich. I'm on slide five with the first quarter highlights. At Industrial Activities level, net sales were $5.1 billion, down 5.7% compared to Q1 2015 on a constant currency basis with share of total revenue increasing in CV on the back of the strong demand in Europe.

We achieved an operating profit of Industrial Activities for the quarter of $178 million, down 20% versus Q1 prior year with operating margin of 3.5% for the quarter. Here the profit contribution by business shows a positive impact of the CV recovery and Powertrain's strong result. Adjusted net income, which was previously defined as net income before restructuring and exceptional items, was $1 million, down 32% year-over-year, mainly as a result of the lower operating profit.

Net industrial debt at March 31, 2016 was $2.5 billion versus $1.6 billion at the end of December. The increase was due to seasonal investment in working capital, albeit at a much slower pace than in Q1 2015. Available liquidity, $8.2 billion at the end of March, inclusive of $3 billion in undrawn committed facilities, versus $9.3 billion at the end of December.

Moving to the next slide. Industrial Activities net sales walk by segment on a constant currency basis and net sales spread by region and currency. Excluding the negative impact from currency translation, net sales decreased $320 million in the quarter. Agricultural and Construction Equipment were down $350 million and $49 million, respectively, for the quarter as a result of weaknesses in end markets in NAFTA and LATAM, partially offset by improvements in both Commercial Vehicles and Powertrain. Negative effect translation impact was $228 million or 4.2%. As you can see on the net sales by currency pie chart, our top line in Q1 continues to be negatively affected by the strengthening of the U.S. dollar when comparing average rates in the quarter to prior year versus our major trading currencies that make up almost 75% of our revenue.

As far as net sales by region, the share of EMEA net sales increased year-over-year to 59% of the total where it was 49% last year, and it was driven by increased sales in the region in all segments, excluding CE.

Next slide, operating profit in the quarter was down $45 million with a decline in Ag that was partially offset by year-over-year improvements across all other industrial segments, showing the ability of the portfolio to buffer the impact from the adverse market conditions in Ag row crop. Margin in the quarter closed at 3.5% with margin improvement in each segment other than Ag. FX translation had no impact in the result.

Looking at the adjusted net income walk, consolidated operating profit was down $52 million with Financial Services operating profit flat year-over-year on improved net interest margin, offsetting slightly higher provision for credit losses and currency translation impact. Interest expense was $13 million above last year mainly due to higher cost of carry of the liquidity and higher debt in Brazil.

Other net, excluding the previously announced exceptional non-tax deductible charge of $502 million, was favorable $9 million primarily due to lower FX losses. JV income was $12 million unfavorable mainly due to APAC JV due to end market demand weaknesses.

Lastly, we had lower taxes as a result of the profit reduction. Given the losses in certain jurisdictions and the inability to book the related tax benefit, the company recorded a tax charge in excess of its long-term effective tax rate objective of 34% to 36%.

Moving on to slide eight, the change in net industrial debt for the quarter and some focus on specific quarterly dynamics. Net industrial debt of $2.5 billion was $0.9 billion higher than in December 2015, including a $0.2 billion negative foreign exchange translation impact.

Net industrial cash flow in the quarter was an outflow of $0.6 billion, primarily as a result of the working capital investment of $0.7 billion, although it was $375 million lower than in Q1 2015, primarily due to an increase in inventory related to the usual seasonal buildup in the quarter in preparation for the selling season in the second quarter. The $0.4 billion improvement over the same period last year comes as we continue to diligently optimize our investment in working capital, as clearly depicted in the last three-year trend. Capital expenditure was $80 million in the quarter. The reduction for the quarter is mainly coming from lower spending for regulatory requirements.

Moving on to slide nine, our Financial Services business net income for the quarter at $87 million, slightly up compared to Q1 2015 with improved net interest margin more than offsetting credit losses and negative impact of currency translation. In the first quarter of 2016, retail loan originations were $1.9 billion, slightly down compared to the first quarter of 2015 on a constant currency basis, primarily due to the decline in Ag sales. The managed portfolio of $24.9 billion as of the end of March was down $0.6 billion compared to December on a constant currency basis, primarily in NAFTA and EMEA. Credit quality remained strong with delinquencies of 3.7% for Q1, up slightly over Q1 2015.

Slide number 10 shows the company debt maturity schedule and the available liquidity. As of the end of March, available liquidity is $8.2 billion, up $1 billion compared to Q1 2015 and $1.1 billion lower than December 31, 2015. The decrease is mainly attributable to the seasonal cash absorbed from operating activities and the repayment of third-party debt including the repayment of the 7.25% $300 million bond of CNH Industrial America. This was partially offset by a new $500 million 4.875% five-year bond from Financial Services. Our liquidity to revenue ratio was 32% versus 35% at the end of December and 23% at the end of March 2015. Net intersegment balance was at $1 billion at the end of March, flat compared to December end.

This concludes the financial review portion of the presentation and I'll turn back to Rich on the business overview section.

Richard J. Tobin - Chief Executive Officer

Thanks, Max. Agricultural Equipment net sales decreased 13.6% in constant currency as a result of unfavorable industry volume and product mix in the row crop sector in NAFTA and the Brazilian market and LATAM. Net sales increased in EMEA, primarily in Western Europe and APAC. Operating profit for the quarter was $90 million, operating margin of 4.2%. The big impact in Ag operating profit was lower wholesale volumes in NAFTA and LATAM and the impact of negative fixed cost absorption and the lower industrial activity. Despite this, we were able to post positive net pricing during the quarter and extract the benefits of lower material costs, resulting in a decremental margin of 25%. Our expectation is that Q1 will be the lowest margin quarter for the year in Ag. As we discussed back in January when we were talking about the guidance – go to that slide please.

If you take a look at the underproduction in NAFTA that we were frontloading the underproduction this year as opposed last year, remember we had cut production in Q2 and Q3 and then brought back production in Q4 this year. We had guided back when we'd given the full year estimates that we were going to come out running very low in the beginning. And if you look at the bottom portion of the slide, NAFTA row crop production is down 50% quarter-to-quarter, and that has resulted in a 27% reduction in channel inventory. So we will be ramping up production somewhat in Q2. We've got the August shutdown in Q3 and then we'll see where we are in terms of meeting our channel inventory objectives for the year. My estimation is that we'll probably be in balance in Q4 or slightly under retail in Q4 and slightly over production to retail in Q3, so back to more normal seasonality.

What else do we have? So you could see the stats, I think the most important one is the channel inventory issue. Let's go on into the industry volume. We've seen some deterioration in the high horsepower tractor demand in NAFTA. So we're changing those estimates for the year, largely as a result of the used inventory clearing process and the continuing challenging market environment, particularly in tractors in LATAM was down 41%. In combines, demand in NAFTA was down 16%, which is in line with our full year forecast and up 31% in APAC. So other than high horsepower tractors, we're pretty much in line of where we thought we would be. And I think that that retail number for Q1 in NAFTA high horsepower is somewhat affected by the amount of used that's getting cleared through the system. So, overall, I think it's relatively healthy that this is going to be the last year of destocking.

And moving on to Construction Equipment. In Construction Equipment, net sales decreased 8% in constant currency due to negative unit volumes and mix, primarily in NAFTA and LATAM, offset by improved performance in APAC, particularly in India. Operating profit was $14 million at an operating margin of 2.6%. Construction Equipment's operating profit increased as a result of improved margins in NAFTA and APAC, lower material costs and improved productivity from our efficiency programs, more than offsetting the negative effects of challenging trading conditions in NAFTA.

So you've seen a couple of things and we're trying to remain disciplined in pricing as best as we can. There's some return to India, which had not been a contributor to our profits over the past 24 months, and then the biggest change you see in the $28 million, that's as a result of some of the facility consolidations that we've been doing since 2014 are flowing through the P&L. So, from a demand point of view, it's been a relatively weak quarter, but we're executing well in terms of lifting the operating profit.

Next slide. Construction Equipment's worldwide overproduction was 18% for the quarter, but it's down 18% vis-à-vis Q1 of last year. So more or less, it's a neutral position in terms of where we are with channel inventory, and that is somewhat affected by the amount of inventory that we're building up in India. And looking at industrial retail demand during the quarter, LATAM market continued to be challenging with both light and heavy segments significantly down 40% and 45%. Demand in NAFTA, EMEA and APAC was flat or slightly down for light equipment and down 12% for heavy.

Next slide. Net sales increased 5% on constant currency basis in Commercial Vehicles, primarily as a result of the favorable truck volume in EMEA, Europe in particular. In LATAM, net sales decreased 53% due to lower industry volumes in Brazil and Argentina.

Operating profit for the quarter was $38 million. This represents a $49 million increase if we normalize for the lost profits of Venezuela, which we remeasured, as you remember, last year. The increase is a result of improved volume and mix in EMEA, which was largely offset by LATAM in defense specialty vehicles. From an execution standpoint, it was an encouraging quarter as the segment delivered positive pricing across all regions, improved material costs, reduced cost of quality, and improved manufacturing efficiencies as a result of efficiency programs and world-class manufacturing programs. We expect this trend to continue for the balance of the year.

Next slide. First quarter overproduction versus retail was in line at 18% with demand and the projected pre-buy impact in the light commercial range due to the transition to Euro VI later in the year. Strong order intake for trucks in Europe across the board with book-to-bill at 1.3. In the quarter, European truck market grew 18% compared to Q1 2015. Light vehicle market increased by 18% while medium and heavy grew by 19%, respectively. In LATAM, new truck registrations declined 34% to Q1 2015 and down 5% in APAC.

Market share overall for trucks in Europe was flat versus last year with an increase in light vehicles offsetting the marginal decreases in medium and heavy, as a result of fleet sales timing and customers waiting to see the new launch that we'll have in the heavy Commercial Vehicles segments in June. Order intake for trucks in the year was up double-digits across the segment with book-to-bill, as I mentioned, at a healthy 1.32. Additionally, Iveco participated in the European truck manufacturers European Truck Platooning Challenge. I would ask to you that you could click on the link if you'd like to see, we have a short video on it, and I think if you're well aware of it. I think it was relatively successful for the group.

Moving on to Powertrain. Net sales at $882 million slightly increased on a constant currency basis. Sales to external customers accounted for 44% of the total sales. Operating profit was at $53 million for the first quarter, a $17 million increase compared to first quarter 2015 and an operating margin of 6%. This is the highest margin for FPT in the quarter. The improvement is mainly due to positive product mix to third-party business, improved raw material costs and industrial efficiencies from higher component volumes and world-class manufacturing initiatives.

During the quarter, Powertrain sold approximately 130,000 engines, a decrease of 1%. For the quarter, by major customer, 46% of engine units were supplied to captive customers with the remaining 56% to external, which is positive to margins. Additionally, Powertrain delivered under 20,000 transmissions and over 50,000 axles, an increase of 24% and 22%, respectively, compared to the quarter.

In terms of the outlook, I touched on, in NAFTA, we've revised down the industry for high horsepower tractors now to 20% to 25% versus our previous forecast. Outlook for combines is as maintained. EMEA demand confirmed to be mostly stable, LATAM to be down 15% to 20% in tractors and 5% to 10% in combines. APAC slightly improved with tractors now flat to plus 5% and combines 5% to 10%. In Construction Equipment, markets are expected to remain flat or slightly down, except for light in LATAM now expected to be down 5% to 10%. In Commercial Vehicles, we now expect EMEA, principally Europe, to be up between 5% to 10% and LATAM to be down 15% to 20% from the previous 10% to 15%. The balance of the world is unchanged.

So given that, based on these outlook premises, CNH Industrial is confirming its guidance as follows. Net sales of Industrial Activities between $23 billion and $24 billion and an operating margin of between 5.2% and 5.8%; net industrial debt between $1.5 billion and $1.8 billion, excluding any potential cash payments for the EC investigation and related matters where the timing of the payments is uncertain.

That concludes the presentation. I think I'll hand it over to Federico for question and answer.

Federico Donati - Head of Investor Relations

Thank you, Mr. Tobin. Now we are ready to start the Q&A session. Bertrand please take the first question.

Question-and-Answer Session

Operator

Thank you. We'll take our first question today from Joel Tiss with BMO. Please go ahead.

Joel Gifford Tiss - BMO Capital Markets (United States)

Hello.

Richard J. Tobin - Chief Executive Officer

Hello. We are here. Go ahead.

Joel Gifford Tiss - BMO Capital Markets (United States)

Hi. It's Joel Tiss. I just wanted to ask on the Commercial Vehicle business what's holding back the operating margins? Is it more of a structural issue, or is there – it's just sort of the puts and takes of all the different geographic, Latin America being weak and other things like that?

Richard J. Tobin - Chief Executive Officer

I mean, a portion of it is Latin America being weak, but it generally is backend loaded. If you look at the seasonality of the Commercial Vehicle business, margins tend to climb through the year and that's our expectation for this year. So we expect to have margin accretion for the following three quarters.

Joel Gifford Tiss - BMO Capital Markets (United States)

Is this a high single-digit operating margin business in sort of normalized times, if you could get all the different markets to pull in the same direction at the same time?

Richard J. Tobin - Chief Executive Officer

Let me rephrase it. I mean, we don't give out segmental operating margin targets, but we expect to improve operating margins full year 2016 versus 2015.

Joel Gifford Tiss - BMO Capital Markets (United States)

And I just wondered what's next after you get your debt down a little bit further. It seems pretty – there's not a lot of debt to begin with. And I just wondered what are you thinking next? Is it share repo or acquisitions or – I just wonder what you think.

Richard J. Tobin - Chief Executive Officer

Yeah. I think that the capital structure, the way it is, is to try to get our rating improved and get to investment-grade rating. So there's excess liquidity on our balance sheet and that will remain there until that happens. And then to the extent that does happen then there'll be a return of capital would be the likely avenue of that excess cash coming back.

Joel Gifford Tiss - BMO Capital Markets (United States)

Great. Thank you very much.

Richard J. Tobin - Chief Executive Officer

You're welcome, Joel.

Operator

Our next question comes from Robert Wertheimer with Barclays. Please go ahead.

Robert Wertheimer - Barclays Capital, Inc.

Yeah. Just a quick question on what your thoughts are on the sustainability of the particular upside, I guess, in Southern European truck? The fleet is very depressed, maybe not in Germany but certainly across Southern Europe. Are you seeing a lot of real optimism amongst fleet? And do you think we can continue for some time?

Richard J. Tobin - Chief Executive Officer

We expect it, Rob, to continue through 2016, for sure. I mean, the unemployment rates and the GDP numbers for Southern Europe are continuing to improve and interest rates remain where they are. So our expectation for the year and the reason that we had upgraded unit volume demand for 2016 for the Continental Europe is influenced by Southern Europe. So at least through the balance of this year, we expect it to continue.

Robert Wertheimer - Barclays Capital, Inc.

And you have in the past outlined some long-term margins for truck I think at mid-cycle. I mean, I assume there's a chance to go above that target in a strong up-cycle if such occurs?

Richard J. Tobin - Chief Executive Officer

Look, we're well on our way to reaching those target margins. I think that when we reach them, we can ensure that we'll try to maximize over that. But right at this point, we're working our way to reaching those target margins. And it's not all volume related, as you can see from the profit improvement at least quarter-to-quarter if you looked at 2015. So it's about 50% market related and 50% self-help. We're in front on the self-help side, so we're tracking in the right direction.

Robert Wertheimer - Barclays Capital, Inc.

Thanks, Rich.

Richard J. Tobin - Chief Executive Officer

Thanks Rob.

Operator

We will now move to Monica Bosio with Banca IMI. Please go ahead.

Monica Bosio - Banca IMI Intesa Sanpaolo

Good afternoon and good morning, everyone. I would ask three questions. The first is related to the provisions for the antitrust investigation. Could you please give us some more details on the timing of the investigation? When do you expect it could be and if the provision is enough to face a potential fine?

And the second question is just general, on the back of what you have told before on the Agricultural segment and the Commercial Vehicle segment, should we expect a back-loaded here, so with most of the fundamental of the company concentrated in the last quarter? And the very last question is your feeling about LATAM. I know it's really difficult, but do you feel it might have reached the bottom? Thank you very much.

Richard J. Tobin - Chief Executive Officer

Okay, Monica, for obvious reasons, I am not able to answer your question about the provision, nor the timing of the payment. As soon as we know, I'm sure that we're going to tell everybody, but that is still ongoing, so I am unable to comment on that.

On the Ag CV side, as I mentioned before on the CV that we would expect a normal seasonality for margins to ramp through the year and then it's going to be backend loaded. On the Ag side, I think you need to be careful and not to model in that fourth quarter margin that you saw last year, which is heavily influenced by the fact that we have cut production in Q2 and Q3 and then re-ramped in Q4. We'd expect to see the lowest margin in Q1, margins to come up in the following two quarters and then we reserve Q4 depending on where we are in inventory about the level of production performance. So CV should look like every other year in terms of seasonality and Ag will be less backend loaded than it was in 2015.

Monica Bosio - Banca IMI Intesa Sanpaolo

Okay.

Richard J. Tobin - Chief Executive Officer

On LATAM, I think let's get through the process ongoing in Brazil and see how that gets settled. In Argentina, Argentina is actually doing quite well in Ag right now. I think the truck was down, but that is because of the Euro V transition at the end of last year. So we would expect Argentina truck to be down in the first half of 2016, but market conditions in Argentina are improving in Ag and our execution in Argentina, we're doing quite well. I think we gained share in both primary categories in Q1. So we're happy with the developments or pleased with the developments of what's happening in Argentina. Brazil, I think we need to wait until we see what happens with the political solution.

Monica Bosio - Banca IMI Intesa Sanpaolo

Okay. Thank you very much. Very, very clear. Thank you.

Richard J. Tobin - Chief Executive Officer

Thanks, Monica.

Operator

We will now take a question from Ann Duignan with JPMorgan. Please go ahead.

Ann P. Duignan - JPMorgan Securities LLC

Hi. Good morning, guys.

Richard J. Tobin - Chief Executive Officer

Hi, Ann.

Ann P. Duignan - JPMorgan Securities LLC

Hi. In Europe on Commercial Vehicles, can you just talk a little bit about whether fleets are increasing their fleet size or whether we are just seeing pull-forward of replacement because of low interest rates? How are you feeling about the core fundamentals in European CV?

Richard J. Tobin - Chief Executive Officer

I think it is somewhat interest rate driven, as we've talked about before, but I think it's the medium size fleets that are growing. I think that we saw the large fleets were replacing last year, which was driving the top line. I think what we see and especially since more of Southern Europe bias now, you're seeing kind of the smaller fleet and individual operators that is driving the growth here.

Ann P. Duignan - JPMorgan Securities LLC

Okay. That's helpful. And I know you had 1% of your Commercial Vehicle sales were NAFTA. Can you expand on that?

Richard J. Tobin - Chief Executive Officer

It's prototyping. It's nothing. It's not a commercial – I don't even know how it got in there, quite frankly. It's 1%. You got me, Ann. And it's not distribution sales; it's prototype material.

Ann P. Duignan - JPMorgan Securities LLC

Okay. I was just curious if...

Richard J. Tobin - Chief Executive Officer

Yeah, no.

Ann P. Duignan - JPMorgan Securities LLC

...anything that's coming over or something.

Richard J. Tobin - Chief Executive Officer

No, no. If we enter North America, you'd be the first one we tell.

Ann P. Duignan - JPMorgan Securities LLC

Thank you. I'll be prepared for that disclosure, but anyway. Just one follow-up. I think you said your debt went up in Brazil. Can you just expand on that?

Richard J. Tobin - Chief Executive Officer

What was that about Brazil? Sorry.

Ann P. Duignan - JPMorgan Securities LLC

Debt increased in Brazil?

Richard J. Tobin - Chief Executive Officer

Oh bad debt.

Ann P. Duignan - JPMorgan Securities LLC

Bad debt. Okay.

Massimiliano Chiara - Chief Financial Officer

Our interest expense in Brazil.

Richard J. Tobin - Chief Executive Officer

Oh interest expense. It was an interest expense comment.

Ann P. Duignan - JPMorgan Securities LLC

Okay.

Massimiliano Chiara - Chief Financial Officer

So basically with the losses there, higher losses in Brazil, particularly on the truck side, that is growing over there and the cost of debt in Brazil is higher than the average.

Ann P. Duignan - JPMorgan Securities LLC

Okay.

Richard J. Tobin - Chief Executive Officer

A comment on the interest cost line.

Ann P. Duignan - JPMorgan Securities LLC

And the interest costs. Okay. Great. That's helpful. I appreciate it. Thank you.

Richard J. Tobin - Chief Executive Officer

You're welcome, Ann.

Operator

We will now move to Joe O'Dea with Vertical Research Partners. Please go ahead.

Joe J. O'Dea - Vertical Research Partners LLC

Hi. Good morning. On NAFTA and underproduction and kind of outlook for the rest of the year, it sounds like the back half of the year that could be more aligned with retail. So could you just kind of give a refresh on where you stand? I think, a quarter ago, you were talking about taking dealer inventories down about 30%. Maybe your comfort level with where those stand? And then just particularly because we see the industry data out of AEM, it still looks like 100-plus horsepower inventory is pretty high there, so helping us kind of parse out what's going on in small, mid versus higher horsepower?

Richard J. Tobin - Chief Executive Officer

Yeah, sure. The reason that we took down high horsepower tractor is, from our view, the combine inventory is almost in balance now. So the bulk of that needs to be taken out is in the high horsepower segment. That's where we've made the most significant cuts in the production to let that go. So that's probably going to take the balance of the year. But, I mean, we've took – if you look at the slide and look at the relative cuts in production, those are relative to production numbers in Q1 where we had already cut. So you can imagine the levels that we're running at right now. But it's costing us some share in the short term, but it's healthy overall because we are trying to let the amount of late-model used get bought up in the marketplace, and it's a way that we can protect pricing. And so far in Q1, it's worked. We've lowered channel inventory. We're working on the 140-plus horsepower segment, and it's not to the detriment of pricing that we're selling into the marketplace. So that's where really the balance of the heavy lifting is going have to be done between now and the end of the year.

Joe J. O'Dea - Vertical Research Partners LLC

Okay. And you had previously talked about how a year ago there was a fair amount of competition chasing what was going on in the livestock sector in some of the small/midsize I think high horsepower, if you take 100-plus horsepower and the small/midsize within that. Has anything sort of shifted more positively in the end market there versus prior expectations?

Richard J. Tobin - Chief Executive Officer

No. I mean, I think that there was a significant amount of the growth rate that we had seen in dairy and livestock has dissipated, if you look at it in terms of the horsepower class. But in terms of pricing, it's stable. I mean, it's a competitive – the lower the horsepower segment, the more the competitive dynamic of the industry is, so we'd expect it to be that way, but it's not prohibitive now that the growth rates have slowed.

Joe J. O'Dea - Vertical Research Partners LLC

Okay. And then just one on price/cost, still some benefit from material costs in the quarter, how you see that progressing over the course of the year as we do see some increasing input costs here and how you are planning for that?

Richard J. Tobin - Chief Executive Officer

We don't expect to see input costs increasing. I mean, Brazil is a little bit of an outlier. If that was to ramp back up, we would probably see some inflation there. But if we're talking about EMEA and NAFTA, we expect to hold those material benefits for the balance of 2016.

Joe J. O'Dea - Vertical Research Partners LLC

Great. Thanks very much.

Richard J. Tobin - Chief Executive Officer

You're welcome.

Operator

Our next question comes from Tyler Etten with Piper Jaffray. Please go ahead.

Tyler L. Etten - Piper Jaffray & Co. (Broker)

Hey, guys. Thanks for taking my questions. I was wondering if we could talk a little bit more about the Brazil inventories right now. How are you feeling about those and what kind of levels are you looking at compared to normal, or are they normal right now?

Richard J. Tobin - Chief Executive Officer

They're reaching normalization in harvesting equipment, and actually, I mean, the big ag trade show's going on right now in Brazil. And from what I understand, that demand in sugarcane harvesters and combines is actually okay, considering the conditions. I think that there's still too much tractor inventory. Our target is to reduce dealer inventory under current forecasts somewhere in the order of 30% to 40% by the end of the year.

Tyler L. Etten - Piper Jaffray & Co. (Broker)

Okay. Great. That's helpful. And again, on Brazil, I was wondering if the guidance for the year is focusing on grain prices being the status quo the entire year and if financing rates of FINAME would stay the same. Is that what you are looking at or do you expect – when you are forecasting, do you expect things to get worse in Brazil?

Richard J. Tobin - Chief Executive Officer

Here is what we know about Brazil is that moda froda (35:32) expires in the beginning of June, or June 4. So we're hoping that that's going to pull some amount of demand unless something gets announced around FINAME rates, which clearly under current conditions I don't think we can expect anything. So we would expect some amount of pull and we're seeing it at least in harvesting now. But then right now, we're not expecting Brazil to get any worse. I mean, you can see the levels that we're talking about across the businesses. But we're not expecting getting it to be demonstratively better either in our forecast.

Tyler L. Etten - Piper Jaffray & Co. (Broker)

Okay. Great. Thanks for the color.

Richard J. Tobin - Chief Executive Officer

Welcome.

Operator

Our next question comes from Massimo Vecchio with Mediobanca. Please go ahead.

Massimo Vecchio - Mediobanca Banca di Credito Finanziario SpA (Broker)

Good afternoon. Three questions from my side. First one on Iveco. I understand you don't give segment margins, but I was wondering if you can indicate an incremental margin for the second half the same way you are indicating decremental margin on Ag.

Richard J. Tobin - Chief Executive Officer

Massimo, isn't that the same thing?

Massimo Vecchio - Mediobanca Banca di Credito Finanziario SpA (Broker)

Sorry.

Richard J. Tobin - Chief Executive Officer

If I give you the growth rate and the incremental margin, it's the same thing. But yeah, we expect it to be accretive over the balance of the year.

Massimo Vecchio - Mediobanca Banca di Credito Finanziario SpA (Broker)

Okay.

Richard J. Tobin - Chief Executive Officer

And it will demonstrate the same seasonality that you saw in 2015.

Massimo Vecchio - Mediobanca Banca di Credito Finanziario SpA (Broker)

In 2015?

Richard J. Tobin - Chief Executive Officer

That if I can give you.

Massimo Vecchio - Mediobanca Banca di Credito Finanziario SpA (Broker)

Okay. The other two questions is Brazil, your competitors are talking about the positive pricing in Ag. Can you give some indications on these? And third question is Russia and Argentina, probably some markets which are giving some positive signs. I was wondering if you can expand on what is your position in those markets.

Richard J. Tobin - Chief Executive Officer

Okay. In Brazil, we're pricing for inflation and everybody is, but that's really at the end of the day net neutral in terms of profitability. Argentina, as I commented before, we're pleased on what's going on in Argentina in terms of some of the laws that President Macri has put in in terms of taxation in the farming sector. I think we need to get some stability in the banking sector for that market to really take off. But as I mentioned before, we're doing quite well in Argentina on the Ag side, gaining share in both tractors and combines at least through Q1. Russia, I think we need to wait. There is some rumblings about reopening of the Russian market. We don't see it quite yet, but at least the dialogue is improving from where it's been over the last 48 months or so.

Massimo Vecchio - Mediobanca Banca di Credito Finanziario SpA (Broker)

Do you think Argentina can compensate Brazil or the dimensions are too different?

Richard J. Tobin - Chief Executive Officer

It can't – a normal Brazil in terms of its size is significantly larger, it buffers Brazil, but it doesn't compensate for it.

Massimo Vecchio - Mediobanca Banca di Credito Finanziario SpA (Broker)

Right. Thank you very much.

Richard J. Tobin - Chief Executive Officer

You're welcome.

Operator

We will now move to Larry De Maria with William Blair. Please go ahead.

Larry T. De Maria - William Blair & Co. LLC

Hi. Thanks. Good morning, Rich. A quick question on Ag. Can you just talk about the emissions change coming up next year and whether you plan on building more inventory later in the year and the possibility of a pre-buy, considering you're obviously talking about too high of an inventory and trying to get that down also. So can you just rectify that? And then secondly, can you talk about order boards in Europe and the sustainability of European Ag and how you would gauge maybe the downside risk in the second half on Europe? Thank you.

Richard J. Tobin - Chief Executive Officer

Sure. All right. We are already Tier 3 compliant in harvesting equipment, large tractors, and sugarcane harvesters in Brazil and we expect to be fully compliant. I've seen the comments before about stockpiling and pre-buy. There may be some, but we would consider that more to be an entry year number rather than impacting the full year. So we don't – we may be ahead of the cycle in terms of the introduction of Tier 3 and electronic transmissions already. So I don't expect that we'd be building up inventory during 2016 to accommodate that overall.

And then the order books in Europe are stable from where we ended up at the end of 2015, we're more or less the same with the roll-forward. It's been a little bit choppy. I mean, I think that you've seen the commentary from some other competitors, which in terms of the regional splits we'd agree with in terms of Germany being slightly down, France a little bit choppy, Poland being a little bit down, but Eastern Europe being up somewhat. We're right in line with those particular forecasts. At the end, net-net, it ends up being a relatively stable kind of flat environment.

Larry T. De Maria - William Blair & Co. LLC

Okay. That's really good color. I appreciate that. And as it relates to Eastern Europe being up slightly, is that a change in the market or would you attribute that to choppiness? Because, obviously, if Eastern Europe turns, that could be relatively meaningful.

Richard J. Tobin - Chief Executive Officer

I think it's just a question of some of those markets have been down for a period of time. If you go back and look at 2014, 2015, you've had – Germany was up quite a bit during that period. So it's just buffering some of the impact there, but it's not the smaller markets at the end of the day, but they do kind of even out some of the bigger markets as they go up and down, whether it's legislative driven or something else.

Larry T. De Maria - William Blair & Co. LLC

Okay. Thanks, Rich. Good luck.

Richard J. Tobin - Chief Executive Officer

Yeah. Thanks, Larry.

Operator

Our last question today comes from Ross Gilardi with Bank of America. Please go ahead.

Ross P. Gilardi - Bank of America Merrill Lynch

Yeah. Thanks a lot. Couple of questions. I want to squeeze one in on Powertrain actually. Your engine units sold were flat, which strikes me as being significantly better than your overall addressable markets unless you are just disproportionately tied to just the European truck market. So could you talk a little bit about that?

Richard J. Tobin - Chief Executive Officer

We're disproportionally tied to the European truck market. You answered the question.

Ross P. Gilardi - Bank of America Merrill Lynch

Okay. Simple as that. Well, I wanted to make sure.

Richard J. Tobin - Chief Executive Officer

Yeah, simple as that. If you take a look at the growth rates in European trucks and where it happens and we've got in terms of unit volume a bias to the light Commercial Vehicle segment in terms of third-party customers.

Ross P. Gilardi - Bank of America Merrill Lynch

Okay. And what about just transmissions and axles being up 24% year-on-year, what's going on there?

Richard J. Tobin - Chief Executive Officer

That's all internal demand.

Ross P. Gilardi - Bank of America Merrill Lynch

That's all internal? Okay. And then, Rich, could you ballpark like what your mix of small versus large ag equipment is in North America these days?

Richard J. Tobin - Chief Executive Officer

In terms of units?

Ross P. Gilardi - Bank of America Merrill Lynch

Yeah.

Richard J. Tobin - Chief Executive Officer

It depends on where you want to...

Ross P. Gilardi - Bank of America Merrill Lynch

Well, I don't know about units. Actually, I'm sorry. I didn't mean to cut you off. Just to clarify, I don't know about units. Just in terms of overall revenue mix.

Richard J. Tobin - Chief Executive Officer

No, we don't. I can just tell you that we do not participate at the lower end of the AEM reports. Our bias is 100 horsepower and up. So there's...

Ross P. Gilardi - Bank of America Merrill Lynch

Yeah. I realize that. I just...

Richard J. Tobin - Chief Executive Officer

There is a significant part of the market that we don't touch.

Ross P. Gilardi - Bank of America Merrill Lynch

I realize you are not in the very low end. I'm just trying to understand how much the sort of small to mid would be buffering your overall NAFTA Ag result?

Richard J. Tobin - Chief Executive Officer

Well, I mean, we don't give you the regional split in the Ag results, but it's more or less where it was last year. The New Holland brand in North America serves primarily dairy and livestock. That's been the growing portion of the market and they've been doing quite well – they did quite well last year. So that is a natural buffer and one of the strengths of having the brands positioned the way they are and splitting them between row crop of KSIH (44:32) at the upper end, I mean, these are not absolutes, of course. And with a bias towards the upper end, the New Holland more of its traditional dairy and livestock that's allowed us to buffer the impact of being disproportionately weighted towards one or the other.

Ross P. Gilardi - Bank of America Merrill Lynch

Got it. Thanks. And then one of the first questions was on capital allocation and you emphasized the desire to get back to investment-grade as sort of the top priority. I mean, you have a buyback authorization out there and it sounded like, a quarter ago, that you were going to try to use some of that. Has that changed because of the $500 million charge at all, or would you still expect to buy back some stock this year?

Richard J. Tobin - Chief Executive Officer

Our expectation is to use the authorization.

Ross P. Gilardi - Bank of America Merrill Lynch

Thanks a lot.

Richard J. Tobin - Chief Executive Officer

You're welcome. Thanks a lot.

Operator

That will conclude the question-and-answer session today. I would now like to turn back the call over to Federico Donati for any additional or closing remarks.

Federico Donati - Head of Investor Relations

Thank you, Bertrand. We would like to thank everyone for attending today's call with us. Have a good evening.

Operator

That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.

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