Deere & Company (NYSE:DE) Q2 2019 Results Conference Call May 16, 2019 10:00 AM ET
Josh Jepsen - Director of Investor Relations
Cory Reed - President, John Deere Financial
Ryan Campbell - Vice President and Chief Financial Officer
Brent Norwood - Manager, Investor Communications
Conference Call Participants
Adam Uhlman - Cleveland Research
Andy Casey - Wells Fargo Securities
Chad Dillard - Deutsche Bank
Jamie Cook - Credit Suisse
Joe O'Dea - Vertical Research Partners
Courtney Yakavonis - Morgan Stanley
Tim Thein - Citi
Jerry Revich - Goldman Sachs
David Raso - Evercore ISI
Ross Gilardi - Bank of America
Sameer Rathod - Macquarie
Robert Wertheimer - Melius Research
Larry De Maria - William Blair
Steven Fisher - UBS
Mig Dobre - Baird
Ann Duignan - JP Morgan
Steve Volkmann - Jeffries
Seth Weber - RBC Capital Markets
Stanley Elliott - Stifel
Good morning. And welcome to John Deere & Company Second Quarter Earnings Conference Call. Your lines have been placed on listen-only until the question-and-answer session of today's conference. I would now like to turn over the call to Mr. Josh Jepsen, Director of Investor Relations. Thank you. You may begin.
Hello, good morning. Also on the call today are Ryan Campbell, our Chief Financial Officer; Cory Reed, President of Ag and Turf Division and Brent Norwood, Manager of Investor Communications. Today, we will take a closer look at Deere's second quarter earnings, then spend some time talking about our markets and our current outlook for fiscal 2019. After that, we will respond to your questions. Please note that slides are available to complement the call. They can be accessed on our website at www.johndeere.com/earnings.
First, a reminder. This call is being broadcast live on the Internet and recorded for future transmission and use by Deere & Company. Any other use, recording or transmission of any portion of this copyrighted broadcast without the expressed written consent of Deere is strictly prohibited. Participants in the call, including the Q&A session, agree that their likeness and remarks in all media may be stored and used as part of the earnings call.
This call includes forward-looking statements concerning the Company's plans and projections for the future that are subject to important risks and uncertainties. Additional information concerning factors that could cause actual results to differ materially is contained in the Company's most recent Form 8-K and periodic reports filed with the Securities and Exchange Commission.
This call may also include financial measures that are not in conformance with accounting principles generally accepted in the United States. Additional information concerning these measures, including reconciliations to comparable GAAP measures is included in the release and posted on our website at www.johndeere.com/earnings under Quarterly Earnings & Events. Brent?
John Deere completed the second quarter with solid results despite uncertain conditions in the agricultural sector. While near term ag markets remain challenging in the U.S., foreign markets such as Brazil showed signs of strength. Additionally, the ag division continues to make solid progress, advancing our technology investments and innovative new product programs.
In construction and forestry, end market demand remained strong, resulting from broad based industry drivers such a GDP growth, oil and gas activity and infrastructure investments. With order books extending into the fourth quarter, the division is on track for a solid finish to the year.
Now, let’s take a closer look at our second quarter results beginning on Slide 3. Net sales and revenues were up 6% to $11.3 billion. Net income attributable to Deere & Company was $1.135 billion or $3.52 per diluted share.
On Slide 4, total worldwide equipment operations net sales were up 5% to $10.273 billion. Price realization in the quarter was positive by 4 points, while currency translation was negative by 4 points.
At this point, I’d like to welcome to the call Cory Reed, President of Ag and Turf with responsibility for sales and marketing in the Americas, as well as a number of platforms, including precision ag and crop harvesting. Over his 20 plus year career at Deere, Cory has held many roles within the Ag and Turf division and the most recently served as President of John Deere Financial.
Thanks Brent. I’ll start with a review of our agriculture and turf business on Slide 5. Net sales were up 3% in the quarter-over-quarter comparison, primarily driven by higher shipment volumes and price realization, partially offset by negative impact of currency translation.
Operating profit was $1.019 billion, resulting in a 14% operating margin for the division. During the quarter price realization offset material and freight inflation, while other production costs ran slightly higher than expected. With regards to material cost inflation, keep in mind that our steel contracts operate on a three to six month lag to spot prices. Lastly, changes in currency had an unfavorable impact to the margins of 1.5%.
Before we review the industry sales outlook, let’s look at the fundamentals affecting the ag business, on Slide 6. Despite high production levels forecasted for the ’19 and ’20 season, corn's global stock to use ratio is expected to decline in response to record consumption outpacing supply. Conversely, wheat stock to use ratio is projected to increase in ’19 and ’20 due to a sharp production recovery from last year’s drought stricken regions, such as Europe and Australia.
Meanwhile, Soybean stock to use ratio was forecasted to remain at elevated levels through ’19 and ’20 marketing year in response to higher than expected yields in U.S. and the ongoing trade dispute between the U.S. and China. The inventory increase is further compounded by uncertainty for near term global demand as the African swine fever has significantly diminished the herd size in China.
Slide 7 outlines U.S. principal crop cash receipts, an important indicator for equipment demand. 2019 principal crop cash receipts are estimated to be roughly $117 billion, a decline of 4% since last quarter, reflecting the recent pressure on commodity prices resulting from rising stocks, diminished market access and near term demand uncertainty. The confluence of these factors compounded further by U.S. late planting seasons have adversely affected farmer sentiment in recent weeks.
As a result, further trade progress between the U.S. and China is becoming increasingly important to the near term sentiment. By region, our 2019 ag and turf industry outlooks are summarized on Slide 8. Industry sales in U.S. and Canada are forecasted to be flat to up 5% for 2019. However, as near term fundamentals have weakened, we anticipate large ag industry sales to be on the lower end of that range with Canadian demand turning negative due to adverse weather and currency fluctuations and further complicated by tariffs on certain crops, such as canola and lentils.
Our small ag equipment compact tractors continued to show a strong order book for 2019, driven by healthy U.S. economy and GDP growth, while growth from midsized tractors is more modest due to the softness in the livestock and dairy sector.
Moving on to the EU 28, the industry outlook is forecast to be flat in 2019, stabilized by healthy margins for the arable and dairy sectors in the south and west regions, offsetting less favorable conditions in the north central and northeast regions. In South America, industry sales of tractors and combines are projected to be flat up 5% for the year with strength in Brazil balanced by slowness in Argentina on account of high inflation and political uncertainty.
Farmer sentiment remains quite positive in Brazil, which had a very strong first half of the year. Farm margins in the region continue to be supportive of equipment demand and sentiment has been boosted following record corn and soybean harvest in 2019. We experienced positive farmer sentiment at the recent Agri Show where equipment sales continued at healthy levels. Furthermore, this year’s Agri Show featured the initial launch of our leading technologies to the Brazilian market, products such as Combine Advisor, Exact Emerge and Exact Apply were well received during their debut.
Shifting to Asia, industry sales are expected to be flat to slightly down as key growth markets slow modestly. Lastly, industry retail sales of turf and utility equipment in U.S. and Canada are projected to be flat to up 5% in 2019 based on solid economic factors that are supported by continued consumer confidence.
Putting this all together on Slide 9, fiscal year 2019 sales of worldwide agriculture and turf equipment are now forecasted to be up approximately 2%, which includes a negative currency impact of about 3 points. The reduction from previous guidance relates to recent softness in the North American large ag and dairy markets, as well as our decision to under-produce retail for the remainder of the year. Furthermore, we’re reducing our full year operating margin forecast from 12% to 11% to reflect unfavorable movements in volume and mix, as well as the impact of the lower production schedules. Also, the unfavorable impact of currency is over a point.
Before moving on to Construction & Forestry, I’d like to acknowledge the challenging conditions that many of our customers are facing right now. As such, we’d like to highlight a key initiative that is producing positive results for producers, and helping them better manage the many variables affecting their operations, even while end markets remain difficult. Over five years ago, the agriculture and turf division began executing the deliberate shift towards the crop production systems business model. This strategy reframed our approach to innovation and deeply impacted three primary areas of business; number one, our product portfolio planning; number two, our go-to-market strategy; and number three, the integration of precision ag technologies.
Our production system strategy ensures that innovation efforts focus on the entire system of producing a crop, leveraging the entire suite of Deere products from the field prep to planting, protecting and harvesting, driving tremendous value for our customers by maximizing yields and decreasing input costs. The results from this approach have been clear. Today, Deere is producing meaningfully differentiated technology and has achieved its highest North American market share in over a decade.
The strategy’s first step involved in focusing efforts on product portfolios that optimize a crop system. To do this, we formed production system innovation teams organized by crops, such as corn, soy and small grains. These teams ensure innovation focuses on farming jobs that address our customers' biggest pain points and have the most potential to unlock value. The team then work across the various product platforms to allocate R&D investments accordingly.
Next, we engage our dealer channel to focus on the agronomic impact of our equipment. To do this, we conducted LEAD events around the country, LEAD standing for Leading Economic and Agronomic Decisions. These events hosted local customer demonstrations showing the agronomic impact of our technology and equipment. Today, many dealers now employ agronomist, and host their own LEAD events.
Lastly, our integrated precision ag technologies are the most critical enabler of our production system strategy. Today, John Deere is the global leader in precision agriculture and our unique combination of best-in-class machinery, dealer channel and advanced technologies deliver improved outcomes for every pass, every field and every season, bringing real value to farming operations with both reduced costs and increased yields.
Precision Ag is the common thread across each production step, helping farmers and helping producers to manage their operations. It allows farmers to use the same guidance line from planting to spraying, or leverage a common display interface through each step. Increasingly, agronomic data is driving farming decisions and our digital platform provides an opportunity to integrate data across all the production steps and to use it through the entire season to create real value.
The John Deere operations center is our digital platform that allows farmers to plan their work in the off season, monitor and control their operations in real-time and then analyze all the data. Today, we are the only ag OEM to have a comprehensive digital ecosystem, combining both agronomic and machine data into one application. Today, the operation center has over 145 million unique engaged acres in its system globally, leveraging data across each production step results in making decisions differently.
It also allows for the precise soil prep at the beginning of season. It makes each seed count in planting and gives every seed the best opportunity for success during the season. It makes every drop count in applications, adding the right amount at the right location, whether nutrient, herbicide, or pesticide. And lastly, it makes every grain and farming output count in harvesting so that farmers get maximum value from the work they’ve done throughout the season. Even small changes in these items can produce tremendous value for our customers, driving better yield and lowering cost of their operations.
With each production step, equipment can use the data gathered from every pass as connected machines deliver data to the cloud. Simply put, each production step informs the next and subsequent steps can measure the outcomes of prior steps. In order to unlock the power of data, we've designed our digital systems to be as open as possible. Our systems, in other words, are compatible with those of many other industry players.
Openness is an easy thing to say but a more challenging thing to do. At John Deere, we’re committed to growing our leadership position as the most open platform in the industry based on these three important factors: number one, customer control; number two, customer choice; and number three, compatibility. Our first guiding principle is that customers control their data, while Deere provides the most secured means to protect their privacy. That said, customers do not farm alone and often employ trusted advisors as an integral part of their operation and the decisions they make.
John Deere Operations Center gives customers the control to grant access to whomever they choose, providing secure collaboration environment for farmers. Regarding customer choice, the operation center maintains over 115 connected third-party providers. It provides unparalleled access to the industry leaders. From aerial image services to farm profitability providers, these connected partners make our digital platform more valuable and easier to use for customers.
Lastly, John Deere has a history of leading the industry in machine and technology compatibility. Thus, ensuring that our equipment works well in multi-colored fleets. We help pioneer the creation of standards that enable equipment interoperability, such as ISOBUS, the ADAPT standard and AgGateway. Our compatibility efforts also enable customers with mix fleets to bring their data into the operations center.
In summary, while we’ve made great strides to-date, we’re still in the early innings of executing this strategy. One of our next steps involves rolling out our latest technology to new markets, such as Brazil. As I mentioned, we’re just now introducing Exact Emerge, Exact Apply and Combine Advisor to the Brazilian market, and have been very encouraged by the early results. We look forward to updating investors as we move ahead in these areas in the future.
I’ll now turn the call back over to Brent Norwood. Brent?
Thanks, Cory. Now, let’s focus on Construction & Forestry on Slide 11. Net sales of $2.99 billion were up 11%, a result of increased shipments and positive price realization for the quarter, partially offset by the negative impact of currency translation.
Operating profit was $347 million, largely benefiting from increased price realization, shipment volumes and a lower impact of Wirtgen purchase accounting, partially offset by higher production costs and less favorable product mix.
Moving to Slide 12, the economic drivers for the division remain broad based and supportive of continued equipment demand for the year. For 2019, total construction investment and housing starts are both slowing, but do remaining supportive. Meanwhile, oil and gas activity hovers at solid levels for equipment demand growth with oil prices firmly in the mid 60s, and infrastructure investments are growing at the state and local level. Furthermore, equipment rental utilization remains high, while rental rates continue to grow in 2019. Importantly, CapEx budgets from the independent rental companies continue at levels supportive of further equipment demand.
Lastly, global transportation investment this year is forecast to grow at about 4%, though results vary by market and product line. The overall positive economic indicators are reflected in a healthy order book, which is now extending into the fourth quarter.
Moving to the C&F outlook on Slide 13. Deere's Construction & Forestry 2019 sales are now forecasted to be up about 11% compared to last year, driven by strong demand for equipment, as well as an additional two months ownership of Wirtgen. Wirtgen's 2019 forecasted sales have been reduced slightly as certain geographies have slowed in recent months. The global Forestry market forecast is expected to be flat to up 5% with growth coming primarily from cut-to-length products in Europe and Russia. C&F’s full year operating margin is projected to be about 11.5% with Wirtgen margins forecasted to be above that.
Let’s move now to our financial services operations. Slide 14 shows the provision for credit losses as a percentage of the average owned portfolio. The financial forecast for 2019 shown on the slide contemplates a loss provision of about 23 basis points. Current forecast puts loss provisions on par with the 10 year average and below the 15 year average.
Moving to Slide 15. Worldwide financial services net income attributable to Deere & Company was $121 million in the second quarter. For the full year, in 2019, net income forecast is now $600 million compared to previous guidance to $630 million. The reduced forecast contemplates a higher provision for credit losses.
Slide 16 outlines receivables and inventories. For the company as a whole, receivables and inventories ended the quarter up $1.3 billion. In the C&F division, the second quarter increase is a result of a higher order book and production schedule, while the full year rise is largely attributable to a historically low field inventory position at the beginning of 2019. It's worth noting that our forecasted inventory to sales ratio is below the 10 year average.
For Ag, the quarter’s increase is due to continued demand for small ag products, and a front-end loaded production schedule for large ag. By the end of the year, we forecast $50 million decrease in inventory and receivables compared to 2018 due to reduced production schedules.
Moving to Slide 17, cost of sales for the second quarter was 75% of net sales and our 2019 guidance is about 76%, down about a point from 2018. R&D was up about 10% in the second quarter and forecasted to be up 6% in 2019, or 5% when excluding Wirtgen. The year-over-year increase in 2019 primarily relates to strategic investments in precision ag, as well as next generation new product development programs for large ag product lines. SA&G expense for the equipment operations was down 1% in the quarter, and projected to be up about 6% for the full year or 5% excluding Wirtgen.
Turning to Slide 18. For the quarter, the equipment operations tax rate was 22% and the full year effective tax rate is still projected to be between 24% and 26%. Slide 19 shows our equipment operations history of strong cash flow. Cash flow from the equipment operations is now forecast to be about $4.1 billion in 2019, up from $3.3 billion in 2018.
The company’s financial outlook is on Slide 20. Our full year outlook now calls for net sales to be up about 5% which includes about 3 points of price realization and one point related to an additional two months of Wirtgen ownership. On the negative side, we expect currency to be about a 3 point headwind for the year. Finally, our full year 2019 net income is now forecast at $3.3 billion.
I will now turn the call over to Ryan Campbell for closing comments. Ryan?
Thanks Brent. Before we respond to your questions, I’d like to share some thoughts on current ag industry fundamentals and our response to a very dynamic environment. First, it’s important to acknowledge the confluence of difficulties impacting U.S. farmers in recent months.
In addition to persistent uncertainty around global trade and market access, grain framers are also contending with weather related planting delays and uncertain near term demand prospects due to African swine fever. The resulting decline in commodity prices have taken a toll on farmer sentiment and correspondingly our large ag sales forecast has countdown. Deere has historically been quick to respond to end market fluctuations, and we’ve already taken action this year by reducing factory schedules.
Furthermore, we are actively identifying opportunities to further manage costs, while continuing to invest for the long term. Ultimately, these measures ensure we'll be best positioned at year end to respond to market dynamics in 2020. Importantly, the underlying fundamentals of replacement demand remain intact, even if the market faces current headwinds. As such, we expect a continued gradual recovery to resume once these challenges abate. The hours and age of the fleet along with the technology advancements included in our latest offerings will continue to drive demand.
As Cory noted, our production systems approach prioritizes investments that produce cost savings or yield enhancements for farmers. Many of the current pressures today illustrate the need for technology to help farmers adapt to an ever changing and fluid environment. Lastly, the long term positive fundamentals for agriculture remain enact, and we continue to see a growing need for technology to transform farming practices. Our proven ability to perform throughout the cycle combined with our leadership in precision agriculture give us confidence in our ability to deliver strong results over the long term for our customers and investors.
Now, we’re ready to begin the Q&A portion of the call. The operator will instruct you on the polling procedure. In consideration of others and our hope to allow all of you to participate, please limit yourself to one question. If you have additional questions, please rejoin the queue. Angela?
Thank you. We will now begin the question-and-answer session [Operator Instructions]. Our first question comes from Adam Uhlman with Cleveland Research. Your line is open.
I was hoping we can start with the domestic farm equipment business. What are shipment volumes looking like? What were they here in the second quarter? What are you planning for the second half of the fiscal year? And then could you also talk about used equipment market trends, the weakness -- have we seen any weakness unfolding there? Thanks.
If we start thinking about shipment volumes, as we think about the latter portion of the year with what we’ve seen given the uncertainty and our move to reduce production levels, we'll see lower production shipments in the second half of the year. So that’s definitely the case. I mean, if you look at couple of our larger facilities on a unit basis, they’ll be down second half -- compared to second half of 2018 in the 20% range.
I think from a used perspective, we continue to see that market be stable. Pricing has been stable, I'd say by and large we’re very comfortable with where we’re at. And if you look at combines, there has been some conversation on combines ticking up. Seasonally, that’s normal in that new retail combines are being sold and you’re taking trades and those trades don’t move until you get closer to the harvest. So we think that’s a normal pattern, but we feel good about where we’re at today.
A - Cory Reed
Adam, this is Cory. I was going to say that on the late model used, in particular, what we’ve seen is high demand. If you look at volumes, they've come down since the 2014 timeframe. So you have a lot of the late-model used has been moved into the market and lot of folks are looking for late models. And that’s driving what some of the continued demand in the market today is replacement demand is really holding the market in there.
Our next question comes from Andy Casey with Wells Fargo Securities. Your line is open.
On the decision to under-produce -- to reduce inventory, is that isolated specifically to North America, or are there other regions also doing that. And the reason I ask is it looks like you’re set up to hold margins for ag and turf in the second half in the mid 10% range despite that 20% down number. I’m just wondering if there is any anything going on in other regions?
Andy, when we look at that under production, I’d say it’s really North America and in large ag. In particular, there is maybe a little bit of that as you look at mid-size equipment but that is mostly a U.S. and Canada issue. Thank you. We’ll go ahead and jump to the next question.
Our next question comes from Chad Dillard with Deutsche Bank. Your line is open.
So with a tougher environment in large ag. To what extent are you changing the pricing assumptions, or funding allocated to any discounting or motions as we go into the 2020 early order programs for the planters and sprayers?
As we think about pricing and as noted with our guidance, we haven’t seen a change. So we’re still expecting about 3 point of price with both divisions participating, so no major change there. I think a big part of that is continuing to manage used, and as we calibrate and reduce production levels that’s all trying to keep that in balance. So I’d say no major shift in terms of our view.
No, I’d agree. On the price side., we’re holding through the remainder of the year, and we’ll have very similar programs as we open up those early order programs going into next year.
Our next question comes from Jamie Cook with Credit Suisse. Your line is open.
Just color on potential cost cutting that you guys alluded to. Obviously, you’re little more concerned about the market, we’re cutting production levels. I mean what would you need to see to take actions on the cost side? And is this only if trade war stuff doesn’t get resolved? I'm just trying to understand the opportunity and what levers you could pull? Thank you.
I mean, I think as we’ve gone through this before, always start certainly managing production levels and trying to manage field inventory and where we’re at and what we want to deliver there. So that’s certainly step one as we go through there. I think the cost side is the combination of continuing to invest in the long term. And how do we protect R&D and continue to invest in the product. Really good example of our view on that is as we went through ’15 and '16, we continued investing in R&D and we’re able to deliver products, like Combine Advisor and like the ExactApply and the sprayers that came out during that time that had we pulled too hard on those, may have been impacted.
So we want to take a long term view from an R&D perspective, but then, look, certainly they cost opportunities. So I think those are the things that we’re continuously looking at, and then we’ll be looking at regardless of the environment in terms of costs.
I think one of the factors that you’re seeing now, as we reduced production schedules. There's a bit of inefficiency that comes into our factories, and so that takes a little bit of time to work that out. And we’re certainly committed to working that out. The other aspect on our SA&G budgets, we’ll continue to look at those. But one aspect to that is we’re investing in customer support initiatives in order to support all of the precision ag and production systems approach that Cory has alluded to and offers like connected support and expert alerts are truly differentiated in the industry. So we’re going to be surgical about this. But for sure, we’re taking a look at it and there’s some opportunity certainly to the extent things potentially get worse.
Our next question comes from Joe O'Dea Vertical Research Partners. Your line is open.
Related to Jamie’s question, I think earlier in the year, you were talking about something in the area of around $850 million cost headwinds that you had in 2019, and tied to materials inflation and tariffs and supply chain constraints and currency, but when we think about things that you can manage. Can you give us any sense of the opportunities that you have within those cost headwinds to address some of them and quantify kind of what that opportunity set looks like, by how much you could take that down independent of what happens with currency, for example?
Joe, I would say starting just at the high level we've talked about I think material and steel, in particular is progressing as we expected, because of the lagging of our contracts as we get into the third quarter on the ag and turf side on hot rolled coil, we start to see that come down. So you'd expect to see some of that benefit end of the third quarter and into fourth quarter. Now as we pull back production, you see the impact or benefit is dampened as a result of that. You also have the 301 tariffs that we've talked about from China. A quarter ago, we've talked about $100 million impact. We’d say its somewhere between $75 million to $100 million, but that’s a bit of a moving target right now, given some of the uncertainty of how and when that will be put into place, but that’s considered there.
And then the other piece we’ve talked about is then on the logistic side. So while by and large we’ve seen less premium freight, we continue to have some critical components that we’re bringing in that we have air freight. As noted a quarter ago, that will continue into the third quarter. And overall, there has been just higher rates for freight as a result of availability and really low unemployment. So those will be the things that we’ve been talking about that have impacted us, and refers to the initial part of your question there, Joe.
I think as Ryan just mentioned on cost, something that we are always looking at, continuing to look at. I don’t know that we want to talk about or quantify what could be. But I think there is continued focus in terms of how do we do that, both from the material side, as well as from cost structure SA&G and the like. Thank you, we’ll go ahead and go to the next question.
Our next question comes from Courtney Yakavonis with Morgan Stanley. Your line is open.
Just wanted to clarify on the executions for under-production in the second half, I just want to make sure that I heard it down 20%. And then secondly, just wanted to also make sure that is assuming that there is no trade resolution in the back half of the year. And that obviously, the AFS situation persists. I just wanted to understand, is there any upside risk. If there is a trade resolution that you could change those production plans, or is that kind of set in stone at this point?
So, I’d say as we think about what’s going on with the forecast, I would say we’re not assuming trade resolution. I think from a quarter ago to today, trade uncertainty has persisted plus the wet weather conditions and then things like ASF that are impacting near term demand. So those are all contemplated. We’ve not assumed -- we get resolution at this point. And as a result, this is why we are taking down production in an effort to calibrate our field inventory and where we want to end the year to position ourselves for 2020. The only thing I’d point out on that comment on the 20%, that’s a couple of our factories this is an example of large ag factory, so that’s not broadly across the entire division. But on a production unit basis, that’s the magnitude we are seeing in the few of our larger facilities. Thank you.
Next question comes from Tim Thein with Citi. Your line is open.
First, Cory, maybe just I want to make sure I have clarified your comments early on pricing. You alluded it. As we think about pricing for '20 and something like a very similar program, I think you said. You don’t mean -- I mean it’s early but you’re not anticipating similar levels of price increases for '20. Is that correct or I just want to make sure…
Tim, my comment was related to the early order programs that we’d see very similar early order programs that we’ve run in the past. That was the comment.
No, commentary on pricing at this point and what we expect in the upcoming year.
And Josh maybe just quickly on Wirtgen. You're two quarters in a row, obviously, the global economic environment has moved around a bit. But some of the other players in that general market have kind of been holding more steady, so in terms of their commentary, maybe just a sentence or two on Wirtgen and what changed there from a geographic perspective?
So our Wirtgen outlook is down about $100 million in sales, and about half of that’s FX related. So I’d say it’s really, Tim, looking at the markets that we mentioned before, China, Turkey, Argentina, Russia. And then we have seen some mix shifting in markets like India, which is -- we’re actually seeing movement out of concrete paving into asphalt. So from the market share perspective, no change for Wirtgen but you see from a ticket price shift there. But that’s really what we’ve seen with Wirtgen thus far. And probably important to note there too, the margin forecast there has held unchanged from previous quarters. So even with some of that reduction, they pulled some levers and done some things to hold their margin performance, which we feel really good about. So thank you, and we'll go ahead and go to the next question.
Next question comes from Jerry Revich with Goldman Sachs. Your line is open.
I'm wondering if you can comment and just build a comfort level around this production cut getting everything done that we need to in ag in terms of rightsizing the channel. Maybe comment on how order trends have played out over the course of the quarter, any other data points you'd share on just to build our comfort level that we won’t be looking at couple of more production cuts to adjust for the current demand environment?
A - Josh Jepsen
As we look at production levels and what we’re doing to calibrate those. I mean really the idea there is that we are pulling back. It’s based on what’s been happening in the market, what we've seen from order flows. So for large tractors, for example, we're ordered out through September, which is about a month less than we would have been a year ago. So that has impacted that view. Cory mentioned we’ve seen some weakness in Canada also that impacts some of our larger products like combines and like four wheel drive tractors. So I think a few of those things have impacted what we’ve seen there. But I’d say that’s the view. And as I noted with Courtney’s question, we’re not baking in trade resolution. So I would say we’re thinking what we think is a balanced view here, but shifting to where do we want to be ending 2020 to position ourselves well given the dynamics of what 2020 could be. Thank you we go to the next question.
Next question comes from David Raso with Evercore ISI. Your line is open.
Just wanted to be clear the set up for ag and turf going into ’20. I think the company used to feel high horsepower ag 2020 would be a recovery year. The way you’re targeting your inventory exiting this year, if we just kept it simple and said next year was flat, let’s just say. Would production be in line with retail? I'm just trying to get comfortable with the set up going into '20 on how you’re now targeting your ending inventory?
David, you’re right. And the idea being this under-production this year sets us up to be in a position to produce to retail, that’s always where we target to be. As we’ve seen we have uncertainty persist here as we’ve made these adjustments that’s shifted but that’s the idea. We want to be in a position that we’re producing to retail next year. So thank you. We’ll go ahead and jump to the next question.
Our next question comes from Ross Gilardi with Bank of America. Your line is open.
I was just wondering and we’ve heard a lot about how the trade war obviously is impacting in the U.S. farmer, and the Brazilian farmers been on either more of the winning end of that. But what about the European farmer, you talked about rising end stocks for wheat. Now, you’re seeing more cautious trends there at all in the core European markets of Germany and France due to rising wheat inventories. And just what does your European order book look like?
So our view on that market is relatively flat, and I think our order book would be in line with that or supportive of that view. As you think about the trade war and puts and takes there, I think I’d say they’ve been benefited, not to the extend say the Brazilian farmer, but benefited through exports, particularly pork but also dairy going into China. So, I think that’s been supportive. Some of that this year -- prospects looks better because of drought last year. So by enlarge, I think the overall environment there is better with the uncertainty overhang in Europe really on Brexit, and what does that mean for the longer-term.
I think maybe a slide shift but nothing significant right now.
Our next question comes from Sameer Rathod with Macquarie. Your line is open.
There seems to be more political discussion around the National Right to Repair Law. Can you help us understand the impact that could have on the company's top line or margins?
So Right to Repair has been in the news a lot. And I think for us it's important to really carve out two issues that are typically embedded in that conversation. One is Right to Repair and we would say we’re supportive of our customers' ability and their ability to repair their machines. So we work with the AEM to support access to service tools, agnostic tools and the ability to repair. So we would not have any issue or concern with that matter. Right to Modify and when you get into modifying actual code, we think that’s a bigger concern as you get into things like safety and emissions and a lot of other components that would be more concerning. So I think we would delineate between those two. And I'll ask Cory to add his comments.
Sameer, I would say we’re leading the industry in offering great tools to both our customers and repairs of equipment that can get in and keep our customers up and running, uptime is a big deal. So we want to give our customers the opportunity to repair what they can themselves. Also, to use who they want to. But at the same time, we worked to build the dealer network that's best in the industry. It’s keeping them up and running all the time. So we feel strongly about giving them all the tools they need and are leading the industry in the Right to Repair space of providing those tools out to the market.
Our next question comes from Robert Wertheimer with Melius Research. Your line is open.
You’ve been quite clear, but I still just wanted to go back to the high horsepower large equipment side, and just make sure I understand how the business is working in and what you’re trimming. You build most stuff to order, I think and you referenced you’re one month shorter on the outlook than you had been. And so you're building to order but the production is down, and there's 20% fall. So what is falling? Is it just a little bit of clean up of excess inventory that’s not to order and the rest of its chugging along as it is, or am I misunderstanding something?
I think there is a combination. I mean some is you’ve got some geographic distribution areas that are maybe a little bit weaker than others are seeing some impacts. We’ve talked about some of the challenges in Canada, for example, and some other parts of the country. So some of it is just working through some of those things, and I think that’s the biggest piece of that. So I think nothing materially different in terms of how we've seen that activity transpire. Thank you. We’ll go ahead and go to our next caller.
Our next question comes from Larry De Maria with William Blair. Your line is open.
Larry De Maria
A question given the adjustment to the guidance, as it relate to last night's announcement, cancellation of U.S. pork inputs to China, which is independent of ASF. Has that factored into your outlook, or should we think about maybe incremental risk in the midsize range? Just curious how you'd describe maybe midsize as you’ve gone through the large size and what the incremental risk from pork exports and other things like that not going to China, which is maybe incremental to [soybeans] [ph]?
Obviously, very new news so not contemplated in our forecast. But what I’ll tell you is with ASF really ramp -- the implications ramping up over the last month or so, we haven’t seen a material shift or change in our midsize tractors or hand forged equipment. So I think right now I’d say we didn’t have upside or downside implied there based on what’s going on with the pork, ASF or broadly any retaliation with China. Cory?
I would say the broader impact in our mid range has been from the continuing challenges in the dairy market in the U.S., and that’s already been reflected in what we’re doing there. So I don’t anticipate a large impact from the announcement last night.
I think that announcement probably benefits EU back to the other question, EU pork probably see increased exports as a result of that and probably see some incrementally from Brazil as well.
Our next question comes from Steven Fisher with UBS. Your line is open.
Just curious what this year’s experience is telling you about the bigger picture of the replacement cycle. Are we back to the old adage of equipment really just lasting one more year and farmers are just going to run it until they break? And then what did you contemplate for retail sales in 2020 at this point with that 20% production cut?
So we obviously don’t have a guide on 2020 particularly in the dynamic market we’re in right now. So I think that’s probably starting point. As you think about replacement demand, we do believe the drivers of replacement demand remain intact, and that’s hours and age on equipment and technology and productivity. I think what we’re seeing today is a bit of a pause as a result of the uncertainties that are out there, but we feel like those drivers are still there. And as we work through some of these short term uncertainties, you see the resumption of that replacement demand. One thing that I would point out is -- I think one thing we see through the technology and the ability to take down input cost through using precision technologies. There’s appetite to invest in those things that can help reduce breakevens and improve profitability that certainly are important.
No, I would agree. And in fact I mentioned earlier that what we’ve seen -- used the example of the combine market is that our late model combine used inventory is running lower, and that’s really driving the replacement demand side. If you start to think of the technology changes that occurred in the last three or four years, 2014 forward, there's a lot of technology that’s enhancing the productivity of those machines and there’s demand at the top end of the market to bring it in.
If we look at the fleets aging out another year, at the end of 2019, high horsepower tractors 220 plus and four wheel drives, are going to be back to 2007 age levels, same with combines. So it's just another year and its aging out. And as soon as some of these uncertainties abate, we will see a gradual recovery in replacement demand given the factors of age and technology adoption.
Maybe one last thing to add is the importance of up-time accentuated even more. And in times like this right now, we’ve got a really short planting window, because of weather patterns. So as we can -- obviously newer machines but then connected support and other things deliver more uptime as these windows tighten. And I think that’s increasingly important for the customers. So thank you. We’ll go to the next question.
Our next question comes from Mig Dobre with Baird. Your line is open.
I want to talk a little bit about C&F, a question with two parts, if you would. So on your outlook, you lowered the top line by about 2 points and then it looks like about half of that came from Wirtgen. I’m trying to understand the other half. And then on Wirtgen specifically, I’m looking to understand how you view the full year revenue, so the full year revenue contraction. And I asked that because it looks to me like your margin guidance implies very solid margins in the back half versus what you’ve done in the front half. So how much risk is there at this point to that Wirtgen margins? Thanks.
So, I think as you think about the overall C&F, you’re right in terms of reduction. You have about half Wirtgen, we’ve talked about that about half of that half, so a quarter is really FX driven, if you look at the legacy C&F business. I’d say the biggest individual piece of that was where we saw weakness in Canada where it's been a few different impacts, Oil and gas, we’ve seen production come down in Canada specifically a little bit, demand for lumber, because of the slowing of housing starts in the U.S. has impacted Canadian lumber as well. So, I think those have been -- those would be the major drivers of what we've seen on the top line.
And it relates to Wirtgen, as we’ve talked about before, 3Q is their bigger quarter in terms of revenue and margin. And the second quarter came in strong, I’d say as we expected and maybe worth noting in this year with Bauma that falls into the third quarter for Wirtgen. So maybe you see that impact. We saw a good response to the show very positive reaction to their new products. So we continue to feel good about that business, the long-term prospect but also as we talked about no change in our view on margins for the full year.
As Josh said, Bauma years can have a little bit slower start, but we feel really good about how the show went. And then if we take a step back and look at how they performed for each quarter compared to their historical averages and looking what they need to deliver for the rest of the year, its roughly in line with they’ve delivered historically. So we feel comfortable about where we are with them.
Our next question comes from Ann Duignan with JP Morgan. Your line is open.
I think I'll switch gears and maybe take a step back and ask the question about the fundamentals. Can you comment on the notion that the future is bright for global demand, given the unprecedented 30% plus or minus reduction in the herd size in China? And plus the potential that the U.S. export market is more permanently damaged, particularly with South America producing near record crops this year. I mean have you contemplated at all the fact that this maybe more permanent than just a six month production cut?
I’ll start there, Ann, this is Josh. I mean, I think when we say we think it’s early to model or say we’ve seen permanent shift in production or market share globally, I think importantly, we support open markets for our customers and their ability to compete globally. I think in that same vein, we really like our positioning, particularly in those production systems of big grains, corn, soybeans and small grains. So we like how we’re positioned there from a global basis. I think as you think about ASF and the impact there, it’s obviously early there. We do expect that herd size I think as of March was down about 20%. So certainly I think there’s some near term impact there in terms of the demand. However, what we’re seeing is and we’ve seen exports from many different countries and different regions of pork moving pretty quickly to China, whether it’s from U.S. or Brazil or from China -- from Europe.
Ann, this is Cory. I would say we see those. The latest forecast would say that the global demand is still going to rise year-over-year. We feel like we’re in the best positions in those markets that produce grain around the world as we’ve continued to build out the competitiveness of the North American farmer with technology. We’re doing the same now in Brazil. Our focus on two things, creating the most competitive output, so on a bushel or an acre basis, or a hectare basis in different parts of the world. And then investing in things that help differentiate our customers to grow more yield at that lower cost point. So I think we’re positioned well and the demand is holding in there.
Our next question comes from Steve Volkmann with Jeffries. Your line is open.
Most of my questions have been answered. But Josh, can I just ask you on the Slide 16 when you talk about your receivables and inventory. If I'm reading this right on a constant currency basis, you’re actually up about $550 million from your previous forecast. But we've talked a lot about getting production. So maybe can you just square that up for us?
A - Josh Jepsen
So as we talked about -- we talk a lot about what we’re doing on large ag side, and you see some reduction there on the ag side of the business. On the construction and forestry side, compared to where we were it is up. And I think that’s really driven by where we started the year. We came into the year at historically low inventory to sales ratios levels. And even with where we’re going to end or where we project to end this year, we’re below our ten year average on inventory to sales. So I think it’s driven by where we started new customer and dealer demand and comfort level as they pull to get the levels that they’re comfortable with.
And we’re going to continue to monitor that, but that’s really the view is we’re seeing strong enough demand and dealers comfort level with their inventory levels and trying to get there. And as you recall, we had hoped to build some inventory in both '17 and '18 but strong demand impeded that. So we actually drew down. We were at historically low levels in both of those years. So you see us really coming back from that. All right, thanks Steve. We’ll go ahead and go to our next question.
Our next question comes from Seth Weber with RBC Capital. Your line is open.
Just wanted to get a litter bit color on this big step down in the finco profitability in the second quarter and just your comp -- your full year guide implies that snaps back pretty quickly in the third quarter and fourth quarter. So just trying to get a better understanding as to what happened and why that’s going to come back to you quickly. Thanks.
So when we think about our JDF guidance -- we talk about in total, if we think about the full year, we came down about $30 million, really driven by two things, provision as well as tax rate. So tax has moved a little bit on us, that’s one. And then the provision would be the bigger component of that. Provision is really driven by I’d say two major components. One would be our growth in our international portfolio. So as our international portfolio has grown, particular markets like Argentina, Brazil, China, and India, you see the provision move with that. And then the other would be on our multi-use account or revolving credit. So that’s been the other driver.
So as you think about the multi-use, the revolving credit, we take a conservative approach there in that we write off 100% of those balances when they go 90 days past due. Historically, we see strong recoveries post write offs. And in times of stress in the industry, we’ve continued to produce really strong returns in that portfolio. So we think underlying there, we see strong customer fundamentals, some of this I think really driven by just seasonality, as well as what we've seen with commodity prices, number of folks haven’t marketed their grains. So there are few different dynamics there. And I’ll ask Cory to comment too.
I think the thing in this to keep in mind is that we’ve been running at write-off level significantly below. Our averages have been over 10 year or 15 year period. And the adjustment that we’re taking now puts us right in line between the 10 and 15 year average on write offs and the provisions. So my take on it is it’s a really solid portfolio that despite what we have in terms of headwinds in the industry, we see write offs stay in line with our averages historically, which means we have a stronger portfolio today as we have in the past.
And maybe one last thing to just to note on that as we think about the multi-use and that driving the big change in the provision. Overall, our portfolio has grown about 8% and the multi use component is going at a lower rate, it’s about 3% growth this year.
And about 7% of the total portfolio. So thank you, we’ll go ahead and take one more question.
Our last question comes from Stanley Elliott with Stifel. Your line is open.
Can you talk about the engaged acres on a regional basis and then how quickly can some of these technologies start to drive that engaged component in South America and other markets?
I mentioned that we have 145 million. We started first in the North American market, and that’s where predominant number of those acres reside today. But the fastest growing engaged acres are places like Brazil see things building out communications network that allow our machine population get connected. We’re taking more technologies in. I mean it’s incredible to see the growth rates around the world. The European market guidance technologies have adopted very fast in a very fast pace, and now we have connectivity and growing across those acres.
The real opportunity is what I mentioned in the production system discussion, customers move from farming to understanding how each pass impacts their cost structure and profitability. And we’re now generating both the data and insights that allow them to evaluate those on a near real-time basis. So really big opportunities for both yield growth and cost management on the customer side being driven off of those engaged acres.
And one thing I’d note, Stanley, is $145 million engaged acres. That includes acres in all four regions, as you think about how we about the world divided up into four, a little over 105 million in North America. So to Cory’s point, we are seeing growth in that outside of North America piece. And as discussed, it’s not just an absolute number in terms of growth in acres, it's the depth. And we think as we offer full solutions across production system, there’s opportunity to have deeper engagement there in the operations center.
If you look right now, I mean planters are lit up all around -- prior to last night’s rain, planters have been lit up all around the country, and that’s taking place. And you can see those acres coming in and being able to evaluate down to the individual seed level what their placement, what their depth, what their singulation, it allows them to understand how they invest in nutrients going forward that ultimately as they close the loop in harvesting and they take that section in and evaluate both their cost structure and yield that they will improve again year-over-year. So the opportunity is growing and more and more customers are adopting the technology that’ll help drive their business forward and competitiveness forward.
Thank you. Well, with that, we’ll conclude the call. I appreciate everyone’s time, and we will be talking soon. Thank you.
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