Deere & Company Q3 2024 Earnings Call Transcript

Good morning and thank you for joining. John Deere completed the third quarter with disciplined performance amid a tough macro backdrop. Financial results for the quarter included an 18.5% margin for the equipment operations. Ag fundamentals remain muted and market demand in Construction and Forestry has tempered, alongside continued price competition, resulting in another quarter of overall challenging market conditions. Despite tougher markets in both Ag and Construction, we continued to execute to our plan, focusing on proactive inventory and cost management. Notably for the quarter, we adjusted rest-of-year production schedules in our earthmoving product lines to target lower year-end -- year-end field inventory levels. As a result, order books across all segments are effectively full for the remainder of the fiscal year as we position our business to respond to changes in retail demand.

These actions, along with a continued focus on cost control, are essential to keeping our business healthy, as we continue to invest in future growth. We now begin with Slide 3 and our results for the third quarter. Net sales and revenues were down 17% to $13.152 billion, while net sales for the equipment operations were down 20% to $11.387 billion. Net income attributable to Deere & Company was $1.734 billion, or $6.29 per diluted share. Double clicking into our individual business segments, we'll start with Production and Precision Ag on Slide 4. Net sales of $5.099 billion were down 25% compared to the third quarter last year, primarily due to lower shipment volumes which were partially offset by price realization. Price realization was positive by slightly more than 2.5 points. Currency translation was negative by a little more than 1 point.

Operating profit was $1.162 billion, with a 22.8% operating margin for the segment. The year-over-year decrease was primarily due to lower shipment volumes and employee separation program expenses. These were partially offset by price realization and lower warranty expenses. Next, we'll turn to Small Ag and Turf on Slide 5. Net sales were down 18% year-over-year, totaling $3.053 billion in the third quarter because of lower shipment volumes partially offset by price realization. Price realization was positive by more than 1.5 points. Currency translation was negative by just under half a point. Operating profit declined year-over-year to $496 million, leading to a 16.2% operating margin. The decrease was primarily due to lower shipment volume and higher warranty expenses, which were partially offset by price realization.

Slide 6 gives our 2024 industry outlook for Ag and Turf markets globally. Across all major markets, we continue to see muted demand resulting from a challenging macro environment. Global stocks of grains continue to rebuild with excellent growing conditions leading to better-than-expected production and lower commodity prices. High interest rates and geopolitical uncertainty further weigh on customers purchase decisions, resulting in reduced demand across all end markets. In the U.S. and Canada, we continue to expect Large Ag Equipment industry sales to be down approximately 15% during the quarter. Demand continues to be pressured by declining farm margins and elevated used inventory levels in late model year machines, which is partially offset by an elevated fleet age, rising farmland values, and stable farm balance sheets.

Within Small Ag and Turf in the U.S. and Canada, industry demand estimates remain down approximately 10%. Further declines in the Turf and Compact Utility Tractor segments, which are more sensitive to interest rates, are partially offset by improving dairy and livestock fundamentals. Turning to Europe, the industry is forecasted to be down approximately 15%, reflecting yield headwinds and weakened margins. Volatile weather patterns continue to drive commodity price and arable cash flow uncertainty, which is enhanced by slightly elevated input costs. However, dairy and livestock fundamentals remain healthy, providing moderate stability to the segment. In South America, we expect industry sales of tractors and combines to decline between 15% and 20%. Commodity price softening and elevated interest rates continue to pressure grower profitability, especially in Brazil, our largest market in the region.

Fundamentals are further pressured by better-than-expected production in Brazil, despite regional weather challenges and a slower-than-forecasted recovery in Argentina. Industry sales in Asia -- in Asia, are forecasted down moderately. Moving on to our segment forecast beginning on Slide 7. Production and Precision Ag, our net sales' forecast remains down between 20% and 25% for the full year. The forecast now assumes roughly 2 points of positive price realization and flat currency translation for the full year. For the segment's operating margin, our full-year forecast remains between 20.5% and 21.5% despite muted demand. Slide 8 covers our forecast for the Small Ag and Turf segment. We expect net sales to remain down between 20% and 25%. The guide now includes 2 points of positive price realization and flat currency translation. The segment's operating margin continues to be forecasted between 13.5% and 14.5%, in line with slowing net sales.

Shifting now to Construction and Forestry on Slide 9, net sales for the quarter were down 13% year-over-year to $3.235 billion due to lower shipment volumes. Price realization was negative by 1 point. Currency translation was also negative by more than half a point. Operating profit of $448 million was down year-over-year, resulting in a 13.8% operating margin, due primarily to lower shipment volumes, unfavorable sales mix, and negative price realization. Slide 10 provides an update to our 2024 Construction and Forestry industry outlook. Industry sales for earthmoving equipment in the U.S. and Canada is now expected to be down 5% to 10%, while compact construction equipment in the U.S. and Canada is now expected to be flat to down 5%. Demand for earthmoving and compact construction equipment is down from robust levels in 2023 and increasingly competitive, as rental re-fleeting decelerates and used inventory levels rise.

While U.S. government infrastructure spending remains supportive and manufacturing investments continue to increase, we are witnessing a sequential slowdown in single-family housing starts amid interest rate uncertainty. This is compounded by continued declines in multi-family housing starts and persistent weakness in the commercial real estate sector. Global forestry markets are projected to remain down around 10%, as all global markets continue to be challenged. The global world building market forecast remains flat to down 5%, as strong infrastructure spending in the U.S. is offset by continued softness in Western Europe. Moving on to Construction and Forestry segment outlook on Slide 11. 2024 net sales estimates are now expected to be down between 10% and 15%, as moderating demand is coupled with planned underproduction.

Net sales guidance for the year now includes about half a point of positive price realization and flat currency translation. The segment's operating margin is now projected to be around 15%, reflecting a tougher competitive environment, decelerating demand, and underproduction of construction equipment. Transitioning to our Financial Service operations on Slide 12, worldwide Financial Services' net income attributable to Deere & Company in the third quarter was $153 million. Net income was lower due to a higher provision for credit losses and less favorable financing spreads, which were partially offset by a higher average portfolio and favorable discrete tax items. For fiscal year 2024, our outlook for net income is now at $720 million, as benefits from a higher average portfolio balance are expected to be more than offset by a higher provision for credit losses and less favorable financing spreads.

Subsequent to the quarter, we announced an agreement with Banco Bradesco to invest and become 50% owners in our Brazilian financing subsidiary, Banco John Deere. This strategic decision reduces incremental financing risks while allowing for continued investment and growth in the Brazilian market. The transaction is expected to close in the second fiscal quarter of 2025. In our quarterly results, we classified Banco John Deere as a business held for sale, which resulted in the net impact of a pre-tax and after-tax loss of $15 million, accounted for in SA&G within the Financial Services segment. Next, Slide 13 outlines our guidance for Deere & Company's net income, our effective tax rate, and operating cash flow. For fiscal year '24, we remain -- we maintain our outlook for net income at approximately $7 billion. Next, our guidance continues to incorporate an effective tax rate between 23% and 25%. And lastly, cash flow from the equipment operations is now projected to be in the range of $6 billion to $6.5 billion.

And finally, on Slide 14, I'd like to hand it over to John May to say a few words.

Thank you, John. This concludes our formal comments. We'll now shift to discussions on a few topics specific to the quarter. Starting off with Deere's performance in the third quarter, net sales declined approximately 20% year-over-year, but we still saw our operating margin come in at over 18%. Clearly, a challenging macro environment, but we've managed to hold margins. Josh Beal, can you kick us off with what happened this quarter?

Great recap, Josh. And on your note about the challenging quarter and decline in demand, farm fundamentals are clearly top of mind right now with corn, soy, and wheat prices all down more than 15% year-over-year, which brings down farm margins as well. Can you walk us through what we're seeing and what this means for both farmers and equipment demand?

This is Jepsen. One important note regarding fleet fundamentals is that North America, we continue to see an elevated fleet age, which enables replacement purchases. Additionally, strong balance sheets are providing support in a downturn, driven by farmland values that are up nearly 5% year-over-year. So while it's definitely a challenging market for customers, there are some supportive factors to account for.

Perfect. Thank you all for that great color. Now, with that context on ag fundamentals, I'd like to move on to our early order programs in North America to better understand how this is translating into equipment sales for model year '25. Luke, our EOPs typically account for roughly 90% of our production for seasonal products each year. Can you walk us through what's transpired so far, as we begin to get some insights into next year?

One thing to highlight beyond just the take rates for our latest solutions is the feedback we're receiving from both customers and dealers on the efficacy of the technology. We continually hear that See & Spray savings are meeting or exceeding expectations and that the ROI pencils out. That said, See & Spray does require significant shifts in the way our customers manage their crop care programs, everything from what chemicals they buy, to how much they buy, to how often they are tendering that their equipment in the field must change, which is a significant investment on the part of the customers. We understand this, which is why we are more committed than ever to dealer engagement and customer success, ensuring we provide the solutions, support, and most importantly, the outcomes that our customers need to succeed.

Yeah, you bet. And just as a reminder, our decision to underproduce is rooted in our learnings from the last cycle. Given that, we began taking actions last year and again this year to drive inventories lower. While this has caused some short-term pain, it is the right plan to manage the cycle and better sets us up for whichever way the market needs. And so with that, I would start by highlighting our situation in Brazil. This market has remained challenged, as you noted earlier. However, we significantly underproduced the market, and despite the industry demand declining more than anticipated, we've still seen inventory decline so far this year and fully anticipate that this trend will accelerate throughout the remainder.

Relative to the North American Large Ag segment, we are beginning to see the impacts of our proactive inventory management decisions with absolute units of new inventory declining double digits over the past quarter, outpacing the industry. We expect further reductions to occur during the fourth quarter, which is in line with historical trends. While we expect our inventory to sales ratios, which remain below industry levels, to end the year at roughly the same level as last year, this reflects a material decrease in the absolute number of years. In fact, to put this into perspective on an absolute basis, we are forecasting to end the year with less than one row crop tractor per dealer location.

That's a great point to highlight, Josh. In fact, we're taking that approach at other factories around the world. For example, our 6 Series tractors in Mannheim, Germany, are also planning a similar shutdown for roughly a third of their fourth quarter production days, which will have an impact on Small Ag margins as well. But to shift back to inventory levels, Luke, can you walk us through the used side?

Yeah, this is John. I'd like to add one additional point to share. I recently spoke with one of our largest dealers in the U.S. who said he does not expect this downturn to be as prolonged as the last cycle. He noted that the proactive steps we are taking to manage inventory are reinforcing that sentiment. As Luke mentioned, Deere and our dealer network are working together to navigate this cycle differently. We are taking action more quickly and making more aggressive decisions to ensure that inventory levels remain balanced as markets soften. And our dealers are working closely with each customer to better rationalize equipment replacement schedules this time. We fundamentally believe that these actions will lead to more favorable cycle dynamics than in previous downturns.

Yeah, definitely, Josh. This is really a story of two businesses, earthmoving and roadbuilding. While our roadbuilding business continues to experience more stable volumes, we've seen some hesitation in earthmoving equipment purchases. Project demand for our earthmoving customers has remained relatively unchanged. However, those same customers are seeing increased competition on their job bids, as well as higher financing costs and overall higher equipment carrying costs following years of -- recent years of high inflation. That means that while still profitable, many customers are experiencing lower profitability compared to just a year ago. And as a result, we are seeing some slowdown in order velocity, which is reflected in our guidance update. Additionally, rental capex spending has diminished, with investments in construction equipment at multi-year lows following years of robust re-fleeting.

Recall that Deere, along with the industry, has been rebuilding our field inventory levels over the past several years. With the recent softening that we've seen, we are taking steps similar to those in our Ag business to underproduce retail demand in both our Construction and Compact Construction Equipment segments through the remainder of the year to best position ourselves for 2025. From a pricing perspective, we continue to see robust competition in the market. This, coupled with rising inventory levels, has required the deployment of additional incentives into the market, resulting in net pricing declines this past quarter.

Yeah, absolutely, Josh. I'd like to start by echoing John's appreciation to our entire John Deere team for their adaptability and resilience to the changes in demand and their continued commitment to delivering for our customers. This quarter, we made difficult decisions to structure the business to align with current market conditions. This involved a mid-single-digit reduction in our global salaried workforce, resulting in one-time expense of approximately $150 million for the business, $125 million of which was booked in the third quarter, while delivering roughly $230 million in run rate savings. The net impact for 2024 is expected to be an expense of about $25 million.

Given the velocity of the market pullback we've seen this year, this has also created volatility in our working capital. As a result, we've seen a downward revision to our operating cash flow guide. However, it's important to note that there are our cost management actions, whether that be our supply management teams that are driving down production costs or focus on reducing inbound and outbound freight or engineering teams working diligently to design out costs from new equipment and retrofit solutions, are yielding savings in 2024 on material and freight, which gives us confidence in our ability to deliver on our net income guide of approximately $7 billion this fiscal year.

And these cost management actions are an example of the many things our team is doing every day to drive a structurally better business that has capital available to invest in value-enhancing products, solutions, and support to help make our customers more productive, profitable, and sustainable each and every day. And as we do that, all stakeholders of John Deere will benefit.

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