CNH Industrial N.V.
Q2 2019 Earnings Call Transcript

Published: 1 Aug 2019

[Operator:]

Good morning, and afternoon ladies and gentlemen, and welcome to today's CNH Industrial 2019 Second Quarter and First Half Year Results Conference Call. For your information, today's conference is being recorded. [Operator Instructions]At this time, I would now like to turn the conference over to Federico Donati, Head of Investor Relations. Please go ahead, sir.

[Federico Donati:]

Thank you, Karen. Good morning and afternoon, everyone. We would like to welcome you to the CNH Industrial Second Quarter and First Half 2019 Results Webcast Conference Call. This call is being broadcasted live on our website and is copyrighted by CNH Industrial. Any other use, recording or transmission of any portion of this broadcast without the expressed written concept of CNH Industrial is strictly forbidden.We are pleased to have here with us today CNH Industrial's CEO, Hubertus Mühlhäuser; and our CFO, Max Chiara, who will be hosting today's call, they will use the material you may download from the CNH Industrial website. After their presentation, we will be holding a Q&A session. As a final comment, please note that any forward-looking statements, we might be making during today call are subject to the risks and uncertainties mentioned in the Safe Harbor statement included in the presentation material.Additional information pertaining to factors that could cause actual results to differ materially is contained in the company's most recent report 20-F and EU Annual Report, as well as other periodic reports and filings with the U.S. Securities and Exchange Commission, and equivalent authorities in the Netherlands and Italy. The company presentation may include certain non-GAAP financial measures. Additional information, including reconciliation to the most directly comparable GAAP financial measures is included in the presentation material.I will now turn the call over to our CEO, Hubertus.

[Hubertus Mühlhäuser:]

Thank you, Federico. And good morning and good afternoon to everyone. As we have reached the halfway point in our fiscal year, we continue to be faced with a well-publicized issues ranging from trade disputes and tariffs to global weather uncertainties driven by climate changes. If there is a silver lining here, it would be that our visibility into the effects of these headwinds are a bit clearer now than they were a quarter or two ago. While farmers struggle with various complicated and difficult decision, the trade calculus has made a hard drop even harder.On a positive note, the US farmers took advantage of recently higher soft commodity prices and sold off crop inventory and further certain subsidy programs delivered by the U.S. administration to relieve the American farmers will assist in these difficult times, but we're certainly mindful of their struggle as we continue throughout the year.While agricultural end markets proved challenging, we are optimistic about the resilience of our customer base that will support continued replacement demand. In construction, infrastructure projects and low interest rates sustained demand, albeit on a slightly lower level than anticipated at the beginning of the year.Finally in Commercial Vehicles, even though the euro area GDP continues tepid pace we have seen for the recent year. The EU truck market is healthy and the migration to alternative propulsion is real and we'll over proportionately benefit our Iveco and FTG brand as market leaders in alternative propulsion and gas.Turning on the second quarter and first half highlights, Q2 Industrial Activities, net sales were down 2% in constant currency, which filled the top line to be flat year-over-year for the first half. Our performance in the second quarter however, has demonstrated our margin resilience in the muted end market environment in our off-highway business with gross margin for agriculture up 20 bps versus Q2 last year.And the performance in our commercial especially weak and powertrain business continue their positive margin trajectory as well, delivering 50 bps and 40 bps of gross margin improvement, respectively. Combined with a normalization of below the EBIT line items such as interest, foreign exchange rates, and taxes helps to improve the bottom line on a year-over-year period, with an increase in adjusted diluted EPS in Q1 and first half of 11% and 14%, respectively.Moving on to Slide 4, let me provide you with a high level industry update for Q2. First, I'd like to highlight that in the Ag segment, the North America, row crop market is largely weaker due to a pause in demand for combine harvesters being driven both by Canadian and U.S. end markets. Despite this backdrop in the major row crop segment, the performance of the used equipment portfolio remained healthy with both demand and pricing stable.The U.S. administration has released instructions to access the 2019 farmer’s aid package debt together with the 2018 package and the disaster relief support contributes about $30 billion over the last two years period helping to provide stability to U.S. farmers and supporting some of the replacement demand.EU tractor demand remains healthy in the quarter, up 9% with combines down almost 22% due to the spillover impact from extremely dry weather conditions suffered in Central and Northern Europe during the last harvest season. In South America and Brazil particularly, farmers had a gap in funding between the early run-off of the 2018, 2019 Moderfrota program and the new plan for 2019, 2020 has been announced at the end of June.Interestingly, this program for the new season was confirmed with similar support level to that of the prior one. We would anticipate that there is demand that has been pushed out into Q3 that would have come during the second quarter and the absence of the early runoff.In terms of construction end market, this is probably where we have seen the most shifting of demand trends, particularly in road building and site preparation with expectations for a stronger market in the EU and slightly weaker in all other geographies.The South American volumes have improved slightly across most market segments, due to the anticipated financing incentives, with the exception of infrastructure that still has not had the much needed investment. Finally, North American industry demand has been weaker than originally expected in the sub-segments in which we compete.For trucks, the European truck market was up 17% year-over-year, with light duty trucks up 13%, primarily in the [indiscernible] subsegment while medium and heavy were up 25% which much of the strength is coming from new requirements around trucking drive activity with so called electronic tag aircraft and other safety measures.South America was up 23% with Brazil, up 49%, and Argentina, down 46%. For buses, the European market was up 4% this quarter and the South American market was again quite strong with an increase of 54% with both geographies also demonstrating good order books.In general, despite a muted end market scenario, we continue to make progress on our trajectory confirming our guidance for the full year, and of the realized negative FX impact on our net sales for Industrial Activities. Further, we confirm our adjusted diluted EPS, as well as our net debt guidance.At this point, I'll hand it over to Max for the financial overview of the presentation. Max?

[Massimiliano Chiara:]

Thank you, Hubertus and, good morning or afternoon to everyone on the call.In summary, terms, we finished the quarter with solid earnings in spite of a very challenging market environment. We had market weakness, we are experiencing in the combination of the current slowdown in North America, row crop and effects from a dry unfavorable 2018 European harvest, coupled with persistent challenging market conditions in Turkey and Australia. In this environment, we have continued to push pricing and diligently managing our cost and we have taken additional actions to accelerate the savings in the coming quarters.Moving now to Slide 5, and the key figures for the second quarter and first half. Net sales of Industrial segments were down 7% on a reported basis and 2% in constant currency. Adjusted EBIT was down 8% in the quarter and 3% year-to-date. Second quarter adjusted net income of $430 million was up 8% from last year and for the first half it was $678 million, up 13% from the same period in 2018.Adjusted EPS up $0.03 to $0.31 per share for the quarter and up 6% for the first half. The adjusted tax rate for the quarter was 24%, relatively flat from last year and we expect it to be 27% for the full year 2019. Not included on the slide, but worth nothing is the decrease in net interest expense when compared to the second quarter of last year, as well as the improved foreign exchange result compared to last year due to the non-repeat of FX losses in emerging markets, both contributing to the year-over-year increase at the bottom line level.Net debt of Industrial Activities was flat in the quarter to $1.5 billion, free cash flow of Industrial Activities was $0.4 billion offset by dividend payments of $275 million and a $45 million spend in our share buyback as we have started our $700 million buyback program in the second quarter. As well as negative FX translation effect of $60 million versus positive $230 million last year on our euro-denominated debt. Available liquidity was $9.9 billion, down $0.2 billion compared to the end of March, 2019, and up $0.9 billion compared to the end of December, 2018.Turning to Slide 6, let's discuss the second quarter and first half performance in our Industrial Activities net sales, excluding now the impact of foreign exchange translation, which represent 4.4% in Q2 and 5.4% in H1 of our net sales percentage change year-over-year.For the second quarter, net sales at constant currency of our industrial activities, decreased 2%. Agricultural Equipment decreased a net 3% as a result of lower sales volume in the European and rest of world regions, partially offset by a 3% positive price realization performance across all geographies.Construction equipment sales decreased 3% whereby at 2% positive price realization was more than offset by lower volume in North America due to the continuation of the inventory destocking actions in our dealer network and the weaker end user demand in certain key markets in rest of world, primarily in the Indian subcontinent.Commercial and Specialty Vehicles sales decreased slightly with lower truck and bus deliveries offset by favorable volume and specialty vehicles, higher sales in services for maintenance and repair contracts and a positive price performance.Powertrain sales were down 1% due to lower sales volume, primarily in the rest of the world region. In terms of regional segment mix for the quarter, it was largely unchanged from last year.Turning to Slide 7 now, with an overview of our operating results by driver. Industrial Activities adjusted EBIT was $527 million, down 8% year-on-year with a resilient performance in margin at 7.5%, flat year-over-year; primarily due to the lower volume, mainly in Europe and in the rest of the world regions, as well as higher product costs due to raw material and tariff headwinds, and an increase in R&D investments, offset by a positive price realization across the portfolio.On Slide 8 now, with the view by segment of the gross margin and the EBIT contribution. All segments with the exception of CE, delivered an increased gross margin. Our gross margin was up 20 bps on the back of a strong price realization, more than offsetting lower volume and raw material headwinds.For Commercial and Specialty Vehicles, gross margin increased 50 bps, and in Powertrain 40 bps. Industrial Activities, gross margin was up 20 bps to 18.6%. Our adjusted EBITDA for the second quarter is down $75 million year-on-year due to the lower adjusted EBIT and the lower D&A primarily due to negative FX translation. The adjusted EBITDA margin was down slightly at 10.9% in Q2.Turning now to the individual segment performance on Slide 9 starting with Ag worldwide unit deliveries were down 9% in tractors and down 15% in combines, and worldwide production was down 2% versus last year in the second quarter.While the company unit inventories ended up 33% in tractors, primarily lower HP tractors; and up 1% in combines, with North America unit inventory down 20% in high horsepower tractors and down 5% in combines. Production performance was slightly above retail in Q2 in anticipation of the production summer shutdown.Adjusted EBIT was $341 million in the second quarter of 2019, with adjusted EBIT margin at 11%. Positive net price realization was more than offset by unfavorable volume and mix, high product cost, primarily related to the increased raw material cost and tariff and increased product development spending driven by investments in precision farming, including the preparation for the rollout of our top of the line high horsepower tractor later in the year, and the introduction of Stage V engine applications.While uncertainties in the agricultural end-markets related to the trade tensions remain unresolved and negative weather events are impacting planting and harvesting patterns and market sentiment, we believe the cyclical replacement demand remained stable with used equipment inventories at low level, supporting new equipment sales in North America.Order book remains lower than last year with the exception of South America, where we see double-digit order pick up, both in tractors and combines. With the exception of South America on a consolidated basis, we have intervened and reduce our production program versus the previous cycle by 10% in Q3, to maintain our inventory balance for the second part of the year.We reiterate that we currently expect to slightly under produce retail in AG for the full year of 2019. We expect to counter the production cuts with; one, resilient price performance; two, the continued execution of our cost efficiency program with a focus on G&A labor cost reduction. And three, the positive mix impact expected from new product launches, which start ramping up the levers in the second part of the year, while we continue to stay firm on our investment and innovation.Turning to Slide 10, construction worldwide unit deliveries were down 10% with compact equipment, down 9%; general construction down 7%;and road and site, down 21%. Worldwide production was relatively flat versus last year with compact equipment down 1%; general construction, up 6%; and road and site operation, down 9%%Inventory in units were up 36% in preparation of the production summer shutdown. Adjusted EBIT was $25 million in the second quarter of 2019, with adjusted EBIT margin of 3.3%. Positive net price realization including the steel tariff surcharge, mainly North America, was more than offset by higher product costs, primarily related to increased raw material cost and tariff.End user demand in the construction industry in the U.S. remained stable, supported by standing for public and infrastructure investments. Despite the strength conditions in the construction industry, still challenge in the residential sub segment.As a result, our order book is down in North America, while we have started to see some improved orders in the other regions, particularly in compact equipment and road building. This mixed environment has convinced us to adjust our production to the low end of our estimates. And for the balance of the year, we expect production down year-over-year. So that on a full-year basis, we expect to achieve a production performance in balance with retail.In the meantime, our 80

[Hubertus Mühlhäuser:]

Thank you, Max.Please join me now on Slide 16, when we turn to the market outlook for the full year 2019. Many of the uncertainties we had touched on last quarter are still evident today, but our understanding of how the moving parts affect our business has become clearer. Additionally, weather condition in many geographies continue to trend unfavorably to much of the second quarter with the end results for machinery demand and crop yield still somewhat in question.That being said, we are still cautiously optimistic with some of these macroeconomic headwinds will be resolved in the near term and at least strengthen sentiment in the latter part of the year. I won't run through all the segments by region here, but as I said earlier, we believe that cyclical replacement demand in agricultural remained stable, reduced equipment inventories at low levels and supporting new equipment sales in North America.With reference to South America demand we remain optimistic for the second part of the year. In terms of construction equipment, we have raised expectations in the compact and service subsegment for South America and rest of the world. In the road building and sire preps, we have lowered, many of the industry volume expectations. While globally we see the CE market as steady there are pockets of weakness in Asia that for the industry are sometimes more significant than for our specific demand.The truck market in Europe for heavy is expected to be flat to slightly down and in light it is anticipated to be up with positive trends in natural gas for both segments as previously anticipated. In the South American market and particularly Brazil, demand recovery should continue driven by attractive borrowing rates old fleet renewals and increased freight demand and hence we are expecting at least a 15% growth rate.On Slide 17, we highlight our guidance for the full year of 2019. As a result of the updated end market outlook and as mentioned in my opening remarks, our 2019 targets are as follows

[Federico Donati:]

Thank you very much for that. This concludes our prepared remarks for the second quarter results, and we can now open up for questions. Karen, over to you.

[Operator:]

[Operator Instructions] We will now take our first question from Ann Duignan from JPMorgan. Please ask your question.

[Ann Duignan:]

My first one maybe on commercial vehicles. If you could explain the strategic rationale for re-entering the heavy duty markets, why does the market need another S-WAY truck and can you talk a little bit about the number of new competitors entering the natural gas environment. Please?

[Hubertus Mühlhäuser:]

Well, interesting quite some. First of all, we are a significant player in that segment in Europe, obviously. Secondly, I think if you look at the lineup of our commercial vehicle we had profitability issues and the heavy segments which we have now sold with the new S-WAY, which actually has far better cab -- it was received very, very well and the same time takes cost out, and hence, improving our margins.So it's no question that we will continue to producing and also providing to the market and heavy-duty trucks. And what I said is -- it is a game changer for our business. This truck was received very, very, very positively by really all stakeholders.And then thirdly, it goes without saying that our distribution network in Europe, of course, depends on a full-lineup of commercial vehicles from light to medium to heavy. And so, all-in-all we are very, very pleased with this truck as it will allow us, we believe, to increase our market share to go back to historical levels.And on top of that, of course, given that we have the leader with 55% market share in the LNG, so liquefied natural gas segment for the heavy, and that this segment as predicted has nearly doubled already year-to-date with 2% coming from 1% last year and continues to grow.We see this growing as we have said to the low-double-digits, perhaps in the near future. And given that we are the leader there with our heavy duty LNG trucks. I think these are all reasons that's been very much for us staying in that segment. And of course I'm saying in the commercial vehicle business. Does that answer the question?

[Ann Duignan:]

But the competitors in LNG, how many are new, who are your competitors. And how many new competitors are entering the market as we speak?

[Hubertus Mühlhäuser:]

Ann, you're very difficult to hear. Can you repeat that, I think you said competitors on the LNG side entering the segment. Is that what you said?

[Ann Duignan:]

Yes.

[Hubertus Mühlhäuser:]

Who is entering is very obvious, [indiscernible] is really the second player in the market here, being a bit late to the party. They are gaining share, obviously, as you would expect, however we still keep the majority of the market and the third player in that is Volvo. But the majority of the shares I said 55% with us. And we basically believe firmly that with an improved cab and truck. S-WAY plus the LNG, we can definitely maintain that share or even increase that share. Max, you want to add something.

[Massimiliano Chiara:]

Now, I just want to add that we have this record in terms of economy of 600 kilometers that is unsurpassed in the industry right now. With the less -- with less developed infrastructure is key to push demand forward.

[Hubertus Mühlhäuser:]

Yes. And on the infrastructure, by the way also that has improved dramatically and I think the increase of nearly ten folds of the penetration in Germany and speaks for the sustainability of that trend and the resilience, and the adaptation of LNG and very solution in the truck industry that's going to stay there. Okay…

[Ann Duignan:]

I appreciate that. And I look forward to 80/20 in the PowerPoint presentation, Hubertus.

[Hubertus Mühlhäuser:]

Pardon?

[Ann Duignan:]

I look forward to you applying 80/20 to the PowerPoint presentation on earnings day.

[Hubertus Mühlhäuser:]

Okay, good. Very good. Interesting comment. Thanks, Ann. Next question. At least make sure that you ask one question per person please. Thank you. Thanks Ann.

[Operator:]

Thank you. Your next question comes from the line of Joe O'Dea from Vertical Research. Please ask your question.

[Joe O'Dea:]

You heard us a number of things that you touched on at the end of your comments around some of the things that give you optimism on AG heading into 2020 or arguably things that could also help the back half of the year. And so, just a question around what you think keeps that demand on hold it in the back half versus the recent taking advantage of better commodity prices. We're seeing some of the aid payments flow through this month. Why that's not translating into better demand in the back half.

[Hubertus Mühlhäuser:]

Well, I think the farmers itself have benefited from the higher commodity prices and have reduced their stock of crops in the last month, which is a positive, but I think the hanging in there right now and waiting now for the harvest they want to see whether there's Frost and we believe that we're going to see then the demand pattern coming up in Q4 beginning of October.So that's right now what is holding it up. They are waiting in there. There, you're going to see what they're going to have in the beans then, how the yields are they want to see, how the weather comes and then also they want to basically use the positive effects of caps depreciation and tax incentives as I've said.We are cautiously optimistic that in Q4, demand will pick up and we are still confirmed and also optimistic for 2020 but make no mistake, it's not an easy time right now for the U.S. farmers because as we said, other people stepped into the supply chains of soft commodity, we're seeing that in South America right now.That is the reason why our order book is significantly up for AG, specifically in Brazil, and these are kind of competitors that the U.S. farmers then have to deal with because of these uncertainties that have been created around the trade disputes, so that in all, it's kind of the reasons why I guess demand right now is a bit muted. But why we are cautiously optimistic for the latter part of the year Q4 mainly and then going into 2020, but it won't be easy for them.

[Operator:]

Your next question comes from the line of Larry De Maria from William Blair. Please ask your question.

[Larry De Maria:]

I understand you're cautiously optimistic sentiment around the fourth quarter and into next year. Curious and I apologize if you discussed this earlier and I missed it, but curious about how you're thinking about second half production and the usual four quarter true up in the Ag markets in North America specifically, if you think you're at what point do you think you need to maybe make a call on production and compare that to where your inventory you think is and where the industry inventory is, please. Thank you.

[Hubertus Mühlhäuser:]

Well I give that to Max, we have make calls on our production. I think we said something about second half that, Max….

[Massimiliano Chiara:]

We have took the call right now for the balance of the year and we are expecting to production to be down 10% in Q3. Q4, there will be the positive trend. The expectation is for a positive trend in retail as typically happens at the end of the year and with as our production program right now. We expect to under produce returns significantly in Q4 to close the year-end balance production to retail for the full year.

[Larry De Maria:]

And how would you characterize. Thank you for that characterize inventory in the industry vis-à-vis, you guys were taking inventory into next year.

[Hubertus Mühlhäuser:]

Right now for our perspective on inventory and total channel between company inventory and dealer inventory on our end, we see two areas where there is some work need that needs to be done, particularly, obviously the situation in the combined market in Europe is not helping Hence, there is a potential risk of some inventory sticking out there for longer than anticipated.And then the second area obviously is we continue to keep a very close eye on North America, row crop, which is, under control. While we expect lower horsepower tractors also to be watched out during the balance of the year.

[Operator:]

Your next question comes from the line of Chad Dillard from Deutsche Bank. Please ask your question.

[Chad Dillard:]

So I just had a question on North America. Just trying to think through just like what your expectations are for that market facilitation program. To what extent is that cash flow built into your back end outlook for agriculture and do you think that could actually please farmers to either pay more debt back or buy more equipment?

[Hubertus Mühlhäuser:]

Okay. Max why don’t you take that.

[Massimiliano Chiara:]

I think the question is about cash flow on the, on the pharma side although you expect. Right.

[Chad Dillard:]

Yes. The market facilitation program, just the impact and what you're kind of what you're baking in terms of growth there?

[Massimiliano Chiara:]

So I think between waiting for the harvesting results and allowing the farmers' to cash in on the subsidy programs, we expect demand to move forward in the latter part of the year starting in October and which is what Hubertus said during the call. And also, there will be a tweaking on intention to purchase equipment based upon farmers level of profit to optimize the tax, environment.

[Chad Dillard:]

And then over to South America -- over to South America. What activity levels have you seen since the phenomenal funding was replenished are you starting to see a snap back and into what extent is that assumption of pent-up demand baked into the back end of the year?

[Massimiliano Chiara:]

So basically, what happened in South America, the funding that was appropriated through then BNDS the Bank of Development in Brazil run out at the end of April. And so, and end of April mid of May, so basically there has been at a halt on the retail market for a month and a half.At the beginning of June out, the government, the Brazilian government has announced the new [indiscernible] program for the before the harvesting year 2019-2020, which start at 1 of July of the year at more or less similar conditions, so slightly higher interest rate but actually more funding available and so the expectation is that the demand that halted in the second quarter would be catched up in -- caught up in Q3, and together with the expectation of a strong harvesting season and the potential increase in arable land in particular in Brazil, we expect demand to improve significantly in the second part of the year after a negative first half.

[Hubertus Mühlhäuser:]

And to add on that despite the negative first half we have gained share in South America and Brazil, specifically by mid-single-digits, and we basically, of course, we want to continue to attack and want to increase our share there. Now on a better market in the second half. So we're really positive about Brazil. Thank you.

[Operator:]

We will now take our final question. Your next question comes from line of conversion Gungun Verma from Goldman Sachs. Please ask your question.

[GungunVerma:]

I had one question on Precision AG, obviously you're investing increasingly in the development of this technology. Can you remind us how material is the contribution from Precision AG in overall sales and EBIT in AG?

[Hubertus Mühlhäuser:]

Well, I don't think that we disclose the individual sales and I also want to keep our powder a bit dry for the Capital Markets Day. I think you are going to hear a lot about Precision AG there and I think we disclose there what the sales are and for most importantly what our projections are, but at this point in time we don't want disclose, but we will see a lot more about that on the Capital Markets Day. So stay tuned and please be there.

[Gungun Verma:]

Sure. Can I then ask a follow up question, please. Just one on commercial vehicles, your competitors are talking a lot about aftermarket and services segment. I'm not sure if you've disclosed this in the past, but can you comment on how big the aftermarket businesses is for IVECO?

[Hubertus Mühlhäuser:]

Same thing there, we basically -- Max going to -- are we disclosing that. I mean what we basically, what you're going to see is, and I said that with the new track which is completely connected, right now, we will significantly increase the aftermarket by offering services that we have not yet provided so far. We are working there in partnership with world-class companies such as Amazon and Microsoft and I said facing here, I'm just going to be part of the Capital Market Day, where we basically going to give a trajectory how this so-called trend around privatization, driven by digitalization is going to affect positively our business and as of course improving the mix dramatically, because the margins, of course on those services are significantly better and then on the whole goods business. Max, do you want to add anything?

[Massimiliano Chiara:]

Not this time.

[Hubertus Mühlhäuser:]

He does not. Okay, thank you very much.

[Operator:]

Thank you. That concludes our question-and-answer session. I would now like to turn the call back over to Federico Donati, for any additional or closing remarks.

[Federico Donati:]

Thank you, Karen and thank you, everybody. And have a nice day.

[Hubertus Mühlhäuser:]

And I think we wish everybody a nice summer, right. Stay tuned and see on September 3rd. Bye-bye.

[Operator:]

Thank you, ladies and gentlemen that does conclude our conference for today. Thank you for participating. You may now disconnect.