AGCO Corporation (AGCO) Q4 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the AGCO 2020 Fourth Quarter Earnings Release Conference Call. At this time all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to Mr. Greg Peterson, AGCO Head of Investor Relations. Thank you. Please go ahead, sir.

Thanks, Shelby, and good morning. Welcome to those of you joining us for AGCO's fourth quarter 2020 earnings call. This morning, we'll refer to a slide presentation and we posted those slides to our website at www.agcocorp.com. The non-GAAP measures that we'll use or that are used in that presentation are reconciled to GAAP measures in the appendix of those slides. This morning we will make forward-looking statements, including demand, product development and capital expenditure plans and the timing of those plans and our expectations with respect to the costs and benefits of those plans and timing of those benefits. We will talk about production levels, share repurchases, dividend rates and our future revenue, price levels, margins, earnings, cash flow, tax rates, and other financial metrics. We wish to caution you that these statements are predictions and that actual events may differ materially. We refer you to the periodic reports that we file from time to time with the Securities and Exchange Commission, including the Company's Form 10-K for the year ended December 31, 2019 and the Form 10-Q for the quarter ended September 30, 2020. These documents discuss important factors that could cause the actual results to differ materially from those contained in our forward-looking statements. These factors include, but are not limited to, adverse developments in the agricultural industry, including those resulting from COVID-19, including plant closings, workforce availability, supply chain disruption and product demand, weather, commodity prices and changes in product demand may also influence. We disclaim any obligation to update any forward-looking statements except as required by law. A replay of this call will be available on our corporate website. On the call with me this morning are Eric Hansotia, our Chairman, President and Chief Executive Officer; and Andy Beck, our Chief Financial Officer. And with that, Eric, please go ahead.

Thank you, Greg, and good morning. And we appreciate your interest in the AGCO and your participation on the call today. We'll start on Slide 3 that provides the financial summary. We finished 2020 with a very solid fourth quarter while overcoming supply chain delays and ongoing COVID challenges. I want to start this morning by thanking AGCO's 21,000 employees for their hard work that resulted in our world-class support for our farmer customers throughout the pandemic. I could not be more proud of their efforts that enabled AGCO to do our part for the global food supply chain while keeping our factories and co-workers safe. These efforts help deliver fourth quarter sales growth of 8% and 180 basis points of operating margin expansion on an adjusted basis. Another major focus for us in 2020 was reducing our inventories. The progress we've made in this area contributed to record cash flow from operations for the year as well as put us in a great position to benefit from the strengthening market demand we are forecasting for 2021. Positive customer response to our improved product lineup is benefiting our retail sales performance, and we plan to keep investing in new technology. Our substantial cash flow from operations is enabling us to maintain our planned investments in smart farming solutions and enhanced digital capabilities. Products like our smart planters, smart nozzle sprayers, and connected premium tractor products are providing productivity enhancement options for our customers and our new margin-rich sales opportunities for AGCO. The recent rally in soft commodity prices, lifted farmer sentiment and created higher demand for agricultural equipment as we finished 2020. We expect supportive market conditions to continue in 2021 and our new financial outlook reflects this optimism. We are targeting sales growth, margin expansion and significantly higher earnings in 2021. Slide 4 details industry unit retail sales by region for the full year of 2020. As COVID pandemic unfolded early last year, the consumption of grain for food, fuel and livestock was negatively impacted by global economic constraints. Towards the end of the year, grain consumption began recovering consistent with improving economic activity and increased grain exports to China. Following reduced forecast for ending grain inventories, soft commodity prices grows, which is positive for farmer economics. Consequently global industry demand for farm equipment improved as we finished the year. North America industry sales of tractors increased in 2020 compared to 2019. Growth was strongest in the sales of low horsepower tractors with improving demand for higher horsepower tractors as we finished the year. The fleet age for large equipment remains extended, providing a strong potential for replacement demand in North American market. Industry retail sales in Western Europe decreased modestly during 2020 due largely to the COVID related production constraints. Market demand in the second half of the year increased over the prior year and mostly offset significant declines in demand experienced in the first half. For the full year, industry sales were in the weakest in the United Kingdom and Scandinavia, and they're partially offset by growth in Germany, which benefited from some tax incentives implemented in 2020. Dry weather across much of Western Europe, negatively impacts wheat production. Although strong grain export demand and supportive wheat prices provided some offsets. European dairy and livestock fundamentals have stabilized after weakening earlier in the year. Industry retail sales in South America increased during 2020, with growth in Brazil and Argentina, partially offset by weaker demand in the smaller South American markets. Strong crop production in Brazil and Argentina as well as favorable exchange rates are supporting positive economics. Farmers are replacing their aged fleet following years of depressed demand due to economic weakness and the challenging political environment. As we communicated last quarter, our focus for 2020 was to address the needs of all of our key stakeholders during the COVID crisis. This perspective has guided our actions since the outbreak. First and foremost, we established protocols for all of our facilities, focused on employee health and safety. These protocols have served us well and have been critical factor in maintaining production. During the fourth quarter, we faced considerable challenges with our component availability from our supply base. Due to those efforts of our purchasing and manufacturing teams, we were ultimately able to secure the components in time to exceed our fourth quarter production projections and meet customer demand. The COVID risks of component supply availability as well as COVID workforce issues remain for both our operations and our suppliers operations, which may impact our planned production output. We will stay diligent to attempt to mitigate these issues to the extent possible. We are proud of the way our employees are going above and beyond to keep farmers and dealers operating through these difficult circumstances. Innovative approaches, connecting with our dealers and customers through digital tools have been a positive byproduct that we can leverage in the future. AGCO's 2020 factory production hours are shown in Slide 6. For the full year production was down about 5% compared to 2019 levels. As previously discussed, our manufacturing operations were significantly impacted by the crisis, particularly in Europe and in South America in the second quarter. Our supply chain and production teams have done a great job allowing us to recover the production in the second half. Total company production hours are approximately flat for the fourth quarter versus the same period in 2019. Growth in Brazil was offset by lower production in the U.S. and Europe, where production was reduced to facilitate planned dealer and company inventory reductions. We met our dealer inventory reductions in North America and South America as well as in the EME region. Turning to 2021, we currently project production hours to increase approximately 6% to 8% compared to 2020 levels. In addition, our order board entering into 2021 for tractors is significantly higher in North America, Europe, and South America compared to a year ago. I'm going to now hand over the call to Andy Beck, who will provide you more information about our fourth quarter results.

Thank you, Eric, and good morning to everyone. I'll start on Slide 7, which looks at AGCO's regional net sales performance for the fourth quarter and full year of 2020. AGCO's net sales were up about 7% compared to the fourth quarter 2019, excluding the positive impact of currency translation. The Europe, Middle East segment reported an increase in net sales of approximately 8%, excluding positive impacts of currency translation compared to the fourth quarter of 2019. The largest increases occurred in the UK, Turkey, Poland and Italy. Net sales in North America decreased approximately 10% excluding favorable currency translation compared to the level of experience in the fourth quarter of last year. Primarily due to our dealer destocking efforts, decreased sales of grain and protein equipment, as well as sprayers were partially offset by increased sales of compact tractors and precision planting equipment. AGCO's fourth quarter net sales in South America increased approximately 53% compared to the fourth quarter 2019, excluding negative currency translation impacts. Sales growth occurred across all South American markets with the most significant growth in Brazil. Net sales in our Asia-Pacific, Africa segment decreased about 4% in the fourth quarter of 2020, compared to 2019, excluding positive impacts of currency. Continued weakness in Africa and smaller Asian markets was offset by growth in Australia and China. Consolidate replacement part sales were approximately $345 million for the fourth quarter of 2020, and we're up about 13% compared to the same period in 2019, excluding the positive impact of currency. Turning the Slide 8, we examine AGCO sales and margin performance. AGCO's adjusted operating margins improved by approximately 180 basis points in the fourth quarter 2020 compared to the same period in 2019. Margins were positively impacted by higher levels of net sales, cost control initiatives, pricing as well as a favorable mix in the fourth quarter. Europe, Middle East segment reported an increase of $24.8 million in operating income compared to the fourth quarter of 2019, resulting in – primarily from higher net sales, partially offset by higher warranty and engineering expenses. North American operating income increased approximately $2.7 million in the fourth quarter compared to the fourth quarter of 2019. Despite lower sales, a positive sales mix, improve margins in the grain and protein business and lower warranty expense helped to offset the lower sales. Our South America segment reported operating margins of 5.9% in the fourth quarter as operating income improved $34.1 million from the same period in 2019. Higher sales and improve sales mix and reduced expenses all contributed to the improvement. In our Asia-Pacific, Africa segment operating margins expanded by 150 basis points, 10.6% in the fourth quarter. Higher sales and improve sales mix and cost control efforts contributed to the improvement. Slide 9 details the grain and protein sales, our region, and by product. The sales decreased by about 11% excluding negative currency impacts in the full year of 2020 compared to 2019. Globally grain and seed equipment sales declined 15% with our EME and North America regions showing the largest decline. In Europe, we have had a number of projects deferred until 2021 due to economic conditions caused by the pandemic. Protein production sales decreased approximately 7% in 2020 due to declines in the North American, European regions partially offset by growth in South America and Asia-Pacific, Africa. The protein production segment has been significantly impacted by the pandemic, particularly in North America where protein processing capacity has been challenged. In China, protein producers are beginning to recover from the Asian swine fever and have started to rebuild their production capabilities. Our order flow for protein production equipment in that region has improved throughout the year. Slide 10 addresses AGCO's free cash flow, which represents cash resulting from operating activities, less capital expenditures. Our strong sales and earnings performance in addition to working capital discipline contributed to significant free cash flow generation of $627 million for 2020, which was a record for the company. As a result, our improved working capital position, our net debt at the end of December 2020 was approximately $339 million lower than December 2019. With respect to our capital allocation plans, we will continue to invest as needed in capital expenditures to support new product development and the needs of our factory and the rest of our business. We remain opportunistic on acquisitions and we also plan to retire about $275 million in term loan debt in the first half of this year. This is to repay debt we took as additional liquidity in 2020 at the outset of the crisis. And also we're discussing with our Board, our plans for returning cash to shareholders in 2021. With the exception of our quarterly dividend, we suspended any further shareholder payments at the beginning of the COVID crisis, while we haven't determined the details yet, we intend to return to share repurchases during 2021. Lastly, losses on sales receivable associated with our receivable financing facilities, which are included in other expense net, were approximately $5.6 million during the quarter compared to $12.1 million in the same period of 2019. Our 2021 outlook for the three major regional markets is captured on Slide 11. We currently expect higher retail industry demand across North and South America with relatively flat demand in Western Europe. In North America, higher commodity prices and improve farmer's sentiment is expected to result in increased 2021 retail sales. Replacement demand for aged fleet of larger equipment is expected to drive most of the increase. Demand for smaller equipment is expected to be more stable after several years of increasing demand. We project North American industry unit tractor sales to be up 5% to 10% in 2021, compared to 2020. The EU farm economics are expected to remain supportive in 2021. Higher commodity prices are expected to support healthy demand in the variable farming segment, milk prices have stabilized at profitable levels, but higher feed costs will challenge the economics for dairy producers. Western Europe industry demand is expected to be mixed across the markets in 2021 with total industry demand stable compared to 2020 levels. Elevated commodity prices and favorable exchange rates are expected to support additional growth in South America during 2021, as farmers continue to replace aged equipment. In total industry demand in South America is expected to improve approximately 5% from 2020 levels. On Slide 12, we highlight the assumptions underlying our 2021 outlook. Our priorities continue to be maintaining a safe working environment for our employees and providing proactive support to our customers and our dealers. We also continue to manage our costs while preserving our investments in digital technology and smart farming product development. Our 2021 forecast assumes improved global industry demand when no additional impact from the pandemic. Our sales plan includes market share improvement and price increases of 2.5% to 3% aimed at offsetting higher material cost inflation during 2021. At current exchange rates, we expect currency translation to possibly impact sales by about 4%. Engineering expenses are expected to increase by $50 million to $60 million on a constant currency basis compared to 2020, and be about 4% of sales. The increase is to fund investments in smart farming and precision ag products, as well as to continue our rollout of our platform designs. Operating margins are expected to be up 80 basis points to 100 basis points from 2020 levels driven by higher sales and production, favorable pricing, net of material costs and productivity initiatives partially offset by the increased investments in smart products and our digital initiatives. We are targeting an effective tax rate, ranging from 30% to 32% for 2021. Slide 13, list are selected 2021 financial goals. We continue to operate in uncertain conditions, and this outlook does not consider any further business disruptions caused by the COVID pandemic. We are projecting sales to be in the $10.2 billion to $10.4 billion range with 2021 earnings per share targeted in a range from $7 to $7.25. We expect capital expenditures to be approximately $300 million and free cash flow to be in the $400 million to $450 million range. For the first quarter, we projected improvement in sales and earnings over 2020 levels. Our current estimate for the first quarter is that our earnings per share will be approximately $1 per share. This estimate is highly dependent on the component availability from suppliers and the resulting timing of production. With that, I'll turn it back to Greg.

Before we take your questions, we wanted to remind you that our Annual Analyst Meeting is scheduled for March 3rd. You'll find details of that meeting on Slide 14 and on starting on February 15th, you'll be able to register for the event and we look forward to engaging with you during this meeting. With that let's go ahead and open it up, operator for questions. And as a reminder, we'd like to limit folks to one question with a very brief follow-up. Let's go ahead and start the Q&A.

[Operator Instructions] Your first question is from Kristen Owen of Oppenheimer.

Great. Thank you so much. Good morning and thank you for taking our questions. I was wondering if you could talk a little bit more about the improved backdrop in supporting some of the additional investments in precision ag and digitization. Are you seeing the opportunity to accelerate investments in certain areas? And can you provide some additional detail on areas in the crop cycle where you see AGCO having the highest entitlement at this stage?

Yes, I can start us off. So thanks for your question, Kristen. Yes, so the market starts at the macro level and we'll go to more micro. At the macro level we're seeing a stronger market environment with farmer sentiment going up and we've already seen commodity prices and all that. So that provides a strong backdrop. It marries up nicely with our already existing intention to really focus in on precision ag and what we call smart machines. And so we've taken our portfolio and accelerated it. We're adding more investment to the tune of about $50 million or $60 million to our investment from last year and pulling forward some of the projects that we had planned for. We believe we've got a really good track record here in that. When you take a look at a few of the most recent measures, we won three out of the four Tractor of the Year awards. We won eight of the ag engineering 50 awards in North America, most of any company. So our teams have been delivering good, smart solutions that are well received by the industry and well received by customers and so on. It's a good place to invest in an area of the industry that we think is ripe for more value added to the marketplace. Now, specifically to the crop cycle we actually have investments all through the crop cycle. We see ourselves as the – is a leader in planting technology between – from the factory full planter solutions as combined with the retrofit opportunities that we have through precision planting to upgrade existing planters from where they are today to being latest cutting edge high-tech planters. But we've got a lot of investments in sprayer technology and we've also got the ideal combine and we continue to build on top of that. You saw us come up with; we are the only combine in the industry that has joystick steering. We've taken the steering wheel out. We've got the only combine in the industry where you have auto-hookup of the header. We can – that's our platform. We continue to bring innovation to that platform, as well as our tractor lineup. You see we've launched new tractors in all of our brands this year and got recognized significantly. So precision ag works as a system. All of these tools have to work together, and so that's essentially our approach.

Great. Thank you. And as a brief follow-up, just something shorter term in nature, you did mention some of the supply chain bottlenecks as risk to Q1 production. Can you just provide some additional details there where you're seeing those bottlenecks?

Well, currently I think our most stress from COVID is in our European supply chain, but we've also got a number of suppliers that we're working closely with in South America. It's our number one concern is COVID impacting their operations that reduces their capacity and may cause some distribution disruptions. So we're working with suppliers, we're putting in some safety stock component inventory where it makes sense, and just managing this. The good thing is that this is not a new action for us. We've been doing this now for, in this intense mode with control towers all around the world, around each commodity for about a year when we first had this come up in Asia and the team has gotten to be very, very good at it.

Your next question is from Stephen Volkmann of Jefferies.

Hi, good morning everybody. Thank you. Maybe Eric, if I can stick with the precision ag topic, you mentioned some strong order boards and so forth. I'm just wondering if you could put any meat on the bones. However you would like to kind of define it in terms of how much growth and penetration you saw in precision ag type equipment in 2020 and what that growth could look like into 2021?

Okay. Yes. I can give you a few data points. If we compare 2020 to 2019, our smart planter sales when you buy a full completed outfitted planter from the AGCO factory was up over 200%. Our row unit sales for planters through OEM and retrofit channels through the precision planting business had a 40% growth rate. That's been an ongoing strong ag tech business that's growing and we're spreading the wings of that business to work on projects throughout the crop cycle. In sprayers, we had a 35% growth rate on AGCO machines using smart novel technology, and we doubled our fleet of connected machines. So you're seeing, we've got dashboards that are driving creation of new technology, new innovation, as well as making sure that we're getting that all the way to our customers understand the value that they receive on their farm and speaking to them in farmer economics or agronomy depending on the future. And so those are maybe some examples of where we are today, and we've got projections of those going into – all the way through to 2025 going forward for our smart machine development.

Super, thanks. That's helpful. And then maybe just, almost kind of a similar comment on how the Fendt rollout is kind of going in North America and what we should expect there?

Very strong, it's going a – actually a little better than plan. It's a combination of a product strategy of bringing in the best of the best in the tractor business. We're for those customers that are the most demanding, what the highest technology, highest quality and best support, we serve those customers with our Fendt offering. So we've got a great product that we're very happy with, but the lion's share of the work is more about the whole Fendt experience. Getting our dealers trained, getting our marketing messages clear and then having all of the touch points throughout the buying and support cycle to be to the Fendt level. And so we're rolling out in a measured pace; not every dealer can carry the Fendt brand. They have to earn their way through the performance criteria. And so we feel like we're in a measured rollout and we're slightly ahead of plan. And the customers are really excited. They love the overall Fendt experience. So we think what we've got is the right solution set for these most professional farmers.

Are you willing to say roughly how much revenue in 2020 was Fendt in North America? I'm sure it's still small, but just order of magnitude?

Well, let me just, Steve, I'll say that our – if you look at our total high horsepower sales, they were up about 17% when the industry was flattish or maybe down a little bit. So I'll just – I'll just leave it with that.

Your next question is from Ross Gilardi of Bank of America.

Yes, good morning guys.

Good morning, Ross.

Hi, Ross.

Hey, there. I just want to understand a little better. I mean, just given your order of commentary around the world and why are you guiding the European market flat?

Ross, there's a couple of factors there. First of all, there's – and kind of a backdrop, one of the things that we think will be driving the improvements in North and South America is really that age or age of the fleet and that the level of replacement demand out there. The European market always has been more of a stable market. And don't have these big swings and the cycles that create these imbalances and the fleet age. And so don't think there's that same level that we would have like in North America. Secondly, one of the biggest markets in Europe is Germany. Germany had a number of tax incentives and incentive customers to buy in 2020. The market in Germany was up 11% in 2020. And so we anticipate that, that was somewhat of a pull forward. So that market we're projecting to be modestly down in 2021 with offsetting improvements in some of the other markets that didn't – that were down in 2020. And the yields were relatively mixed in Europe this year. So they're not coming off of a really strong position, but certainly the better commodity prices, we made comments about kind of a stable dairy sector. And so, I think the economics are good for the European farmer, but probably not to the same level of what we're seeing in North America.

And Ross, the order board, you asked about order boards, also, those are up significantly across all the regions.

Well, that's what – that was where my question was coming from Greg, your order boards were up significantly across the regions, and you're saying, hey, you're calling the European market flat for the reasons that Andy decided, it just seems. Given what you're seeing in order boards, that's a pretty conservative assumption?

Now that the retail activity is what we're talking about and what – what the order board reflects are, other things like dealers wanting to kind of get in line to get their products ready for – available for their customers. And they're also seeing inflationary pressures and things like that. So there's other factors that influence these order boards, but we're obviously seeing a strong order situation. And so we're ready to go with if the market is stronger than what we've anticipated.

Okay. Got it. And then just my follow-up was; what are you assuming for North America margins in 2021 in your guidance? And I think part of the issue with your high tax rate over the years has just been the limited profitability in North America outside of GSI has been, it seems like you've come a long way just in the last 12 months. When are we going to see that tax rate actually come down to more of like a mid-20s type rate?

Well, first of all in North America margins we've got them going up, but not as much as what we have in our 80 to 100 overall. The one factor for North America is that exchange rate is going to limit their margin improvement a little bit in 2021. When the Euro particularly is strengthening, that gives us strong – gives us earnings improvement on the translation of our European earnings, but there is a offset to that in terms of the margin impact on our North American results. So a little bit of a headwind on foreign exchange impacts for the North America market. In terms of our tax rate, we are projecting it to come down. This year we were at about 33% where we're saying 30% to 32%. And as you point out that the stronger earnings, particularly in North America and South America will contribute to continued reductions in the tax rates. So as we improve our profitability in the U.S. and can take advantage of that with our tax rate, and let's see where that tax rate goes in the future that we'll continue to pull down that rate. So we're also anticipating opportunities for further tax rate reductions in the future.

Your next question is from Larry De Maria with William Blair.

Hi, thanks. Good morning. I wanted to go in a little different direction here. Obviously you have an activist situation and it's not every day that obviously a board member becomes an activist. So can you just kind of just discuss some of the concessions, how this is playing out, and if you're considering at this point and the divestitures that she has suggested?

Yes. We can talk about that. There's a number of dimensions to that relationship. There's a – one dimension is a board member, but we also have to remember, TAFE's had a commercial relationship with AGCO for about five decades now. Mallika Srinivasan is on our Board as a board member. So that's a second dimension and then there's also a shareholder dimension. So we need to kind of think about managing all of those at the same time, and also recognize it in any kind of partnership that we have. The – you start off with that, the courts – it's an operating partnership, our interests are not always going to be aligned. Although it's been a longstanding relationship, our launch is not always be aligned. And so the board is very, very focused on making sure that we're doing all actions and making all decisions based on what's good for all shareholders. And so we continue the dialogue with TAFE as well as a broader range of all the shareholders that are out there. We're doing very proactive investor outreach and making sure we're listening to what's on their mind, sharing with what we've got going on. Some of those things have to do with, if you – if you take a look at the actions that have happened over the past month, many of those have been in the planning stages and working an analysis stages for quite some time, but you've seen them come to conclusion in terms of an entire new compensation system for the whole company, many different board governance updates, some specifics on that would be where we've had some plan director retirements this year, and some very recent additions of two new independent directors, Bob De Lange from Caterpillar, President role there; and Matt Tsien, the Chief Technology Officer from GM, both outstanding new board members who are going to bring in just terrific experiences and expertise and leadership to the boardroom as we evolve our Smart Machines Solutions and really focus on our farmers. But then we've also enhanced our corporate governance profile. And again, these were in works for quite some time, but we've appointed a new lead director. We've bolstered the definition of the lead director responsibilities. We've rotated the committee chairs for audit, governance, finance, committees; establish term limits for the board leadership positions to more independent oversight. And when we remain very, very focused on strong, independent, and focus on the best governance of the company so that we're making the right decisions for all stakeholders and stockholders. So, that's kind of where we stand. I'm very happy as the incoming leader of the company about all of the activity that has happened. I liked the strengthening and we're doing with the board. It's a very fresh new set of committee chair people for which I will be working with. And so I think we're in a good position and we're not done. Where the activities are still underway of looking at, listening to our investors and understanding what other ideas may be out there for improvement and incorporating those over the course of time. So that's a quick overview.

Yes. That was a good overview. Thank you, Eric. And then just, if I could follow up on that? Obviously you have a good balance sheet, which you can actually go to the board to use. How is the acquisition pipeline you noted it might be opportunistic, but how's the pipeline looking? And should we be thinking that you'll be active out there? And that's it, thanks very much.

Yes. You read more about that 2021 may be a good year for acquisitions. We've got a number of target companies like we usually do. It's kind of a well-trained muscle within AGCO of being able to be proactive at understanding what would be a good fit on the one hand. And then also being very responsive to new opportunities that came up that that – we're a bit more of a surprise because of a company change in direction or whatever. So we're actively working that Avenue. And we've got a number of opportunities in the pipeline, but nothing mature enough that we would be able to share any specifics today.

Your next question is from Nicole DeBlase of Deutsche Bank.

Yes. Thanks guys. That's a new one on the last name. How are you?

Good. Hi, Nicole.

Hi, Nicole.

Thanks. Can we just maybe start with the assumptions that you guys are using to get to the dollar of earnings in the first quarter? Can you talk a little bit about the expectation for growth and if the margin expansion is kind of in line with what you're expecting for the full year or any things to consider with respect to just the 1Q outlook?

Sure, Nicole. We're looking at sales growth of around 15% or so. And I think currency impacts of that are going to be about 5%. So have some core growth there as we take advantage of these stronger order boards that we discussed. Our operating margin projections are going to be a little lighter than our full year. So maybe up 50 basis points in the first quarter, we do have expanded engineering expenses and some higher – other investments that are – we're kicking off early in the year that are going to limit the margin expansion to some extent. And so that's kind of how we think the first quarter is going to go. The shape of the year will be very different than what we had in 2020 because, as Eric mentioned, we had issues with COVID that severely impacted our second quarter and then we had a strong catch-up in the second half of the year. And so, we do see a significant improvement potential in the second quarter. And so that's where you'll see the strongest year-over-year improvement.

Got it. Thanks, Andy. That's really helpful. And then my follow-up. Can we just talk a little bit about South American margins another impressive quarter kind of better than expectations. If you could talk about drivers of upside and then how to think about the sustainability of the margins that you guys have seen as we've moved through 2020 as we turn the calendar into 2021?

Sure. As you say, the South American margins, we were really ahead of schedule there. The markets really helped us with stronger sales and production giving us better leverage over our cost, but also we're seeing good growth in some of our higher margin businesses down there. The planting area with Precision Planting and our momentum planter sales have been very good. Growth in our grain and protein business down there has also been very strong. So, we're seeing a better mix of sales and that's helping us along with core productivity improvements and things like that. As we move into 2021, we are expecting to continue to move our margins up. We certainly won't do it at the same pace we did in 2020 versus 2019, but still like to see at least 100 basis point improvements. So being the force next year, we're – a lot of the same elements of growth improved production, improved sales are going to help drive that margin improvement. We do see one of our better markets for margins, Argentina actually coming down. So that will be a little bit of an offset. And we're challenged in South America with the high inflation that we're seeing right now. So it's a big challenge to keep up with the cost changes with our pricing. So we're focused on achieving that as well. But overall margin improvement again in 2021.

Your next question is from Joel Tiss of BMO.

Hi, guys. How is it going?

Hi, Joel…

Hi, Joel.

I wonder if you could talk a little bit about if there's any way to tilt that your protein production segment into more of a way to protect customers and their animals from future diseases. It seems that there has been a series of outbreaks and different things, and you guys are in a great position to maybe be able to address some of that.

You bet. So, one of our key – of certain macro again and go to micro to answer your question. Sustainability is going to – has got a very high focus for the company. You're going to see our sustainability report coming out with our annual report and it's embedded in our go-forward strategy and so on. One of our focused areas within the overall sustainability topic is animal welfare. And so, there is a number of opportunities to bring both kind of like we think about precision ag, where there is new farming practices on the one hand, the new technology on the other to help with farmers getting more productive and more sustainable. Well, we can do that. Our focus is to do that same thing with animal protein production and we've invested in – we're building up some new facilities on the University of Georgia campus. They've got one of the top protein production research sites in the world. So we're going to be putting a few buildings right on their campus to have student research go on, on a number of different trial cases, much like we do on our model farms or our crop tour activities with agronomy. We'll be doing that there with a combination of tests of changing of practices as well as new technologies, sensors, reporting mechanisms, optimization protocols, and so on. So that's underway and we look to learn about the problems, learn about how to solve them, and then turn those into solutions that we can sell to the protein producers.

Okay. And am I allowed to ask about your current mix of high horsepower across the whole company? What percent of revenues roughly as of today? And where could it be in five or 10 years?

Yes, I'm not sure I have a number there for you. We'd have to maybe do calculation, but I would say just generally, we're – our business is focused on the high horsepower sector. So particularly, in Europe, we have a heavy reliance on high horsepower equipment on the premium sector. And so our market position is very strong in there. In North America, it's less. So it's still a majority of our business. And North America is a row crop or high horsepower. But it's where we need to grow and we want to continue to grow in that sector. And this – really similarly in South America, we're stronger in small tractors and looking to grow in the high horsepower sector with some of the new technology that we've been invested in. So – but overall it's still a large majority of our businesses is tied to that high horsepower sector of the business.

Joel to give you a little bit of color globally high horsepower sales or high horsepower tractor sales are in the low 40s. In North America for this year, it was only about 15. So significant opportunity in North America to take advantage of the technology that we have both in our Fendt brands and our Massey brands and our Challenger brands.

Your next question is from Chad Dillard of Bernstein.

Hi, good morning guys.

Hi, Chad.

Hi, Chad.

So you talked about in the past being able to achieve 10% operating margins I believe at mid cycle. You're guiding to kind of nearly 8% for this year. So I just wanted to understand kind of how we closed the gap that 200 basis points. Can you just walk through the expectations in terms of how much is allocated to volume versus self-help versus product mix versus precision ag? How are you thinking about that?

Yes, we have said there is a volume aspect to that. And so this – hopefully, we're seeing some of that come into play with the market developments that we're seeing. The other areas where we need to focus is continued improvement in our margins in South America, continued growth in the higher horsepower sector, which generally carries higher margins, continued growth in our precision planting business and a better absorption out of our parts business. So getting a larger market share of that. So all of the high margin business areas where we're focusing for growth. And then on top of that we want to continue to be developing more cost effective products and that's a real key element to it and our productivity and purchasing initiatives that we've talked about before. So all of that added up should give us the opportunity to continue to progress our margins from what we've talked to in this current guide.

Got it. Okay…

And we're really pleased with a lot of those things coming to light in 2020. Our overall sales are only up 1%, you can call that flat and yet we were up 110 basis points on margins. And as coming from all the things that Andy was just talking about, the areas where we're focused on to improve our business and do the self-help, we got no market tailwinds in 2020, and yet we had a lot of margin improvement. We're not there yet. We've still got a long road in front of us, but the areas that we're focusing on are delivering.

Got it. And just sticking with margins, so your guidance in 2021 implies a 15% incremental margin, which is a lot lower than kind of like the mid 20s that would be more and more typical for the business. How much of the gap comes from some of the temporary costs coming back from 2020? And is there anything else that you would call out to bridge that gap?

Yes, thanks, Chad. First of all, if you look at our incremental margins implied here on a constant currency basis, taking the currency out, you're more closer to 20%. And then if you take out the engineering investments, we're talking about, we're more in the mid-20s. And so I think that's more in line with what we typically said we think we can accomplish. To your question about some of the costs, other costs that are coming back in, we do have some of that. First of all, we have investments in digital and other technology and some growth initiatives that we put into our planning this year, and also a partial return of expenses like travel and farm show costs we built into the plan as well. That's probably the shows and the travel and some of these things are probably in a $30 million to $40 million range. And so that's built in as well. So those are incremental expenses that we're absorbing that do influence that incremental margin that you've talked about.

And our next question is from Jerry Revich of Goldman Sachs.

Hi. This is Ashok Sivamohan on for Jerry Revich. Can you talk about opportunities for the company to improve its competitive position over the next cycle? What are the biggest pockets of opportunities that you see in any areas where the company's strategy is likely to evolve?

Well, that's a good big picture question. I would say it ties back to a few of the themes we've touched on today. One of them would be to become a stronger full crop cycle partner to the farmer. We have a very strong tractor, historical tractor business, and we continue to invest in and want to strengthen that, but we have more upside potential in some of our non-tractor businesses, planters, sprayers, combines, hay equipments and so on. So that's one dimension. The second dimension, we're investing heavily in precision agriculture and what we call smart machines, machines that can use sensors to understand their environment, to onboard the calculations and optimize their performance automatically, essentially go into autopilot mode. We've been rolling those out with momentum planter, smart – precision planting, ideal combine, so on, and farmers really appreciate them and they end up being good margin products for the company. So that would be a second dimension. Another growth dimension would be our digital solutions and changing aside from our products, changing how we interface with our farmers and allow them to interact with the company through more digital tools as we're creating digital pathways directly to our customer as well as to our dealer to allow them to engage on the research, buying, service and support processes either through brick and mortar like they do today in most of our industry, or if we did it [indiscernible] or a combination of the two. And then we also think there's some upside with a focus on sustainability. Agriculture, I mentioned the animal welfare element of our sustainability focus, but we've got – the other opportunity is to help farmers with carbon sequestration, climate change if you are having a really, really big topic. And all of the industries in the world are looking at how do we reduce our footprint on emissions, how our facilities and our products contribute less to the problem. But with farming, we have the opportunity where farmers can help solve the problem, capturing some of that carbon out of the air through photosynthesis get it back into the soil and sequestered. But the farming has to change their practices and there's new technology that will be able to be brought to the market to facilitate that. So that's another growth opportunity for the future of the company. We'll outline a lot more of this in detail on our March 3rd Analyst Day, but those are some teasers that will be in line. And maybe the wrapper that goes around that is that AGCO intends to be the most farmer focused company in the ag industry. And we're rewiring a lot of what we do in line with what we have started doing with our crop tours and model farms and other things to really be connected to our farmer and be able to be arm in arm with them as they managed through the challenges in the industry.

Great. Thank you, Eric.

You're welcome.

Your next question is from Ann Duignan of JP Morgan.

Hi, good morning everyone. This is Tom Simonitsch on for Ann.

Hi, Tom.

I think you noted 2.5% to 3% pricing will more than offset raw material cost inflation this year. Can you just elaborate on that?

Sure. We, as you say, pricing 2.5% to 3% net of material cost inflation. We expect that to be probably about half a percent. So we are projecting fairly significant material cost inflation we're seeing that right now. And it does – there's a little bit of a lag as it comes from when you see it hit spot prices and things like that to end up hitting us in terms of component costs. Typically, it's better three to six month lag. So, we're really starting to see those increased costs start to hit our component costs. And so, we've got to get this pricing into offset it.

And just a follow-up there. I think you noted some deferred projects in grain equipment. Do you have inflation closes on those projects? Or what sort of pricing power do you have in GSI?

Yes, it's a big challenge for GSI and that there is a heavy steel content to their products and being able to match orders and projects with cost is a concern. We do have the ability and a number of the contracts to make adjustments for commodity price cost changes that's in place and then we also regularly change the price. But it is one of the challenges that we're going to see here for the grain and protein business in 2021 is to keep pace with the change of the steel prices.

Your final question is from Courtney Yakavonis of Morgan Stanley.

Hi, good morning guys. Thanks for the question. I wanted to go back to the comment about the shape of this year is going to be very different and you gave us some good color on 1Q and 2Q. But in light of the comments that you're making about material cost pricing kind of flagging when it hits your P&L. Anything else you can help us as we think about kind of the first half versus the second half cadence, given the strength of the second quarter and especially given that production was much higher as it compare in the second half of 2020 just to make any high-level thoughts as we're modeling out the full year.

So Courtney, as you think about 2021, the seasonality is going to be a lot I guess I would say more normal. So that implies the second quarter is going to be likely our biggest volume quarter in addition to margins. We have – especially in North America, we have a couple of businesses that are very first half centric. Precision Planting does at least half of their business probably in the first quarter ahead of planting season. So those sales and especially margins will be especially good, especially in North America. Grain and protein, second and third quarters are heavy for that business. So second quarter will benefit both the grain and protein as well as precision planting and then just production levels overall. If you recall, we closed plants this year as result of COVID in Europe and South America, and had an extended shutdown for our Valtra business. So Europe volumes and margins will look obviously significantly better and probably much more similar to 2019 or 2018 in terms of volumes and margin as it relates to first or third quarter. So yes, so much more normal seasonality as we think about this year.

Okay, that's helpful. And then – and just anything you would call out on margins for the first half versus the second half? I know you set up 50 bps in the first quarter, but is that roughly what we should be thinking about in the second half as well and then…

So in the second quarter, we're talking probably 300 basis points or 400 basis points year-over-year because of the significant production shutdowns this year. And then the back half in total probably is going to be similar to last year.

This concludes our Q&A portion of the call. I'd like to turn it back to Greg for any closing remarks.

We just like to thank everyone for your participation today. And again, remind you of our analyst meeting on March 3rd. Thank you very much and stay safe.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.