Good morning. My name is Sia, and I will be the conference operator today. At this time, I would like to welcome everyone to the AGCO 20 22nd Quarter Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.
Thank you. At this time, I would like to turn the conference over to Greg Peterson, Head of Investor Relations. Please go ahead, sir.
Thanks, Thea, and good morning. Welcome to those of you joining us for AGCO's Q2 2020 earnings conference call. This morning, we will refer to a slide presentation that's posted on our website at www. Ecocorp.com. The non GAAP measures used in the slide presentation are reconciled to GAAP measures in the appendix of the presentation.
We will make forward looking statements this morning, including demand, product development and capital expenditure plans and timing of those plans, acquisition expansion and modernization plans our expectations with respect to the costs and benefits of those plans and the timing of those benefits. We'll also discuss production levels, share repurchases, dividend rates and our future revenue, price levels, earnings, cash flow, tax rates and other financial metrics. We do wish to caution you that these statements are predictions and that actual results 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 ks for the year ended December 31, 2019, and the company's Form 10 Q for the quarter ended March 31, 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-nineteen, including plant closings, workforce availability, supply chain disruption and product demand. We'll also include weather, commodity prices, changes
in
product demand. So 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 later today. On the call with me this morning are Martin Muschhagen, our Chairman, President and Chief Executive Officer Eric Hansodia, our Chief Operating Officer and Andy Beck, our Chief Financial Officer. And with that, Martin, please go ahead.
Thank you, everybody, and I hope that everybody is safe and healthy. Thank you, Greg. I need to basically make one echo is not allowed to be used in order to defend the variance in the budget. So that means when the weather is different, people need to be to find solutions. We appreciate your interest in AGCO and your participation on the call today.
I want to start this morning by thanking Echo's 21,000 employees, of which about 10,000 jobs have been created during my time for their hard work that resulted in our world class support for our pharma customers throughout this pandemic. I couldn't be more proud of their efforts and of the efforts of Eric and his team that enabled Eco to do our part to support the global food supply chain, while keeping our facilities and co workers safe. As we discussed on our Q1 call, the health and safety of our employees and the communities in which we operate is our first priority. We introduced a robust safety protocol for our frontline workers who keep our plants and parts warehouses operating to support our customers. In addition, our supply chain teams did an outstanding job, enabling our factories in Europe and South America to ramp up quickly after being closed for most of April.
Lastly, our dealers along with our sales and marketing teams have been outstanding as they generate strong sales activities for AGCO products under unique and challenging conditions. Slide 3 provides our financial summary. Our 2nd quarter results demonstrated strong execution as we overcame COVID-nineteen related production disruption in Europe and South America in order to deliver solid profitable quarter. Margin improvement in our North American, South American and Asia Pacific Africa regions highlighted our quarter. Our focus on cash conservation was also very helpful.
Our Q2 free cash flow exceeded the Q2 of last year by nearly €100,000,000 and our balance sheet remains in very excellent shape. Slide 4 detailed industry unit retail sales per region for the 6 months or 1st 6 months of 2020. Consumption of grain for food, fuel and livestock feed is being negatively impacted by the economic constraints caused by the pandemic. As a result, soft commodity prices have trended lower in the first half of twenty twenty. Consequently, global industry demand for farm equipment is expected to be weaker in 2020 due to challenge in farm economics and uncertainty caused by the pandemic.
North American industry retail sales of tractors increased in the 1st 6 months of 2020 compared to the same period in 2019. Growth in the sales of lower horsepower tractors were partially offset by softer demand for higher horsepower tractors and combines. While the need to replace a relatively aged fleet in the large farm sector remains lower commodity prices and a cautious farmer sentiment are influencing equipment demand. The special COVID-nineteen aid package for U. S.
Farmers and livestock producers could offset some of the impact of lower commodity prices. Industry retail sales in Western Europe decreased in the 1st 6 months of 2020 due to largely production constraints. Market demand was weakest in Spain, the UK and France, with dry weather across much of Western Europe expected to negatively impact wheat production, stronger grain export demand and supportive wheat prices are providing some offsets. European dairy and livestock fundamentals have stabilized after weakening earlier in the year. Industry retail sales in South America decreased during the 1st 6 months of 2020 with the decline in markets outside of Brazil and Argentina.
In Brazil, the benefit of a strong first corp as well as favored exchange rates are supporting relatively positive economics. However, farmers are remaining cautious with regards to equipment purchases due to the current economic and political environment. Industry retail sales in Argentina increased significantly during the quarter as farmers are using investments in equipment as a hedge against the potential devaluation of the peso. Also, the level of uncertainty is higher than normal. We believe the markets we serve are relatively resilient, and we continue to aggressively support retail activity in our global markets.
Before I turn the call over to Erik, I would just make one statement regarding our, let's say, communication today. 1, we talk about the industry, which is something not all our peers are doing. And second, we also give guidance again, which is also different, which means, of course, that we want to be conservative. So you need to look at our guidance as a conservative approach to the remainder of the year. So Erik, now the details.
Very good. Thank you, Martin, and good morning to all on the call. As we communicated last quarter, our focus for 2020 has been to address the needs of all of our key stakeholders, namely our employees, our dealers, customers, suppliers, shareholders and our communities during this COVID crisis. This perspective has guided our actions since the outbreak. First and foremost, we established protocols for all of our facilities focusing on employee health and safety.
These activities have served us well and have been a critical factor in keeping our facilities operating. 2nd, as Martin said, 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 when we return to normal. Lastly, in terms of business continuity, our focus has been on our supply chain, manufacturing and parts distribution operations. Since April, we've been able to successfully ramp up our production in Europe and South America by focusing on component availability and safe working conditions.
In addition, our focus on cost management was evident in the Q2 as we reduced our expenses while our operations were shut down. Despite these reductions, we are continuing to fund our most important projects as we look to strengthen AGCO for the long term. Slide 6 details our production status for our 4 operating regions. Our teams are working hard leveraging both internal capabilities as well as the resources of our dealer partners and suppliers to support our customers under these unprecedented and unique circumstances. As we discussed last quarter, our manufacturing operations have been significantly impacted by the crisis, particularly in Europe and South America.
Our supply chain and production teams have done a great job securing parts to allow us to restart production in our factories, and we will make a great effort to keep them running. In the Q2, production was significantly reduced or suspended in most of the company's European and South America facilities, largely due to shortages in our supply chain. After being closed most of the month of April, all of our factories are now operational. The shutdown of our Valtra plant in Sulati, Finland extended through May due to a fire at our casting supplier factory, but it is returning to full operations in early June as planned. Our recovery from the COVID shutdown has been much faster than expected.
Our second quarter results were better than anticipated due to this quick ramp up, and we anticipate that our Q3 will be stronger than normal as we catch up with our order board built up during the 1st and second quarters. The following slide shows AGCO's 2020 schedule for factory production hours, and that's shown on Slide 7. Total company production hours were down approximately 19% for the Q2 versus the same period in 2019. Most of the decline was caused by factory shutdowns, with the largest decline in Europe and South America. We anticipate that our 3rd quarter production will be higher than the prior year as we recover from production losses in the 2nd quarter and deliver against our current order board.
Our production levels in 2020 also factor in targeted reductions in both company and dealer inventories. We have made good progress on both fronts in the first half of the year. Company inventories are lower than June 2019 and dealer inventories are below their prior year levels in all of our regions. Turning to our order board. Our June 2020 order board for tractors is higher in North America, Europe and South America compared to a year ago with strong increases in both Europe and South America.
I'll now turn the call over to Andy Beck, who will provide you more information about our
Thank you, Eric, and good morning to everyone. I'll start on Slide 8, which looks at AGCO's regional net sales performance for the Q2 and first half of twenty twenty. AGCO's net sales were down about 13% compared to the Q2 of 2019, excluding the negative impact of currency. The Europe Middle East segment reported a decrease in net sales of approximately 20%, excluding the negative impact of currency compared to the Q2 of 2019. Sales declines were driven primarily by lost production caused by the impacts from the COVID-nineteen crisis and were experienced in virtually all markets.
Net sales in North America decreased approximately 9% excluding the unfavorable impact of currency compared to the levels experienced in the Q2 of 2019. Lower sales of grain and protein equipment, high horsepower tractors and sprayers were partially offset by higher sales of hay tools and replacement parts. AGCO's 2nd quarter net sales in South America increased approximately 21% compared to the Q2 of 2019, excluding negative currency translation impacts. Large tractors, momentum planners and grain and protein equipment produced most of the increase. Growth in Brazil and Argentina was partially offset by lower sales in the smaller South American markets.
Net sales in our Asia Pacific segment decreased about 4% in the Q2 of 2020 compared to 2019, excluding the negative impact of currency. Sales were also impacted by product availability with lower sales in Africa, partially offset by growth in China and Australia. Consolidated replacement part sales were approximately $399,000,000 for the Q2 of 2020 and were up about 8% compared to the same period of 2019, excluding the impact of currency translation. Slide 9 examines AGCO's sales and margin performance. AGCO's adjusted operating margins declined by about 2 20 basis points in the Q2 of 2020 compared to the same period last year.
Margins were negatively impacted primarily by lower net sales and production. Cost control initiatives including employee furloughs, hiring freezes, delayed merit increases, eliminated travel costs and reduced discretionary spending, as well as favorable material costs helped offset some of the impact of the factory closures experienced in the Q2. EuropeMiddle East segment reported a decrease of $117,800,000 in operating income compared to the second quarter of 2019, resulting primarily from lower net sales and production volumes, as well as a weaker mix, partially offset by lower engineering and other operating expenses. Despite lower sales, North American operating income increased approximately 13,300,000 dollars in the Q2 compared to the Q2 of 2019 as operating margins reached 11.7%. A strong pre order program along with higher parts sales produced a positive sales mix.
In addition, improved margins in the grain and protein business contributed to the margin expansion. Our South America segment reported an operating profit in the 2nd quarter, resulting in a $12,600,000 improvement from the same period in 2019. Higher sales and improved sales mix, including strong seasonal planner sales and reduced expenses all contributed to the improvement. In our Asia Pacific segment, operating margins expanded by over 500 basis points despite modestly lower sales. A richer sales mix and expense control efforts contributed to the improvement.
Slide 10 details the grain and protein results by region and by product. Our grain and protein business sales decreased about 15%, excluding negative currency impacts in the 1st 6 months of 2020 compared to 2019. Globally, grain and seed equipment declined by approximately 23% with the Europe, Middle East and North America region showing the largest declines. Farmers and grain elevators in North America have been slow to invest given a weak profitability outlook stemming from low crop prices and a significant decline in ethanol demand. In Europe, we've had a number of projects deferred until 2021 due to economic conditions caused by the pandemic.
Protein production sales decreased approximately 3% in the 1st 6 months of 2020 due to declines in the North America, European and Asia Pacific Africa regions, partially offset by growth in South America. 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 the production capabilities. Our order flow for production equipment in Asia Pacific Africa region has improved throughout the last 6 months. Slide 11 addresses AGCO's liquidity and free cash flow for the Q2 and first half of twenty twenty.
Starting with free cash flow, which represents cash used in operating activities less capital expenditures, seasonal requirements for working capital are always greater in the first half of the year and thereby result in negative free cash flow for both the 1st 6 months of 2019 2020. Our cash and working capital usage stabilized in the Q2 2020 and allowed us to generate nearly $100,000,000 more free cash flow in the Q2 compared to the Q2 of 2019. As it relates to returning cash to shareholders, we plan to maintain payment of our quarterly dividend. With regard to share repurchases, we completed $55,000,000 of share repurchases in the Q1 and suspended future repurchases during the 2nd quarter given the uncertainty. We will continue to evaluate market conditions to determine the proper time to reinstate our share repurchase program.
During the Q2, AGCO completed a new term loan facility, which provided an additional $530,000,000 of borrowing capacity. Including the new facility, AGCO total available funds as of June 30, 2020 was approximately $1,300,000,000 consisting of cash of approximately $400,000,000 and available borrowing capacity of $870,000,000 Our net debt was about $125,000,000 below June 2019 levels. We feel confident we have sufficient funding provided the length or severity of the pandemic on our operations is not more significant than we currently estimate. Other details for the quarter include the losses on sales receivables associated with our receivable financing facilities, which are included in other expense net, were approximately $4,300,000 during the Q2 of 2020 compared to $11,000,000 in the same period in 2019. Our updated 2020 outlook for the 3 major regional markets is captured on Slide 12.
We currently expect lower retail industry demand across all of our 3 major regions compared to last year. In North America, the USDA is projecting 2020 farm income in the U. S. To remain challenged due to low commodity prices, partly offset by additional subsidy payments. We project North American industry tractor sales to be down approximately 10% in 2020 compared to 2019.
EU farm income is expected to soften in 2020, driven primarily by lower milk prices and continued dry conditions. Although industry demand is expected to be more stable in the second half of twenty twenty, it will not provide an offset to the significant declines experienced in the first half of the year. Accordingly, industry demand in Western Europe is expected for the full year of 2020 to be lower than 2019. Following 2 years of supported farm income and lower levels of industry demand, we expect industry sales in Brazil and Argentina to stabilize. The smaller markets in South America are expected to be considerably weaker.
In total, industry demand in South America is expected to decline modestly from 2019 levels. Slide 13 highlights the assumptions underlying our 2020 outlook. Our priorities for 2020 continue to be maintaining a safe environment for our employees and providing proactive support to our customers and dealers. We will also continue to manage our cost while preserving investments in digital technology and smart farming product development. Our 2020 forecast assumes softening of industry demand across all regions as this global markets recover from the pandemic.
Our sales plan includes market share improvement, price increases of 1% to 1.5% and targeted dealer inventory reduction. At current exchange rates, we expect currency translation to negatively impact sales by about 3.5%. Engineering expense is expected to be relatively flat compared to 2019 on a constant currency basis at about 4.1 percent of sales, implying a year over year growth in the back half of the year. Operating margins are expected to be slightly below 2019 levels with the negative impact of lower net sales and production volumes offset by an improved product mix and favorable pricing net of material costs. We are targeting an effective tax rate between 36% and 38% for 2020.
Interest and other expenses expect to be approximately flat compared to 2019 levels. Slide 14 lists our view of selected 2020 financial goals. We continue to operate in uncertain conditions and this outlook does not consider any further business disruptions caused by the COVID-nineteen pandemic. We are projecting sales to be in the $8,300,000,000 to $8,400,000,000 range with 20.20 earnings per share targeted in the range of $3.50 to $3.75 We expect capital expenditures to be approximately $225,000,000 and free cash flow to be in the $200,000,000 to $250,000,000 range. In terms of our 3rd and 4th quarter results, we project 3rd quarter results to be modestly above 2019 levels due to a strong 3rd quarter order board.
We expect 4th quarter results to be modestly below the Q4 of 2019 as we experienced the impact of softer market conditions, targeted reductions in dealer inventory levels and accelerated engineering expenses. That concludes our remarks. So operator, we're ready to take questions.
The first question will come from Jamie Cook with Credit Suisse. Please go ahead.
Hi, good morning and nice quarter. I guess just the first question, it sounds like the order book looks pretty good. Could you just provide color on how much is up and how much of it is up just because you couldn't deliver tractors versus actual orders? And then my second question, just trying to South America turned a profit in the quarter, I guess, which was nice to see. Is that ahead of where you thought?
And how do we think about margins in that business as we exit the year and going forward? Thank you.
Good morning, Jamie. Greg will answer your question on giving some color on REIT on order book and then Andy will talk about South America.
So our order board is up significantly, as we said, especially in Europe and South America. And I think we'll leave it at significantly for today, Jamie.
But do you have any color
on the front?
I love Davey what he's asking for.
We have let me just say we have good visibility through the Q3.
Okay. And is it new orders or just you couldn't deliver tractors? Like I'm just trying to understand the fundamentals better.
Yes. So we've got strong order activity in both regions. And so there is a part of it that were shut down for the entire month and couldn't produce, and we weren't able to make all of that back up. So there's it's a mixture of both, but some of it is strong retail activity.
Okay, thank you. And then just the color on South America, please?
Jamie, South America, we had a stronger second quarter than we had expected. We had a much stronger mix of sales. There's some good seasonal products that we sold in the first half of the year, particularly our planner business. We had very strong sales in Argentina in the Q2, which has helped our mix as well. So those certainly helped us in the Q2.
As we look into the back half, our revenues are going to be higher than last year, excluding exchange, taking exchange out of the mix. And we'll expect to be significantly better in terms of profitability. Overall, we're looking for our profits in the second half to be roughly breakeven compared to pretty sizable losses a year ago. So we're making progress. In South America, we're doing a number of things in terms of cutting cost.
We're localizing more of our products in order to reduce the material cost. One of the challenges that we're facing is the weakening of the real. And so all our imported content on our equipment is causing the cost to go up. So we've added some additional pricing in the second half. We also are doubling our efforts to localize more of the content of the product.
So we're also working very hard in selling complementary products. Our gram protein business is up and profitability is up there. I mentioned the planter business that's growing quite well and we do well in precision planting as well down in South America. So a lot of good things that are helping improve our results in South America.
Okay. I appreciate the color. Thank you.
The next question will come from Steven Volkmann with Jefferies. Please go ahead.
Hi, good morning, everybody.
Good morning, Steven.
I'm wondering if we can talk a little bit about your outlook on market share and you have various new programs of products that are being launched. I mean, just kind of update us on how that's working and how much market share you're kind of expecting in the second half?
We're very pleased with the first half already. We're gaining market share in most of our primary markets, and it's showing up in our new product investment areas. So planter sales, high horsepower tractor sales, combine sales. So it's the as we become more of a full line offering, as we focus more on precision agriculture, those are the areas where we're making the biggest gains. And it's both a product story as well as the strengthening of our distribution network and the confidence that the marketplace has in the total experience that they're getting.
So, so far, we're very pleased with market share and we expect that to continue for the rest of the year.
And how about the scent rollout in North America?
Going well. Above expectation.
Yes, going well.
But we don't talk too much about it. We want to be successful, but we also don't want to create too much tension.
Precision planting and precision planting is doing well. It continues to grow. And so although that's not a traditional market share story, if you think about it in terms of market share of planters being updated either through new or retrofit, we continue to grow that business strongly and it had a fantastic first half of the year. In fact, it beat expectations. Thank you.
The next question will come from Courtney Yakavonis with Morgan Stanley. Please go ahead.
Hi, guys. Just on the comments on low horsepower growth, offset by combines in North America. Can you just remind us how big low horsepower is for you versus high horsepower? And was this kind of a 1 quarter on what you got or have you seen those low horsepower trends continue through the quarter and into the Q3?
Yes. So low horsepower and large horsepower are actually moving in opposite directions right now in North America. It's a very large market, 150 horsepower and up is what we consider large horsepower, high horsepower. And that's the professional producer segment largely. Then the low horsepower is a bit of a mix.
Big farms still buy small tractors. So there's some of that segment that goes to the large farms. But additionally, there are lots of other segments that buy the low horsepower site. So landscapers, hobby farmers, people who have a job in the city, but they have a small operation going on, horse farmers, things like that. And so what we've seen is during COVID, a lot of people are getting the idea that I've got a project or an idea or something like that.
And so we're seeing an uptick in demand. It's actually stronger than we originally expected from these non professional producers. And so that's been a pleasant surprise. We expect that it may moderate over time, that it's perhaps a more seasonal thing based on the situation where everybody is more at home than they were in the past. So we believe it's more
of a short term uptick.
This is Mark from Arjes earlier. But it seems like your outlook for Brazil is for a much more or I think you commented farmers are exhibiting a much more cautious approach to equipment purchases. So can you just kind of talk about are you seeing a drop off in order rates in Brazil relative to the strength that you saw in the 1st and second quarters on an organic basis? And maybe you can give us a little bit of a framework for how to think about margins if sales do surprise to the upside in the back half?
Just to make sure it's clear what's happening in South America. If you look at retail activity in Brazil in the first half of the year, actually the retail activity for the industry is up. It's up about 5% or 6%. So and it's actually getting better throughout the first half of the year. I think the comments that we're making are still valid that farmers are being fairly cautious because if you look relative to their income levels, there should be much more significant investment right now.
But we're seeing a little bit of that turn and a little more activity in Brazil. The other factor that we always talk about and look at is what's happening on the financing front and the Fonami financing programs by the BMDS are now out for the year that runs July 1 to June 30. And those programs are I would say modestly improved over what we had a year ago. The interest rate on the subsidized financing is down about one point and the availability of financing looks pretty good. So from the financing standpoint, it's relatively positive.
Farm income is going well. So I think we're expecting to see things moderately trend up there. In Argentina, as we talked about, we saw significant sales in the first half as farmers tried to turn their cash into hard assets. And so we saw a significant investment there. We don't expect that to continue.
We think they're trying to get ahead of any peso devaluation that could occur. And then the real decline in the market is in markets outside of Argentina and Brazil. So markets like Peru, Chile, Paraguay, all those markets are down about half. It's about half of what it was a year ago. So, and we don't expect much recovery in the second half.
So, most of the decline you see in the South America total numbers are about with as regard to these other South American markets and we see the Brazilian market stabilizing and continuing to be, I think probably a little better than last year for the rest of the year.
Thank you. The next question will come from Ross Gilardi with Bank of America. Please go ahead.
Yes, thanks. Good morning, guys.
Hi, Rob. Hi, Rob.
I'm sorry, I jumped on late and sorry if you covered any of this. But the margin improvement that you're seeing in North America, could you talk about how GSI is or is not contributing to that? And what are your margin expectations for GSI going forward? Because obviously they got hit pretty hard the last couple of years. And I'm just wondering if you're seeing some mean reversion there that might be helping out.
What we're seeing is, as we mentioned on our comments, we're seeing the revenue be down in our grain and protein business is down in the second quarter about 15%, down in the Q1 as well. So even with that, our margins are up. Our margins were up significantly in the Q2 in gram protein. We admittedly had a weak margin quarter a year ago. So this was a kind of recovery back to what we expect to be more normal level.
So good work by our teams there to turn that back around. For the rest of the year, we're really seeing weak revenue. So our revenue will be down, but we'll continue to improve on margins. So our focus with the grain protein business has been cost reduction. We've done a number of footprint rationalizations that are ongoing and we're rightsizing the business and really focusing on our most profitable areas of that business.
So we expect to continue to improve profitability in the gram protein business this year and next year.
So when you think about sort of what normalized margins are for all of CSI, I mean, I think when you bought that North American grain storage piece, the margins, if I remember correctly, were somewhere in the mid teens. And then it feels like they dropped well into the single digits in the last few years. Is there any reason you can't get back to where you were, at least get back to like a low double digit level over the next several years? Or has something changed dramatically in the market that would hinder you from doing that?
Yes, I think that's what we're targeting to get those margins back up. We did that original purchase of GSI had those very high margins as you pointed out. Some of the other businesses that we have, we put in that grain and protein sector like in the egg business, some of our European business that we bought in the grain sector didn't have that same level of margins, but they're all relatively good margins above AGCO's average. And so we believe that grain protein should be an above average margin business. What's really hurt the margins has been the reduction in the grain side of the business, particularly in North America, that's where most of the profitability was and really significantly high margins.
And that part of the market has declined kind of in the same line with high horsepower tractors and combines in North America. So we're seeing a significant reduction in that demand level. And as that I think recovers, we'll get that mix back and the margins will recover. So
You will like what you will see in the future.
Yes, we're doing a lot of things structurally and strategically with that business. And I think with some market recovery, we'll get those margins back up.
Okay, got it. And then, can you comment at all on normalized margins for South America through the cycle? Obviously, you've seen a lot of improvement this quarter and sounding like you think you'll be somewhere around breakeven this year or in the back half of the year. But what about just longer term, where should those margins be? And rather than just throwing a number out there, just curious how and when you think you get there?
We have a margin improvement outlook for South America that we're working towards. It's, I would say, progressive year over year margin improvements. What we are looking for, it's not going to come in one period, but we think we've got the capabilities of continuing to move that those margins back up closer to the company average.
Is it a new product or product density issue and just having more higher margin products or is it a cost and execution issue in order to get there? I'm just trying to get a sense as to how much of it you feel like is really under your control.
Yes, I think the challenge we have is in terms of the, I think our product costs. And as I mentioned, we've been challenged by the weakening of the currency. And when we brought in a lot of the new products into South America, new technology, there was a much higher imported content. So we've been somewhat being as we improve the cost structure, we've been taking a step back as the currency impacts the imported content. So that's why our focus is on localization of more of the content.
And the other thing that we're focused on is a broader full line portfolio of sales. So growth in our non tractor business in South America is extremely important and making good progress in selling planners, our precision planting business. We're doing much better in combines this year. So all of those will contribute to improvement in the overall margin profile of the South American business.
Got it. Thanks, Ann.
The next question will come from Joel Tiss with BMO. Please go ahead.
I appreciate you guys taking my question. So I want to ask the same sorts of questions about, can you give us a sense like over the next 3 years, what the focus do you feel like the sort of the product transition to have more high horsepower and better precision planting and all those kinds of things. Is that largely in place? Or are there a lot more steps to take to be able to drive the structural margins of the company higher over the next 3 to 5 years?
This is a question for Alex. Very good. So we've got a lot of foundational elements in place. The work we've done on the Ideal Combine, the Precision Planting business, great foundational work. We've got a strong sprayer business, strong commercial hay business.
So there's a lot of things that are good platform elements, but we've got a lot to build on top of that. And so we've got a whole portfolio strategy in terms of products to continue to bring out more and more smart machines on the product side. In addition to that, in parallel, we're working extensively. One of our biggest investments is on digital investments to be able to provide the interaction with our dealers and the interaction with our customers in a more of a digital versus analog format. And we think that that's the way the customers want to consume information in the future.
And so we're investing heavily in that. That's kind of an experience, how you research our company, how you select a product, how you get serviced by that product, how you get supported, how the connected machine interaction works, all of that. And so there's a product element, there's a digital interaction element, and then there's a distribution element. We've got a fair bit of work ongoing still to strengthen our strong dealers and then also fill in some open territory. In each of our regions, we still have some uncovered territory that will provide growth, and we're looking at extending existing dealers or trying new approaches in those uncovered territories.
So we've got several opportunities for further growth, and we've got our organization focused on those.
And then as we go through these sort of very stressful times for everybody, is there anything that sort of comes up in terms of PLS, product line simplification, parts of the company that maybe don't fit or need to be deemphasized as we go forward? Anything significant enough to talk about?
Nothing really to talk about at this stage. We are happy with our portfolio. We've made some acquisitions over the last several years. So we feel like we've filled in some key gaps and we're happy with the portfolio that we have. And our focus right now is in improving the performance of that portfolio and both product and the digital element of it and then our distribution partners to support it.
That's great. Thank you so much.
The next question will come from Tom Simonitch with JPMorgan. Please go ahead.
Thanks. Good morning. This is Tom on for Anne Deignan. So you're expecting 2020 production hours down 8% globally. Can you comment on any regional variation to that plan in the back half?
You noted some catch up of lost production in Q2, but also just curious if you have made any changes to summer shutdowns that would impact normal Q3 production?
Yes. Dave, can I have it, Steven?
So yes, Tom, the if you look at where we are and where we're going in terms of the biggest changes, not surprisingly in the Q2 with the shutdowns we had, the most significant Europe was down 22%, roughly, in South America, we're down in the mid-30s. So going into the back half of the year then, we expect Europe to be about flat, but it's going to be up in the Q3 and then down similarly in the 4th. One of the things that we have going on as we get closer as we get through the back half of this year is we have some more work to do terms of our dealer inventories. We expect for the full year to take about $150,000,000 out of our dealer inventories and a lot of that is going to happen in the Q4. So if you look at the shape of our earnings, it will be it will reflect the fact that we'll be up in Europe in the Q3 and in South America in terms of production and then Europe will be down significantly in the Q4 and South America will be kind of flattish.
So kind of an unusual pattern, but that's what we're looking at.
Thanks, Greg. That's helpful. And maybe you could just discuss pharma sentiment in Europe. The fundamentals look pretty stable, but how does that weigh up against an expected decline in direct payments in EU budget through 2027?
Yes. Interestingly, if you look one of the barometers, we look at a number of indicators in each region, and one of the barometers we watch is the CIMA index, and that turned around nicely. It was it had dropped significantly in March April. It's turned around nicely now And that matches what we're hearing on the ground through our dealers and customers in that there's more positive sentiment. There's more clarity on what the farm aid package will look like in Europe going forward, and it looks to be more stable.
So I think that the farmers feel like the road is more clear. They've got a relatively good harvest coming and so their sentiment is up. And we're seeing that in our order board.
The next question will come from Larry De Maria with William Blair. Please go ahead.
Hi, good morning. Thanks. Hey, Larry. Hey, guys. Just to go with you talked about North America a bit.
And obviously, noted mix and the cost control obviously helped the margins, but they're very strong in first half in general. I'm just trying to understand if the business has structurally changed with your offerings in precision planning and we can move towards assumption around double digit operating margins at least on the annual basis moving forward or if this was a little bit of anomaly because you're maybe ramping new production of new products like the Fintractors etcetera in North America or just trying to understand if we've reached a new plateau at double digits, at least on an annual basis or if this is a little bit of an anomaly in the first half?
I'd say, Larry, the first half is much stronger mix for North America with that precision planting business with what we've seen in high horsepower sales, grain and protein business is also stronger in the first half. So there's clearly a seasonal change between the first half and the second half. And then in the second half, as we've talked about, we're lowering some of our revenues and focusing on dealer inventory reduction. But I'll let Eric comment about what we're doing in terms of overall margin improvement in North America. I think we think we're still making progress there.
Yes, there's certainly there's a seasonal aspect, but there's a sustainable structural changes happening in North America. Our dealer organization continues to get stronger. There's been a lot of focus on that. And then our product mix is getting more balanced. And so we've invested heavily in our combine business.
We've invested heavily in planters. We've seen strong sales in planter large planter sales in South America that we're now going to be launching just launched recently in North America. And we've always had great commercial hay business and strong sprayer business. And so the platform of distribution plus products is we feel like it's solidly moving forward with a strong focus on precision ag. We're getting more and more of our machines connected, being able to remotely interact with those machines.
Proactively, we've had something like 600 proactive interventions where we identified an issue before the customer or dealer even knew that there was a problem and we were able to prevent that issue before it occurred by our remote monitoring centers. So that's the focus for the region and I think it's well on track.
That's great. Thank you. And then secondly, obviously production has been down, but we still need dealer reductions. I'm kind of curious why there wasn't a sellout at the retail level, given that the production was down and now you plan to produce more in 3Q. So where are these inventory issues?
I don't know, you just mentioned obviously North America, but maybe just flush out a little bit where the inventory issues are and how confident you are that they're cleared up for normal production in 2021?
Larry, I wouldn't call them inventory issues. I mean, I think in terms of where we are in terms of dealer inventory, we feel like we're in pretty good shape right now. But as we target to be more effective, more efficient and more profitable in the future, we think if there's an opportunity to get our dealer inventories lower that really helps us from a production standpoint, pricing standpoint. And so that's really the driver of these dealer inventory reductions is more of a from an efficiency standpoint. If you look year over year in the Q2, our dealer inventories lower in all of our regions compared to a year ago.
So again, I wouldn't say that we have any issues. In Europe, dealer inventory did come down. But as you saw, the European market was down over 20% in the Q2 and a lot of that was due to product availability as well. So the retail market was down and our production levels and wholesale activities were down as well.
Okay. So it sounds like a little bit more strategic on your guys' part. Thank you and good luck this
year. Yes. We got a lot of focus on retail, not wholesale. We got a lot of focus on building to demand. And so all of those are the tools to get the efficiency that Andy is talking about.
Thank you.
The next question will come from Jerry Revich with Goldman Sachs. Please go ahead.
Yes. Hi. Good morning, everyone. Nice to see the progress on precision planting playing out so well. I'm wondering if you could update us on your sales expectations for full year.
And it sounds like you're gaining a lot of traction in South America off of base of 0, I think, before you bought the business. So just update us on that portion specifically. And also, if you wouldn't mind, just touch on what proportion of the installed base at this point do you estimate has precision planting set up at
this point? Yes, we're looking for about a 20% improvement in our precision planting revenues year over year. That's pretty consistent across North America and South America. And then we have very high percentage increases off of a very low base in Europe. So Europe, we're just getting started there.
So there's a big increase there. And then Eric, you can talk about the installed base.
So we've got a couple of things. We had a 3 pronged growth strategy with that business. Number 1 is to expand the innovation from continue to focus on planting, but expand it to beyond planting and cover the crop cycle, especially on other precision ag elements of the crop cycle. So that's number 1 is expanding innovation. Number 2 is expanding geography coverage and strengthening we had a very strong North America business from the beginning.
We want to have an equally strong business in the rest of the world where there's professional producers doing row crop planting. So Europe is our primary target. Now we feel like we're well on track in South America and our big growth opportunity is in Europe as well as some parts of Asia. And then the 3rd dimension is leveraging that retrofit channel. We've retrofit is something that is somewhat difficult to do, takes a lot of expertise.
We've got some very passionate, highly trained individuals in that channel in the combination of our dealers and our field people. We want to make the most of that channel. So we think that there's a lot of upside with this business when you consider all those growth regions, especially when you consider that our installed base, we believe, is something less than it's still high single digits in terms of the installed base penetration.
Okay. Thank you. And then in South America, you folks at Analyst Day spoke about the need to really get a simplified product lineup out in the field at a lower cost point. I'm wondering if you could update us on what are the key milestones on some of your higher volume models and making that transition? Any firm timelines there would be helpful.
Our big issue there was we came out with a new Tier 3 tractor model and it's very high performing, high quality and so on, but it didn't address the full market. And so what our activity has been 2 pronged. 1 is to bring back into the market our more volume oriented line. We call it our heritage models for a lower price point customer. We've got that done now.
That's back in the marketplace and doing well. And secondly, the activity that Andy talked about is localizing more component production to get our cost base down. When we first launched the product due to our focus on quality and performance, we had a little higher imported content than our ultimate intention was. We wanted to start off on the right foot. It came at a price of a little higher cost base.
So we've been now that we feel comfortable with the product performance, we're working our cost out of the componentry. So those are the 2 major activities. We've got the other activities of growing other products, but that's the big shift over the last couple of quarters.
And Eric, can you talk about the magnitude of margin improvement that you anticipate from getting the local cost point as opposed to what you're paying now? Does that get you a good chunk of the way there towards 4% or 5% margins like you've had historically? Or will you require more work to get there?
It's going to we've got a lot of work in front of us in South America. So the localization is certainly one element of it, but we need to continue to balance the sales performance of our overall portfolio. We've got high market share in tractors. We need to get higher market share in other products. We're seeing that market share gain happening in combine sprayers and planters.
That needs to continue. And then thirdly, we need to continue to work on our dealers' performance. In many years, we have very strong dealers. We've got our own company store in the Mato Grosso region, the big growth area, but we need to continue to strengthen our dealers as well. There's pockets where customers don't have the confidence we need them to have.
And so we need to work on that.
Appreciate it. Thank you.
The final question will come from Stanley Elliott with Stifel. Please go ahead.
Thank you guys for fitting me in. Eric, actually that was
a question I wanted to ask you guys about the company store down in Brazil. Does the experience there, I mean is that
what you're seeing in the margins for 1? And then 2, does it the experience that you've had there, is that something you want to or would consider to expand out more broadly down there just given how
the results have improved?
When it comes to benchmarking, we compare all our sites, all our factories, all our brands globally on a systematic, structured and regular basis and continuous improvement processes guarantee that learnings from one region or one brand or one country also are used if it makes sense in the other areas. So that's the answer to your second question. Yes, we look into that. And yes, if there's something meaningful we can use outside Brazil, we will do so. The first question?
Thank you. This is interesting.
So I'm just in closing, I would like to tell you that we have just heard and been informed about the passing of our former Director, Herman Cain. While our sympathies are with the family, we also would like to make sure that you understand he was a very constructive director for many years, and he helped me personally to understand the American culture in general and the Southern culture here in Georgia and Atlanta in special. I just wanted to mention that here because it has just been published and it just happened today. Thank you very much.
Thank you. At this time, I would like to turn the conference over to Greg Peterson for any closing comments.
Thanks, Tia, and thanks to all the participants. We appreciate your interest in AGCO, and feel free to get back in touch with us today if you have follow-up questions. Thanks, and everyone be safe.
Ladies and gentlemen, thank you for participating in today's conference call. You may now disconnect.