Good morning, and welcome to the AGCO third quarter 2022 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Gregory Peterson, Vice President of Investor Relations. Please go ahead.
Thanks, and good morning. Welcome to those of you joining us for AGCO's third quarter 2022 earnings conference call. We will refer to a slide presentation this morning that's posted on our website at www.agcocorp.com. The non-GAAP measures used in the slide presentation are reconciled to GAAP metrics in the appendix of that presentation. We will make forward-looking statements on the call this morning, including demand, product development and capital expenditure plans, production levels, engineering expense, exchange rate impacts, pricing, share repurchases, dividends, future commodity prices, crop production, our supply chain disruption, inflation, component deliveries, retail revenue, 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, 2021. 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, and product demand, as well as supply chain disruption, weather, exchange rate volatility, commodity prices, and changes in product demand. We wish to 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 site later today.
On the call with me this morning are Eric Hansotia, our Chairman, President, and Chief Executive Officer, Damon Audia, our Senior Vice President and Chief Financial Officer, and Andy Beck, our former CFO and now Senior Vice President and Senior Advisor. With that, Eric, please go ahead.
Thank you, Greg, and good morning. We appreciate your interest in AGCO and your participation on the call today. Our record third- quarter results have us solidly on track to meet our full-year financial targets. That includes strong revenue growth, margin expansion, and record earnings per share. These are further evidence that our strategies are working. The quarter was highlighted by solid operational performance and continued double-digit pricing. Those helped us overcome continued supply chain challenges, inflationary pressures, and significant currency headwinds. The encouraging news is that despite the global supply bottlenecks and inflationary pressures, farmer economics are very healthy. Global end market demand remains at high level, and demand for our products continues to be strong. Our team is working hard to mitigate these challenging conditions to serve our customers and maximize our full-year results.
Let's start on slide three, where you can see that net sales grew 14.5% compared to the third quarter of 2021. Adjusted operating income increased nearly 32%, while margins improved about 140 basis points. We are seeing excellent demand for the technology-rich Fendt full lineup of equipment, our Precision Planting solutions, and replacement parts. AGCO's precision ag sales are up over 21% so far this year. We have experienced strong growth for both our Precision Planting business as well as our Fuse suite of products as farmers see the benefit of these high-tech solutions. We've also made significant progress with our efforts to optimize our South American operations and improve margins there. Through the third quarter, our year-to-date South American operating margins hit 16.5%. That's over 700 basis points of improvement from last year.
Slide four details industry unit retail sales by region for the first 9 months of 2022. Healthy farm income is projected across most of the major agricultural production regions. Elevated crop prices are offsetting higher fuel, fertilizer, and other input costs. Despite ongoing supply chain disruptions, favorable farm economics are generating strong demand for large farm equipment across all major global markets this year. Industry retail sales continue to be negatively impacted by supply chain constraints, which have limited equipment production during the first 9 months of 2022. We continue to believe that the weaker year-to-date industry sales are the result of supply chain challenges, as end market demand remains very strong. North American industry retail tractor sales were down approximately 6% in the first 9 months of 2022 compared to last year.
Smaller tractors declined from record levels in 2021, while increased sales of high- horsepower units offset some of the decline. Industry retail tractor sales in Western Europe decreased approximately 10% in the first nine months of 2022 compared to the strong levels in the same period of 2021. However, forecasts for healthy farm income in Western Europe are expected to support solid retail demand for equipment for the remainder of 2022. In South America, industry sales increased 9% during the first nine months of 2022, with robust demand across all South American markets. Strong crop production levels, as well as elevated commodity prices, are supporting positive economic conditions for farmers who continue to replace their aged equipment. AGCO's 2022 factory production hours are shown on slide five.
You can see that our production increased in the third quarter as we aggressively ramped up our facilities in line with our expectations. For the full- year of 2022, we currently project production hours to increase approximately 6% compared to 2021 levels, with fourth quarter production levels up double digits compared to the fourth quarter of 2021. Our current October production rates are solidly on track to deliver the higher production plan in the months ahead. As we discussed over the last several quarters, supply chain issues have impacted our ability to complete and ship units and caused several inefficiencies in our factories. The volatile supply chain environment is still requiring us to keep higher- than- normal levels of raw material and work- in- process inventory on hand. We continue to face supplier bottlenecks and delays in all regions.
Although trending slightly better in some markets, we expect continued challenges for the remainder of the year. The higher level of production in the fourth quarter, as well as our current volume of semi-finished products, supports our full- year sales outlook. At quarter's end, AGCO's order board remained extended. Orders for tractors and combines globally were modestly higher compared to a year ago and extend into the second half of 2023 on many products. You'll recognize slide six, which highlights our focus on high- margin growth. The first focus area is taking our Fendt full- line brand global. We are working to grow the business along two vectors. The first is expanding the Fendt product line beyond tractors into combines, planters, and sprayers, where we have top- performing products across the board. The second is taking the Fendt full line of products global.
Interest is growing in our premium Fendt product lines in both North and South America. Our Fendt and Challenger combined sales in North and South America are expected to double in 2022 compared to 2020. Our ambitious target is to double them again over the next five to seven years. The second focus area involves precision agriculture. At AGCO, we address the precision ag market in two ways. The first is through our Precision Planting business, which has built an innovation-driven growth record of 24% per year growth since we acquired the business. Precision Planting has been successful in providing automation and intelligence to planters. Now we are growing beyond planters into the other parts of the crop cycle, like spraying, soil sampling, and harvesting.
In addition to their impressive technology, Precision Planting's success is generated through their unique retrofit approach, which reduces the farmer's upfront investment and increases their ROI. By offering solutions through a retrofit approach, we can expand the addressable market beyond AGCO brands to all industry brands. The other way we are addressing the precision ag opportunity is Fuse, which provides OEM solutions for our AGCO equipment. The third high- margin focus area is our global parts and service business. AGCO is already in a leading position relative to having the right parts in the right place when the farmer needs them. We're building from a solid foundation to capture more of the dealer and farmer's business. We're helping dealers become better and more proactive with their service and parts offering with our smart solutions and expanding digital capabilities, which leverage the growing number of connected machines.
As a result, we have driven our after-sales and parts business to grow at 8% annually over the past three years, compared to 4% for the three years prior. Combined, these opportunities provide significant growth potential at higher margins and less variability during cyclical downturns. Our Farmer First approach is also making strides and being recognized in the area of sustainability. During the third quarter, AGCO was named Sustainability Company of the Year by Enablon. One of the ways we are growing our premium Fendt business is by continuing to expand and upgrade our product offerings. During the third quarter, we had a global launch event for the Fendt 700 series.
This high-tech tractor ranges from 200 to 300 horsepower and is the highest- volume row crop tractor Fendt sells. Through our farmer- first approach, we listened to what farmers wanted, and then we delivered it with this new tractor. They told us they wanted the lowest fuel consumption, superior maneuverability, minimal soil compaction, as well as cabin comfort features for long working days. The new 700 series has more than delivered. On slide seven, you can see some of the specifics for this great new tractor. The short version is that it's bigger, smarter, more fuel- efficient, and more sustainable than ever before. The spacious cab with its continuous field of vision is more like a luxury sedan than a tractor. From the joystick control to the extensive automation of processes, we've packed even more technology into it and made it easier to drive.
Its tighter turning radius gives it the maneuverability of a much smaller tractor. Farmers love the Gen 6 version, and based on early indications, there's a lot of interest in this Gen 7 version. It is innovations like this in our Fendt lineup that give me continued confidence in Fendt's ability to win around the world. With that, I'll hand it over to Damon, who will provide more details on our third quarter results.
Thank you, Eric, and good morning, everyone. I will start on slide eight with an overview of AGCO's regional net sales for the third quarter. Net sales were up approximately 26% in the quarter compared to the strong third quarter of 2021, when excluding the negative effects of currency translation. Pricing in the quarter, which was around 13%, contributed to higher sales along with continued strong growth in high- horsepower tractors, combines, and precision ag products. By region, net sales in North America increased approximately 44%, excluding the unfavorable impact of currency translation compared to the third quarter of 2021. The strong year-over-year growth was driven by the success of our Fendt large tractor sales, a significant increase in demand for our Precision Planting products, as well as overall solid pricing.
The Europe, Middle East segment reported an increase in net sales of approximately 15%, excluding the negative impact of currency translation, compared to the sales in the third quarter of the prior year. Despite the overall weaker market conditions due to the factors Eric highlighted earlier, we continue to see good pricing and strong retail demand for large equipment in several countries like Germany and France. In South America, net sales grew approximately 50% compared to the third quarter of 2021, excluding favorable currency translation driven by favorable market conditions, helping deliver significant pricing as well as volume and positive mix effects from growth in Fendt products. Sales were up strongly across the South American markets, with high- horsepower tractors and combines showing the largest increases.
Net sales in our Asia Pacific Africa segment increased about 15% compared to strong sales in the third quarter of 2021, excluding the effects of currency. Higher sales in Japan, Australia, and Africa were partially offset by lower sales in China, mainly related to the grain and protein business, which has been challenged by customer demand being limited by COVID-19- related lockdowns in the quarter. Finally, consolidated replacement part sales were approximately $425 million for the third quarter, down approximately 4% from the third quarter of 2021. Excluding the negative currency effects of 12%, part sales increased about 8% compared to the third quarter of 2021. Turning to slide nine. The third quarter adjusted operating margins improved by approximately 140 basis points versus the comparable period in 2021.
Margins in the quarter benefited largely from higher sales and production volumes as well as positive net pricing. The third quarter price increases of approximately 13% more than offset the significant material and freight cost inflation on a dollar basis, contributing to the margin improvements in the quarter compared to the third quarter of 2021. For the full year, we are now expecting pricing in excess of 10% and not only to offset material cost inflation on a dollar basis, but also on a percentage basis. By region, South America continued its very strong performance, with operating margins reaching nearly 19% in the quarter and operating income improving over $63 million year-over-year. Continued strong end market demand, solid pricing, a healthy sales mix supported by impressive year-over-year growth.
North America operating income for the third quarter improved over $75 million year-over-year, and operating margins reached 12%. Higher sales volume and production, as well as richer sales mix, specifically more Precision Planting and Fendt sales, resulted in the improved third quarter operating results. The Europe/Middle East segment reported a decrease of approximately $50 million in operating income compared to the third quarter of 2021, primarily from foreign currency translation related to the weaker euro. In addition, operating income was also adversely affected by higher material inflation and operational inefficiencies due to supply chain challenges, which, in total, offset strong pricing.
Finally, in the Asia Pacific Africa segment, operating margins expanded over 130 basis points to over 13% in the third quarter, reflecting mainly an improved sales mix. With margin expansion over the last two years in our North American, South American, and Asia Pacific Africa regions from our strategy execution and disciplined pricing, we expect the margin profile to be more balanced across the globe in the years ahead. Slide 10 provides an overview of our grain and protein sales by region and by product. Sales increased about 2% in the first 9 months of 2022 compared to 2021. Globally, grain equipment sales increased approximately 20%, with our South American and North American regions showing the largest increases.
Protein production equipment sales declined approximately 22% in the first nine months of 2022, with the weakest demand in the Asia Pacific Africa region, mainly due to swine-related equipment sales. Overall, grain equipment demand has been strong, supported by improved grain prices and the profitability of farmers. However, North American demand has been muted due to industry-wide price increases to cover the increased cost of steel. The protein production equipment market remains challenged due to labor issues and higher input costs, such as grain. As protein prices are improving, so is protein producer profitability, which should lead to further investment. Slide 11 details AGCO's free cash flow for the first nine months of 2022 and our outlook for the full year. As a reminder, free cash flow represents cash used in or provided by operating activities less capital expenditures.
For the first nine months of 2022, free cash flow has been a use of $566 million, which is over $400 million higher than the first nine months of 2021. The primary driver for the change is the higher inventory levels related to the continued supply chain challenges influencing our safety stock and work- in- process inventory. For the full year of 2022, although we expect our raw material and work in process inventory to continue to remain elevated to help us manage through the continued difficult supply chain environment, we do expect to see a significant reduction in our work in process inventory in the fourth quarter and now expect to generate $400 million-$500 million of free cash flow for the full year, which is up from 2021.
The decrease in our outlook from our previous forecast is related to continued supply chain challenges as well as the timing and geographic mix of sales in the fourth quarter. Our capital allocation priorities remain unchanged and will continue to include investment in our precision ag offerings and digital capabilities, as well as opportunistically adding bolt-on acquisitions to help position AGCO for long-term success. In addition, we have focused on our direct returns to investors this year with our regular quarterly dividend that we increased 20% earlier this year to $0.24 per share, and this year's variable special dividend of $4.50 per share, given the expectations of our strong free cash flow generation. Future returns of cash to shareholders will be based on cash flow generation, our investment needs, which include capital expenditures and acquisition opportunities, as well as our market outlook.
Turning to slide 12 for our current 2022 full- year forecast in the three major regional markets. Despite the continued strong retail demand, especially for high- horsepower equipment, we believe supply chain constraints and the corresponding effects on production will limit demand upside in the fourth quarter. For North America, with higher commodity prices and healthy farmer sentiment, we expect relatively flat demand compared to the healthy levels last year. We expect continued growth in larger equipment segments to be offset by softer demand for smaller equipment after several years of strong growth, coupled with increasing interest rates, which is further slowing this segment of the market. For South America, we expect the industry demand to remain relatively healthy and increase around 10% compared to last year.
This year-over-year growth is driven by the supportive commodity prices and favorable exchange rates, which are allowing farmers to continue to replace aged equipment as the number of planted acres continues to expand. EU farm economics are expected to remain supportive. Elevated commodity prices are expected to offset higher fertilizer and diesel costs. Economics remain positive for dairy producers as milk prices have moved to record levels and are offsetting higher feed costs. However, weakening forecasts for the general economy, concerns over the energy supply, and ongoing conflict in Ukraine are weighing on farmer sentiment. As such, we believe Western Europe industry demand is now expected to be down modestly compared to 2021 levels. Slide 13 highlights the key assumptions underlying our 2022 outlook. Our fourth- quarter results are still dependent on our supply chain's performance.
Our outlook is based on current estimates of component delivery levels for the remainder of the year, and our results will be affected if actual supply chain delivery performance differs from these estimates. Our sales outlook includes price increases of over 10% aimed at more than offsetting higher material cost inflation during 2022. With significant weakening of the euro versus the US dollar, we now expect currency translation to negatively affect full- year sales by about 8% based on the current exchange rate, versus our prior outlook of a negative 7%. Engineering expenses are expected to increase by approximately 10% compared to 2021. The increase is targeted at investment in smart farming and precision ag products, as well as the company's digitalization initiatives.
For the full- year, we expect an operating margin of approximately 9.9%, which is above the 2021 operating margin as a result of higher sales and corresponding production and improved factory productivity, partially offset by increased engineering and digital investments. Finally, we are targeting an effective tax rate of approximately 28% for 2022. Slide 14 provides our outlook for 2022, which continues to be based on the current estimates of our supply chain capacity. Results will be affected if the actual supply chain delivery performance differs from these estimates. We are now projecting 2022 sales to be in the range of $12.5 billion-$12.6 billion, and corresponding earnings per share to be in the range of $11.70-$11.90.
We expect capital expenditures to be approximately $325 million and free cash flow in the range of $400 million-$500 million. With that, I'll turn the call back to Greg for Q&A.
We will now begin the question-and-answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Please limit your questions to one and a single follow-up. The first question is from Stephen Volkmann with Jefferies. Please go ahead.
Great. Hi, good morning, everybody. I guess I'm curious, Eric. You talked a little bit about the backlog, sort of pushing well out into 2023. Can you just comment on sort of where you are? Are the order books basically open for 2023? If not, you know, any sort of trends at the margin relative to what you're seeing for orders over the last few weeks, you know, relative to the major end markets would be appreciated.
Yeah. Our order situation in terms of how we run the process is largely unchanged from what we've talked about in the past. In South America, we only open up one quarter at a time. Then in the rest of the world, we open up longer periods, but we don't confirm pricing on what we call non-retail orders or our wholesale orders. If it doesn't have a customer name attached to it, we don't confirm pricing. We'll only lock in pricing if you have a farmer with a name on it. Our order bank is still extended well into at least the second half of 2023. Order rates continue strong, but they're cooling a little bit back to more of a normative rate, and that's what we expected.
There was such a surge in demand last year in the first half of this year that bringing them back to more of a normal, incoming rate is what we expected. No big changes here from what we've talked to you about the last couple quarters.
Okay, great. Sort of off that base, you did take down your North American and EU industry outlooks a little bit. Was that mostly just the small end, or is there some other trends that you should call out for us?
Two factors there. On the demand side, it's all about small ag in North America was the only place we see demand diminishing. The industry is capped by supply constraints. The expected industry we thought we were going to see is being limited due to the component availability for us and all our competitors. We just aren't able to deliver the amount of machines that we would have liked as an industry.
Got it. Thank you. I'll pass it on.
The next question is from Jamie Cook with Credit Suisse. Please go ahead.
Hi, good morning. I guess two questions just to follow up on Steve's. Can you comment specifically on the order trends by geography? And then as you took down your industry forecast, some of it because of supply chain, does that mean you think that, like, gets pushed into 2023? I'm just wondering if that's incremental to 2023. And then my last question, the margins in South America were, you know, exceptional this quarter. Just wondering, you know, if there's anything that's, you know, one-time there and sort of structurally, how to think about your South American margins just given the improvement in 2022. Thank you. Yeah. I think, Jamie, for us, if we think about the orders by region, all of them were up double digits, with the caveat for North America.
You know, that I would tell you small ag was down, large ag was up significantly. Net North America was down orders year-over-year. EME, we were up over 20%+. South America, we were up, you know, low double digits, and Asia Pacific up into the teens as well. As Eric alluded to, you know, still seeing very strong demand with the exception of the small ag in North America. I think to your question on South America, again, credit to the team. As part of the South American fix plan that we happened to put in place several years ago, you're seeing very good, strong demand as we grow the Fendt and high- margin products there. I would tell you that that's on the backdrop of a very strong market condition as well.
You know, our strongest market that we're seeing is in South America, so you're getting good, strong market demand, which is facilitating the strong pricing environment that we're also getting. Credit to the team for being able to price, coupled with the growth that we're seeing in products like the Fendt products. Overall structural improvements have been made to the South American business. We're very happy with what we've seen, but it's also, I would say, a little bit, you know, enhanced by the very strong market conditions that we're seeing. Thank you.
The next question is from Stanley Elliott with Stifel. Please go ahead.
Hey, good morning, everybody. Thank you all for taking the question. Quick question. With the portfolio change you guys have made in North America, you've got the small ag softening, but the large ag looks pretty healthy. How does the North American margin profile hold up, and how should we think about that longer term?
Well, you know, there'll be two factors and they're both moving in the same direction. We expect the large ag market to kinda stay strong for some time yet. There's still some pent-up demand in large ag. From an industry standpoint, there's more tailwinds there. Small ag, there's probably a little bit of pull ahead during COVID. Although; you know, it's cooling off, and that one's tied more to the economy. We think that that's the movement of the industry. The focus of AGCO within the company is really about growing our large ag participation in North America. We've already established 75 dealer outlets for Fendt. We're growing them steadily according to our plan of only turning on outlets that can meet the very rigorous Fendt excellent total Fendt experience.
We've brought in the Fendt tractors, combine sprayers, planters. They're all performing exceptionally. Customers love them. Our bias and focus is really on growing North American large ag share. With that comes two things. One is should see margin expansion and a bit more stability in margins over time.
I think, Stanley, the other thing I would add to that is precision ag is doing great, up significantly year-over-year. As Eric alluded to in his pre-scripted remarks, you know, that is one of our higher growth and higher margin segments, and we're seeing good growth and expect to see continued growth in the North American market, which should continue to help enhance those margins.
Perfect. You were thinking about the Brazilian election. I mean, is there any potential impact, you know, from your seat that you all see down there? Just curious, kind of high level, what you're hearing on the ground from there.
Well, in the short term, you know, this morning there are several, I'll call it protests, and places that are being blocked for transportation in many parts of the country. It's hard to predict how long that will last. So I'll just make a guess. We hope that won't last very long. We're trying to manage around that. So that's the short term kind of tactical response. Longer terms in terms of policy changes, you know, the ag industry supported Bolsonaro in general in terms of the customer base. You know, they also, the ag industry did very, very well under Lula, and ag is such a big part of the economy that we don't anticipate any major policy changes.
Great, guys. Thanks and best of luck.
Thanks.
The next question is from John Joyner with BMO Capital Markets. Please go ahead.
Hey, good morning, and thank you for taking my question. Maybe just getting back to Jamie's question, and maybe you don't wanna answer this explicitly, but just with regard to the margins in South America, I mean, I guess, has surprised everyone. Has the improvement there surprised you internally? And then where do you kind of see margins settling in, maybe longer term on a structural basis, you know, you know, in terms of percentage-wise?
Well, right now it's a very nice coupling of all our businesses in South America are performing strongly. Damon talked about the structural change we've made in our machinery business, moving from a focus of small machines in the south to larger machines in the Midwest. We've deployed our dealer organization there. We've brought in new products to the market. Our shift has really been to a more large ag focus, a focus away from tractors only to a full line of equipment. Our planters, we've been sold out for three years in a row now. It's performing outstanding, in an outstanding way there. That's our machinery business performing very strong, and we'll be able to apply pricing strongly to that business. The industry's moving in a strong way. Our grain and protein businesses is performing lights out in South America.
We're completely sold out on our grain and protein business as well, applying pretty strong pricing there. Then Precision Planting is also growing nicely with high margins. All businesses are doing well. A bit of strong market help, but they're all just, you know, executing. We see that industry being something like 20% above mid-cycle. Over time, it'll probably drift back to be closer to mid-cycle. With that, margins will come down. We, you know, we've told you for a number of years that we expect every business to be over 10%, and we have no reason to believe South America can't continue that, especially at mid-cycle.
Okay. Excellent. Thank you, Eric. Just one last one. On the parts business, I mean, historically, I guess, the revenue there has run at maybe, like, $1.3 billion or so of sales annually, up through 2019. Now that I believe it's probably running closer to $1.8 billion. I get that the industry fundamentals are better and, you know, you've been able to grow the business in South America, implemented an SAP system, you know, improved fill rates. I mean, there's a lot of things that you've done there, which is impressive, but are there any other factors that have boosted this business? Do you see it kinda continuing to trend higher and maybe even higher as a percentage of overall sales?
Yeah, this one's a really important one. You saw me talk about it every time I get a chance to in terms of one of our three growth engines. Our first foundational effort was to get parts fill rate higher. That means when a customer wants it or a dealer wants it, that we have it available. We've really improved the business to improve parts fill. We believe we have data to show that we have got industry-leading parts fill now in North America and Europe. We've improved significantly in South America with that target to being the same. That builds confidence in the overall channel that when they want a part, they should come to us for it. That was the first step.
Now the second step is to really add digital tools and leverage the fact that we've got this connected fleet out there, machines that we can monitor when they're coming upon a service interval, and pre-populate outreach to the customer saying, "You have a service interval coming up. Can we do that servicing for you or at least order you the parts?" Services like that. They seem simple, but it allows us to capture much more share of wallet for the farmer. Over the last three years, our parts have grown at about 8%, and in the three years prior to that, they grew more like at 4%. We have a fundamental shift happening. Also, if you look back over the last 10 years, whether the industry is up or down, parts sales have kept growing.
We've never had a down year in parts sales. We believe we've turbocharged it, but we don't expect it to go negative no matter what the industry does.
Okay, excellent. Great. Look forward to seeing you next week. Thanks a lot.
Thank you.
The next question is from Nicole DeBlase with Deutsche Bank. Please go ahead.
Yeah, thanks. Good morning, guys.
Morning, Nicole.
Hi, Nicole.
Hi. Maybe just starting on the 4Q production outlook. I guess, could you just speak to the level of confidence in being able to continue to ramp up? I think that ties into maybe what you guys are seeing from a supply chain perspective in real time.
You bet. It's one of our top management topics that we're focusing on. One of the questions you're probably saying is, "Wow, that's a big quarter you have in front of you. Are you sure you can deliver it?" When you peel that back, you say, what are the root causes of the challenge? One of the root causes is the same as we've talked about before, and that's supply chain issues and getting the parts in. But for about half of our unfinished product, machines that are almost fully built, they're waiting on a couple of parts, about half of that population, We now have the parts for. It's just about applying the labor to get those machines built.
We've brought in a number of additional capacity areas to boost our ability to finish off those machines by the end of the year in a high-quality way to make sure that they can get all the way through the channel and fully invoiced to the farmer so that they can receive them for year-end tax purposes. We believe that macro trend, the supply chain is healing, and about half of our issue of our finished goods is really in our camp to solve, and we've brought in a lot of extra tools to do that. Our confidence-
That's really helpful.
Our confidence isn't 100%, but it's strong.
Got it. Okay, great. Just to follow up on Europe, obviously a really hot topic right now among investors. It feels to me like your commentary is just maybe a tad more cautious than it has been on the region. I mean, what is the risk that Europe could be down in 2023 just because of all of the economic and geopolitical issues happening in the region?
Well, you know, there is uncertainty for our European region, so we'll say that. It's hard to give you really exact answers, but we still are quite bullish on Europe. The Europe as an industry does not move up and down in a very volatile way. They hover more around the midpoint through the ups and downs, and that's what we've seen. We expect that to continue. The farmer economics are still very strong for the farmer. Their prices that they can lock in are super high. They can lock in all the way out to early 2024 right now, and we're seeing many farmers do that. You know, all indications are our order bank is very strong in Europe. We've just launched the new Fendt product that I talked about that's got great reception.
Product, industry, farmer ordering, order bank, all positive. We've got, you know, a lot of news articles about energy supplies and things like that, and that's a real topic. We've put in place, I'll call it Plan B options in all of our facilities to have an alternate source of energy, whether that be electric or liquefied natural gas or other things. You know, we're quite bullish about Europe staying strong again next year.
Thanks, Eric. I'll pass it on.
You bet.
The next question is from Mircea Dobre with Baird. Please go ahead.
Yes. Good morning. Thanks for the question. I wanna follow up on this Europe discussion here, because in your assumptions, you have tweaked industry sales lower and, I would like to know what's behind that. From your perspective, if there is resolution to the conflict in Ukraine, hopefully sometime soon, do you think that that's a positive or a negative for equipment demand in Europe and sentiment overall?
Well, the tweaking we did on the European industry was really all supply- related. It's not about demand. It's the industry's inability to supply all of the farmer demand that's out there. AGCO is in the same situation in that regard. There's no change in our view on the demand side of things for the European farmer. In fact, if anything, the profitability has probably gone up a bit for the European farmer since our last quarter. The fundamentals are strong. Your second question is how do we view the conflict easing, if that were to happen, and what's the impact? Net, I think it would be positive for the European farmer in that. Right now there's a cloud of uncertainty, just like the questions you're asking of what's going to happen.
Uncertainty has people, to some degree, hold back a little bit and they have a little element of conservatism. Underlying that is just fundamentally price and cost. There's a price in the market today and a cost in the market. Because there's not enough grain in the world. I don't think anything will change that until we get to a little. If in the spring, South America has an outstanding harvest, that could ease things. We're really probably looking in the next fall before the world will heal itself for having enough grain.
Understood. Maybe a question on where you're gonna be in capacity utilization in the fourth quarter and going into 2023. I mean, if let's say the supply chain starts to ease a little bit, can you continue to increase production hours next year? Do you have the capacity available, or is there something else that you're gonna have to do to adjust the business to address that?
No, we've been investing steadily through this year to add more capacity in our bottleneck areas. You know, I've talked to you about our planter factory has been sold out each of the last three years. That's, I guess, a good problem to have, but we don't like shorting any farmer that wants a product. We continue to invest in all of the facility areas where there's bottlenecks and so if the demand is there, we'll take production up next year in the areas that require it.
Thank you.
The next question is from Seth Weber with Wells Fargo Securities. Please go ahead.
Hi. Hey, guys. Good morning. Hey, Eric, I just wanted to go back to your recent comment when you answered a question just about kind of bringing on more resources to get more product out the door. I mean, should we assume that I'm just trying to flip to this 9.9% operating margin for the year. Should we assume that operating margins kinda tick down across the regions, or is that more just a normalization in South America that gets us to that kinda 9.9, that 9.9 for the year? I'm just trying to understand, like, where the costs are kinda moving around here for the fourth quarter. Thanks.
No, I would not. I would say that in reverse. That's really what we're doing is reallocating resources across our factories. Any factory that's got their situation in a good spot, we're pulling resources out of those factories and moving them to other facilities that need extra help getting these mostly built machines completed. That's what we meant. That's one of the sources of extra capacity. We're tapping into others as well. The labor cost is very small compared to the incremental margins on these machines to get them finished up. It's usually just a couple parts that need to be finished. It's a small number of hours to get a big machine out to the marketplace.
We don't have any concerns that this action will have an impact on cost.
Yeah. I think, Seth, to your question on margin, you'd generally speaking, when you back into the fourth quarter, margin should be relatively flat to Q3. You might see a slight geographic mix. You know, as you looked at the European margins this quarter, they were a little bit low. As Eric talked about a lot of this semi-finished work in process, there's a good amount in Europe. To the extent where as we work through that, you know, you'll sort of see a little bit of an improvement there, maybe offset by a couple of other regions. Overall, total company, we would expect it to be relatively flat to Q3.
Okay. That's helpful, guys. Thank you. Just a quick follow-up on the Precision Planting. Have you, given the delays and with the supply chain semiconductors and stuff, seen any cancellations in those orders on the Precision Planting side of the business since you're-
Not at all. No, not at all. Our demand continues extremely strong. Full- year for Precision Planting, we expect to be up 35%-40%. And our Fuse, we expect, which is our internal brand for AGCO machines, is expected to be up 20%-25% for the full year. Overall, our precision ag business, when you combine those two, is up 30%-35%. We're not seeing any cancellation of orders. We just launched a whole new automated soil sampling business in August. That's getting positive reviews. We're gonna be launching more new products in January at our annual conference. The innovation engine is running red-hot, no slowdown there expected.
Got it. I appreciate it, guys. Thank you.
The next question is from Tami Zakaria with JP Morgan. Please go ahead.
Hi. Good morning. Thank you so much. Most of my questions have been asked already. I have a couple of quick ones. Are you seeing any improvement in China quarter to date, sequentially, or should we expect that region's sales to be challenged for the rest of the year?
I think, Tami, right now, excuse me, we would expect China to continue to be challenged as we go through the fourth quarter here with the sort of lockdowns they've experienced through the first part of the year here.
China is a very small portion of our business. What percent would we say it's?
Out of our Asia Pacific business is probably 10%-15%.
Yeah. Company-wide, China is a very small portion of our total company sales. Although it'll be challenged, it's not very meaningful to the total number.
Got it. That's super helpful. Have you seen any relief in inflationary pressures in your raw materials costs, maybe in the GSI segment, given that it uses raw steel?
Yeah, we're seeing with steel prices coming down, you know, a lot of our products in the, as you say, in the GSI grain and protein sector, they're kind, you know, our materials are indexed to those prices, and so they're coming down. That should give us a little relief in that market with how high we've had to price the equipment, and which I think has affected demand this year. Hopefully, those prices normalize, and that'll help the overall grain and protein market.
Got it. Can I just squeeze in one, a quick one? I'm sorry if I missed it, but did you comment on the level of pricing you're embedding for next year's orders?
We did not comment on pricing, Tami. I think what we expect through the pricing actions that we put in place this year, we said we expect in excess of 10% for the full year. There will be a decent amount of carryover pricing that will go into 2023. As we look at the material cost inflation that we still expect to go into 2023, and we expect it to be up year-over-year, we would expect some incremental pricing in 2023 as well, but we haven't given any specifics as of yet.
Got it. Thank you so much.
The next question is from Tim Thein with Citigroup. Please go ahead.
Thanks. Good morning. Maybe just to circle back, and I apologize if I missed this. Just your near term margin expectations for EME and how we should be thinking about, and really more importantly, you know, looking beyond the fourth quarter, just as we, you know, think about the volatility both from an FX and certainly an energy cost situation, but you know also with the prospect of production hours increasing. Just how do we kind of weigh those all together as to what that means for margins in the near term?
Yeah, we're very bullish about Europe. Our order board is up 20% in Europe from this time, you know, the third quarter last year. Energy cost is less than 1% of our cost of goods sold. You know, there is an elevated energy cost, but it's not a huge impact on the overall business. We've put in place alternative energy sources at every one of our factories, whether that's wood pellets or electricity or other things to be able to continue to running. We've been working with our unions to make sure that they're flexible enough in case we need to work different shifts or different days, that type of thing. The demand continues strong, and that's on the back of strong farmer fundamentals. Pricing is strong, and costs have pretty much stabilized for the European farmer.
They can lock in those prices well into the future, early into 2024, and they continue to order, like I talked about with our order bank. We've got the capacity to continue to grow our production for the European factories next year. Overall, I think I covered every corner of your question there. We're bullish about Europe.
Okay.
From an industry standpoint, we think it'll stay semi flat-ish kinda. You know, we're not giving forecasts, but we don't see any big drop off or anything like that coming in Europe. They usually have quite a stable market from year to year.
Yeah. Okay, yeah, then maybe just one on product mix and how we should think about that, not Europe specific, but for AGCO as a whole. I mean, the company has, you know, obviously expanded quite a bit beyond tractors. And I can imagine there's probably a fairly sizable, you know, spread high to low across individual products. Should we think about that as a. If you know, just given the visibility you have, you know, with backlogs extending as far as they are, should we think about that as a tailwind to margins in 2023? I know you're not giving guidance, but just based on what you have orders in hand, should that be a tailwind or not? Thanks.
Yeah, I don't know if I would give a strong tailwind there. I think, you know, we're definitely moving into a full line of equipment. Planters, sprayers, combines, and tractors, along with our hay equipment and grain and protein. Just because we're adding in those other machinery forms doesn't mean that our margin mix would shift considerably. You know, we have certain tractors we make a good margin on, certain tractors are low, and the same thing with the rest of the products. I don't think it's a fundamental change to our business. We are strengthening our large ag business, so that's a positive. I wouldn't overbake it.
Eric, I would say that, you know, thinking longer term, not really talking about 2023, but longer term, when we talk about those growth areas, the key growth areas of growing and expanding Fendt globally, growing our parts business, growing our precision ag business, those are all of our highest margin businesses. So if we can grow those faster than the rest of the business, which is our strategy, that will give us a stronger mix and give us margin improvement in the future.
Well said.
All righty. Thanks for the time.
The next question is from Kristen Owen with Oppenheimer. Please go ahead.
Hi. Good morning. Thank you for taking the question. I wanted to ask specifically about Precision Planting, some of the strength that you've seen in the back half there. Eric, I think previously you had talked about that business being up 30% for the year. Sounds like maybe now that's higher, 35%-40%. I'm wondering if you can speak to how much you feel like there is unmet demand in that business. If there's any sort of pull-through effect because of the supply chain constraints on whole goods. Just a bit more color on what you're seeing specifically in that business.
Yeah. Quarters one and two were constrained to some degree from semiconductor chips in that business. We've redesigned the product to some degree, and we've gotten extra different chips in and, you know, done a number of different things. We're catching that up now in quarter three and quarter four. Order rates continue strong, and so that's why we've raised our expectation for the year. We expect, you know, the backlog to continue. Like I said, we're gonna launch another new set of products in January. The unmet demand is still strong. We have a very low penetration rate. In most of our products, we're still single-digit penetration rates on these features.
There's a few that crop up into the, maybe into the twenties, but we feel far from saturated in the product features. Then you think about geography. We're growing into Europe. We're just in early days in growing into Europe and still have a lot of headroom in South America. Then when you add to that, we bought a harvesting business. We bought Appareo, we bought JCA. We bought six companies last year to augment Precision Planting. It's a multiple factor of geography, new features coming out of Precision Planting organically, the inorganic growth of M&A. It's a multiplier flywheel that's spinning there.
Great. If I could ask just a follow-up on some of the comments around South America. Can you just give us an update on where you are in terms of your local manufacturing content there?
Do you want to go ahead?
Yeah. Kristen, for us, you know, over the last four or five years, we've localized a lot of our most modern tractor technology in Brazil. As you can imagine, over the last couple of years, we haven't made a lot of progress with localization of components just because of the difficult supply chain situation. As we look forward into the you know, I won't say just 2023, but the coming years, we do have an opportunity to get our local content % closer to where it's been historically, as opposed to lower than it is right now. That certainly is an opportunity as we think about localizing components, and at the end of the day, that should help our cost basis down there.
Thank you.
Our last question today is from Jerry Revich with Goldman Sachs. Please go ahead.
Yes. Hi. Good morning, everyone. I'm wondering, Eric, if we just expand on the precision ag conversation, can you talk about how much runway you folks have on the Fuse suite growth over the next year? I felt like you folks were maybe approaching a full adoption rollout across the portfolio this year. I'm wondering, do we have opportunities to continue to grow the different features to drive continued growth in Fuse? On Precision Planting, you know, how much capacity growth do you folks have based on your latest supply outlook as we look at the next 12 months, compared to the positive revision you made to the production plan this year? Thanks.
On Fuse, we have a lot of upside potential there. We've installed connectivity and guidance on most of our large ag equipment in Europe and North America. We still got a lot of growth potential in South America. We haven't tackled yet any retrofit opportunity and additional features. As there's more and more machine-to-machine communication and other capabilities brought to the market, I think Fuse has still got a lot of upside, both features and geography. For Precision Planting, we announced maybe two quarters ago or so that we're building a very large new facility in Illinois to enable the growth of that overall business. It's a 500,000 sq ft factory. We've broken ground, and it's under production right now.
We'll be live with that in 2023, and that's really to enable to make sure that we can stay on top of all this demand that's coming in for those products and the acquisitions that we made.
Okay. Super. In terms of the production plan, you know, this quarter, you folks are planning to produce more than under normal seasonality. As we think about production cadence in into next year, it sounds like we're gonna be off to a stronger than normal seasonal start to calendar 1Q. I'm wondering if you could just expand on the production plan given, you know, how abnormal 2022 was because of the disruptions.
Yeah. I think as you heard us say in our scripted remarks, you know, we do expect Q4 to be up, I'll say low double digits year-over-year. As we look at the 2023, again, as Eric alluded to, we still see strong demand, so we would expect production hours to, you know, follow more of a traditional seasonal trend, likely be up as we've done some investments. I think the important thing to also remember is even if production hours are flat, the productivity as we go as supply chain starts to improve, the amount of rework of our equipment becomes less, which will allow us to get more units out per factory, even in a similar number of hours.
We still expect it to be up, but I think the quality of those hours as supply chain starts to improve, you know, should improve the output as well.
Thanks.
This concludes our question and answer session. I would like to turn the conference back over to Eric Hansotia for any closing remarks.
Thank you. I'll close this morning by saying thank you very much for your participation and your continued support for AGCO. Despite additional currency headwinds and supply chain challenges, we had a very solid first nine months of 2022. With a lot of work still ahead of us in the balance of the year, we are solidly on track for strong sales growth, margin expansion, and higher full year earnings per share. These results will deliver a record year for AGCO, and equally as exciting, it further positions us for more success as we enter 2023. I want to leave you with our growth slide I discussed earlier and reiterate our plans to grow our business.
We are very convinced that the continuing development of farmer-focused solutions that solve critical farmer problems will greatly expand our addressable market and drive significant sales growth over the long term. We are also engaging strongly on sustainability, helping our farmers make the transition to not only more productive farms, but more sustainable farms. We look forward to seeing many of you at our analyst meeting on December sixteenth. Thank you, and have a great day.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.