Good morning and welcome to Deere and Company's Third Quarter Earnings Conference Call. Your lines have been placed on listen only until the question and answer session of today's conference. I would now like to turn the call over to Mr. Tony Hiekel, Director of Investor Relations.
You may begin. Thank you. Also on the call today are Raj Kalathar, our Chief Financial Officer Doctor. J. B.
Penn, our Chief Economist and Josh Jepsen, our Manager, Investor Communications. Today, we'll take a closer look at Deere's 3rd quarter earnings, then spend some time talking about our market and our outlook for the remainder of the fiscal year. After that, we'll respond to your questions. Please note that slides are available to complement the call this morning. They can be accessed on our website at www.johndeere.com.
As a reminder, this call is being broadcast live on the Internet and recorded for future transmission and use by Deere and Company. Any other use, recording or transmission of any portion of this copyrighted broadcast without the expressed written consent of Deere is strictly prohibited. Participants in the call, including the Q and A session, agree that their likeness and remarks in all media may be stored and used as part of the earnings call. This call includes forward looking comments concerning the company's plans and projections for
the future that are subject to important
risks and uncertainties. Additional information concerning factors that could cause actual results to differ materially is contained in the company's most recent Form 8 ks and periodic reports filed with the Securities and Exchange Commission. This call also may include financial measures that are not in conformance with accounting principles generally accepted in the United States of America or GAAP. Additional information concerning these measures, including reconciliations to comparable GAAP measures is included in the release and posted on our website atwww.johndeere.com/earningsunderotherfinancialinformation. Josh?
Thanks, Tony. John Deere today reported solid financial results for the Q3 and did so in spite of the continuing impact of the global farm recession and difficult conditions in the construction equipment sector. All of Deere's businesses remained profitable for the quarter and earnings per share was slightly higher than last year. Operating profit for our Ag and Turf division and for the equipment businesses overall was above last year's levels even though sales were down nearly $1,000,000,000 Our results were helped by the sound execution of our operating plans, the impact of a broad product portfolio and our success keeping a tight rein on costs and assets. Now let's take a closer look at the Q3 in detail beginning on Slide 3.
Net sales and revenues were down 11% to about $6,700,000,000 Net income attributable to Deere and Company was 489,000,000 dollars EPS was $1.55 in the quarter. On Slide 4, we see that worldwide equipment operations net sales were down 14% to just under $5,900,000,000 Price realization in the quarter was positive by 2 points. Currency translation was negative by 2 points. Turning to a review of our individual businesses, let's start with Agriculture and Turf on Slide 5. Net sales for the division were down 11% in the quarter over quarter comparison with a decrease primarily due to lower shipment volumes in the United States and Canada.
Also affecting sales was the negative impact of foreign currency exchange. Operating profit was $571,000,000 Ag and Turf operating margins were 12.1% in the quarter. The gain on the sale of a partial interest in SiteOne Landscape Supply contributed nearly 2 points of operating margin in the quarter. Even excluding the SiteOne impact, operating margins were above the levels of last year's Q3. Before we review the industry sales outlook, we're pleased to welcome Deere's Chief Economist, Doctor.
J. B. Penn. He will spend a few minutes sharing his thoughts on the state of the global ag economy. J.
B? B.
Penn:] Thanks, Josh. I would begin with a bit of context that might be useful as we ponder the outlook. Slide number 6 shows the strong tailwinds that now drive the global agricultural economy. Major changes in agriculture and food markets began occurring sometime around the turn of the century and that ushered in a dozen or so unparalleled years characterized by strong demand growth, record high prices and farm incomes, food price spikes, expanded investment and innovation and increased trade. A convergence of forces was responsible.
Global population growth, widespread global economic growth, especially in emerging market and developing countries, rapid urbanization and biofuels. Now in 2000, the UN was projecting that the population would grow from 6,100,000,000 in that year to 9,300,000,000 by 2,050. Today, that projection for 2,050 is 9,700,000,000 dollars So that's another $2,400,000,000 from today's 7,300,000,000 people. Although having slowed somewhat, the global expansion continues, especially across much of the developing world, bringing millions more into the middle class and enabling ongoing improvements in diet. On urbanization, we passed the 50% mark of population sometime around 2010 and that is now expected to approach 70% by 2,050 with implications for food production and trade.
Now slide number 7 reflects global ag as a whole, showing the production and consumption of all global grains. Now perhaps the most noteworthy point of the slide and one often overlooked with all the focus on supply, acreage and yield, and that is the persistent consumption growth. Consumption remains very strong, still rising steadily year after year and it has risen without fail every year since 1994, 'ninety five even including the Great Recession of 2,009. Now fueled by earlier high prices and after 4 consecutive great growing seasons worldwide, commodity supplies now are fully adequate to meet all needs. Prices, of course, have moved off the previously high levels and farmer margins have narrowed.
Slide number 8 provides more details showing global stock holdings and the supply to use ratio. While carryover stocks have reached levels of 15 years ago in physical quantities, it is important to remember that we are now consuming 1 third more grains, so the supply use ratio is the key indicator. While it has moved above the average of recent years, it remains in a sensitive area and especially so when viewed with Chinese grain stocks excluded. Notably, the Chinese are thought to hold about 45% of the global stocks and the supply use ratio actually has ticked down the last couple of years when the Chinese stocks are excluded. Now Slide 9 illustrates that even with abundant supplies, the production consumption balance still could shift rather quickly.
Any significant production disruption will tilt the supply use ratio downward and prices will immediately move higher. The recent price movements in response to reports of relatively minor weather events certainly highlight the continued sensitivity. You will note from the slide that both corn and soy futures were trading in a rather narrow range in the 1st 4 months of this year. Then we saw some reports of adverse weather in Brazil and Argentina in April. Prices quickly reflected the uncertainty that brought.
Corn moved almost $0.90 a bushel higher. Soy moved $3.25 a bushel higher. That's an increase of 25% for corn, 36% for soy. Then by late June, the South American weather conditions abated followed by the early July USDA WASDE report indicating larger acreages of both corn and soy. The weather premium quickly disappeared from the corn price and it was reduced for soy.
Now just for reference, the U. S. Drought in 2012 reduced corn yields 22% below trend, pushing ending stocks to barely 800,000,000 bushels and prices to new record high. But this year, a corn yield reduction of only 4% would have been sufficient to reduce ending stocks to 1,000,000,000 bushels and push prices to $5 per bushel or higher, a further illustration of the sensitive supply utilization balance. Now there was some expectation that farmers would reduce acreage in response to the softer prices as we came into the Northern Hemisphere planting season.
On Slide 10, we note that despite the softer prices, farmers worldwide did not reduce acreage. Now in the United States, farmer supply response this year was influenced by market prices of course, which provided a paired but still positive margin, but they were also influenced by farm program subsidies, revenue insurance and production cost decline. For example of the subsidy, the agricultural program ARC County forecast 2015 payments for Illinois is $0.37 per bushel on corn base acres and $0.98 per bushel on soybean base acres. So as a result of this combination, U. S.
Farmers this year expanded planted area for all major crops except wheat, illustrating continued profitability despite softer prices. Now we also expected a similar reduction in other parts of the world, but we noted there that farmer supply response was influenced largely by currency values and also some policy shifts notably in Argentina. In this crop year, major exporters expanded grain and oilseed area all around the world and grains and oilseeds were up 3.7% in South America. As an example, Brazilian farmers saw corn prices in reais of $5.24 per bushel in September 2015 compared to $3.43 per bushel the year before, indicating that it was still very profitable to continue to expand. Now Slide number 11 speaks to the financial condition of the U.
S. Farm sector. Overall, the farm sector balance sheet remains strong. Farmer debt has been well managed. The financial indicators are still solid.
It was not until 2000 that farm sector equity reached $1,000,000,000,000 but then it took only 10 more years to add a second $1,000,000,000,000 and 5 years later we've added another $500,000,000,000 Now a major part of that balance sheet of course is farmland and USDA forecast land prices to decline in 2016, cropland to decline 1%. This is the first time since 2,009 and only the second time in almost three decades. Now Slide 12 summarizes the situation across the global ag sector. As I noted supplies are fully adequate, the risk premia have been erased from the grain markets. We saw very little reduction coming into the year in response to the lower prices and that was because of the aberrational forces at play, the subsidies, the risk measures and also currency values, which boosted commodity prices.
And we're in the 4th consecutive favorable weather year. So adding all of those things together, barring adverse weather events, little near term improvement in ag market conditions is anticipated, but we would note that the long term drivers, population growth, incomes growth and urbanization are still intact. Now Slide 13 pertains to the U. S. Ag sector and we note that farming is still profitable despite softer prices as evidenced by the continued expansion of planted acres this year and financial conditions across the sector remain solid.
There is some individual farmer stress to be sure, but no widespread stress is yet evident. And finally, slide number 14 lists some key factors that are worth watching in the coming months. And in the short term, of course, weather is key. We know that demand is strong. We now know that supply depends upon the weather.
So it's still weather is the major market disruptor and it's still one season at a time. Attention now will turn from North America to the Southern Hemisphere as the planting growing season gets underway there in late September October. We'll continue to watch that until next spring in the Northern Hemisphere when we'll start focusing on planting and growing conditions here. And over the longer term, I would just note that any of these geopolitical hotspots that could erupt and become a drag on global GDP would be a negative. Lots of other things to watch include relative currency values and political situation in several countries, central bank behavior all over the world.
And so I would just conclude by noting that after a dozen years of unprecedented prosperity, planting, commodity price, food price and trading patterns are now stabilizing. A new commodity price trading range with favorable weather is emerging and weather remains the major commodity market disruptor. The outlook is still 1 year at a time depending upon the weather. I will now turn the call back to Josh.
Thanks JB. Our 2016 ag and turf industry outlooks are summarized on Slide 15. You'll note there are no changes from our previous forecast. Low commodity prices, weakening farm income and elevated used equipment levels in the U. S.
And Canada are continuing to pressure demand for farm equipment, especially high horsepower models. We expect industry sales in the U. S. And Canada to be down about 15% to 20% for 2016, with sales of large ag equipment down 25% to 30%. The EU 28 industry outlook remains flat to down 5% due to lower crop prices and farm incomes as well as persistent pressure on the dairy sector.
In South America, industry sales of tractors and combines are expected to be down 15% to 20% in 2016. This is a reflection of the downturn in Brazil and other commodity driven markets in the region. Shifting to Asia, the industry sales outlook continues to be flat to down slightly. This is due in part to weakness in China, partially offset by improving conditions in India where the monsoon rains have been higher than normal. Turning to another product category, industry retail sales of turf and utility equipment in the U.
S. And Canada are projected to be flat to up 5% in 2016, again no change from our prior forecast. Putting this all together on Slide 16, fiscal year 2016 Deere sales of worldwide ag and turf equipment are forecast to be down about 8%, including about 2 points of negative currency translation. This is unchanged from the previous forecast. Our forecast for the Ag and Turf division's operating margin is now about 7.7% for the year with an implied decremental margin of about 15%.
Now let's focus on Construction and Forestry on Slide 17. Net sales were down 24% in the quarter and operating profit was down 58% due mainly to lower shipment volumes and an unfavorable product mix. The division's decremental margin was 20%. Moving to slide 18, the economic indicators noted at the bottom of the slide, although down somewhat from the previous quarter, remain positive. Notwithstanding these positive signals, the market demand for construction equipment continued to soften.
Among the factors contributing to the weakness, conditions in the oil and gas sector continue to be slow with the impact most pronounced in the energy producing regions of the U. S. And Canada. Contractors are less apt to replenish or grow their machine fleets when faced with uncertain markets. Rental utilization rates continue to decline, leading to a reduction in fleet sizes and higher levels of used equipment.
Also housing starts in the U. S. For single family homes which require more earthmoving equipment remain well below the long term average. As a result, Deere's construction and forestry sales are now forecast to be down about 18% in 2016. Currency translation is forecast to be negative by about one point.
The global forestry market forecast remains down 5% to 10%, primarily as a result of lower sales in the U. S. And Canada. C and F's full year operating margin is now projected to be about 4.1%. The implied decremental margin for the year is about 31%.
Let's move now to our financial services. Slide 19 shows the annualized provision for credit losses as a percent of the average owned portfolio, which was 24 basis points at the end of July. This reflects the continued excellent quality of our portfolios. The financial forecast for 2016 contemplates a loss provision of about 23 basis points unchanged from the previous forecast. The provision remains below the 10 year average of 26 basis points and well below the 15 year average of 39 basis points.
Moving to Slide 20, worldwide financial services net income attributable to Deere and Company was $126,000,000 in the 3rd quarter versus $153,000,000 last year. Lower results for the quarter were primarily due to less favorable financing spreads, a higher provision for credit losses and higher losses on lease residual values. The division's forecast net income attributable to Deere remains at $480,000,000 for the year. Slide 21 outlines receivables and inventories. For the company as a whole, receivables and inventories ended the quarter down $764,000,000 We expect to end the year with total receivables and inventories down about $500,000,000 with reductions coming from both divisions.
Field inventory to sales ratios for new large ag equipment are expected to end the year in line with 2015 year end levels, which is consistent with our previous forecast. TNF inventory and receivables to sales ratios are forecast to end the year roughly in line with last year's levels as well. Our 2016 guidance for cost of sales as a percent of net sales shown on Slide 22 is about 78.7%. When modeling 2016, keep these unfavorable factors in mind and unfavorable product mix and engine emission costs. On the favorable side, we expect price realization of about 1 point, favorable raw material costs, lower pension and OPEB expense and lower incentive compensation expense.
Now let's look at a few housekeeping items. With respect to R and D on Slide 23, R and D was down 2% in the 3rd quarter. Our forecast calls for R and D to be down about 1% for the full year including about 1 point of negative currency translation. This is consistent with our previous forecast. Moving now to Slide 24.
SA and G expense for the equipment operations was down 10% in the 3rd quarter. Most of the decline was attributable to incentive compensation, commissions to dealers, pension and OPEB and currency translation. Turning to Slide 25, our 2016 forecast contemplates SA and G expense being down about 5% with incentive compensation, currency translation and pension and OPEB accounting for about 6 points of the full year change. On Slide 26, pension and OPEB expense was down $53,000,000 in the quarter and is now forecast to be down about 210,000,000 in 2016. On Slide 27, the equipment operations tax rate was 31% in the quarter and is now forecast to be in the range of 29% to 31% for the full year.
Slide 28 shows our equipment operations history of strong cash flow. Cash flow from the equipment operations is forecast to be about $2,100,000,000 in 2016. The company's 4th quarter financial outlook is on Slide 29. Net sales for the quarter are forecast to be down about 8% compared with 2015. This includes about one point of price realization and favorable currency translation of about 1 point.
Turning to Slide 30 and the full year outlook. The forecast now calls for net sales to be down about 10%. Price realization is expected to be positive by about 1 point with negative currency translation of about 2 points. Finally, our forecast now calls for net income attributable to Deere and Company to be about $1,350,000,000 for the full year. In closing, Deere continues to perform well in the face of challenging market conditions, and this is particularly true in relation to previous farm recessions.
Our performance in the Q3 and for the year to date underscores our success developing a more durable business model and a wider range of revenue sources. At the same time, we're continuing to look for ways to make our operations more profitable and efficient by seeking out further structural cost reductions. All in all, we remain confident in the company's present direction and believe Deere is on the right track to deliver significant value to its customers and investors in the years ahead. I'll now turn the call back over to Tony. Thanks, Josh.
Now we're ready
to begin the Q and A portion of the call. The operator will instruct you on the polling procedure. However, as a reminder, in consideration of others and our hope to allow more of you to participate in the call, please limit yourself to one question. If you have additional questions, we ask that you rejoin the queue. Operator?
Thank
Our first question is from Timothy Tine from Citigroup Global Markets. Your line is open. Thank you. So Tony, there's some pretty big moves during the quarter that you alluded to in both corn and soybeans, I guess, grains in general. But I'm curious what you're hearing just in terms of overall sentiment from your dealers in North America and how that's kind of influenced farmer decisions and especially how that kind of carried through in terms of the early the spring early order program, how that finished relative to last year?
Thank you.
Thanks, Tim. Yes, I mean, as you might imagine, and we talked last quarter and even the early part of Q3 where sentiment was a bit more positive as those commodity prices were up. And as we mentioned there, that can change in a hurry. And it's certainly with the commodity prices coming down, I think it's fair to say that the overall mood would be less positive than it was a couple of months ago even. Related to the spring seasonal equipment, we just finished the first phase.
Remember, these are multi phase early order programs. So I want to stress this is still quite early. But we did see on some of those key products like planters and sprayers as well as spring tillage equipment, We are seeing those early order programs down year over year. But as you think about the magnitude of that decrease considerably less of a reduction versus where we were a year ago. In fact, if you look at just plant or EOP in particular, which is often considered a good indicator for large ag in this current environment, orders are down in the single digit range.
So, just to give you an idea, but again, I would stress that it is quite early. So next call?
Our next question is from Andy Casey from Wells Fargo Securities. Ag and turf margin question. You mentioned the margin increased even without the SiteOne gain. First, was that gain consistent with the $76,000,000 identified in the 10 Q? And then, exiting the gain out, really, it's the first positive year to year growth in Q1 of 'fourteen, but the implied Q4 guidance suggests a fairly deep year to year decline.
I'm just wondering what drove the improvement in Q3 and what's changing in Q4 to drive a continuation of the margin declines?
Yes. Certainly, the Q3 was a very strong quarter for ag and turf. On lower sales, the operating margins were higher. Obviously, price realization continues to be very strong. You pointed out the SiteOne gain that was about $75,000,000 I think Josh indicated it just under 2 points of margin there.
But really a lot of it was cost management. And so we had lower production costs, things like obviously incentive comp, material costs continue to be a tailwind for us. Obviously, we had a little higher Tier 4 emissions costs. SA and G was also lower. So those were some of the positives.
Obviously, volume and FX continued to be drags on the profitability as well. As you look out into Q4, I think a couple of things to keep in mind, one is mix shift. So, as you think about the production, a couple of our key factories in particular, you think about Waterloo with large tractors as well as Harvester Works we'll see considerably lower production in the Q4 of 'sixteen versus 'fifteen. Just to put some context around that, Harvester Works for combines would be about a 60% reduction in output hours and Waterloo is about a 20% reduction in output hours. So, couple of very profitable products for us that the production will be down pretty considerably.
The other thing I think that's worth noting is material costs. That's been a nice tailwind for us through the 1st 3 quarters of the year. That actually becomes more flattish. It's slightly negative, but really more flattish in the Q4. So, you lose the tailwind in the quarter, it would be the other item I'd point out.
So those are probably the biggest differences as you move into the Q4.
Our next question is from Jamie Cook from Credit Suisse Securities.
I guess, Tony, the question I usually ask, can you just talk about the progress you've made in the U. S. Or North America on the used equipment issue where we are relative to last year and relative to your expectations and what that implies for do we think we have to take incremental inventory out on the used side in 'seventeen? Thanks.
Thanks, Jamie. Used equipment and I want to kind of parse that out again as we always do. When you think about large ag used inventory, we continue to be down about 23% from the peak of kind of summer of 2014. That's consistent with where we were at the end of last quarter. But keep in mind, seasonality does create a challenge in terms of even keeping things flat.
So I would say that, that is kind of as expected, at least in line with what we would expect. We would hope to see and certainly expect to see progress continue to resume in Q4 with that number continuing to move back down. But to your point, we still have a significant amount of work to do yet this year, but even in 2017. So, that kind of talks to the inventory balance a bit. And I think when you look at the balance sheet of dealers and pricing and the valuation of that equipment, generally what we're hearing is the dealers are feeling a little better about the income or the equipment that they do have and the value that it's at on their balance sheet.
We've seen some pricing stabilization on used equipment. So again, I think things are stabilizing, but I want to be clear, we have a lot of work on the actual level of used inventory at our dealers that will continue into 2017.
Okay. Thank you. I'll get back in queue.
Thank you. Next caller? Next question is from Eli Westgarten from Longbow Research. Your line is open.
Good morning, everyone. Hi, Eli.
Very nice quarter. Thank you. One thing I'd say economists will look at, by the way, is that the movements in commodity prices, particularly in corn, were related to 252,000 money manager long contracts that unwound in 11 days to a negative 100. I mean, it was really money managers that drove it more than the free market. That's public data, by the way.
My question really is looking at production levels as we go into the Q4 and actually into next year. You've indicated your inventory level will be sort of best same place as 15%, but we're talking about a U. S. Market that's down 20%, 25% and almost 30% in big tractors and probably may have some minor fall next year. So it just suggests that there's either planned shutdowns coming now or in early 'seventeen and that has will probably have some weight on the $0.35 that you sort of forget for projecting for the Q4.
Can you give us some color on how production levels you started a little bit on how far down the Q4 will be, but the inventories aren't going to go away. The big shock for farmers
Yes. Eli, let me I'm going to jump in here because, A, I think you're mistaken in what we said, okay. We're not saying that the field inventory levels are the same. We're saying are going to be in line as a percent of sales. They'll be in line.
So that's implying large ag is down pretty considerably when you look at field inventory. So, again, the reason we're clarifying that is, as we've talked earlier in the year, when you're looking at total ag inventories and receivables, you have small ag in there as well and we've seen some increases there. But if you look at just large ag, we have taken pretty considerable reductions in the year to keep those inventory and receivable levels in line with the sales when we get to the end of October. So, I think that's probably the most important statement. In regard to 2017 shutdowns and production schedule, we'll talk more about that next quarter when we have the 2017 output.
So anyway, I appreciate the question and we'll move on to the next caller. Thank you.
Thank you. Our next question is from Jerry Revich from Goldman Sachs. Your line is open.
Good morning,
everyone. Tony, can you please talk about your allocation of pool funds between use transactions versus new this year or the dealers use of pool funds, I should say? And how we should think about as we enter 2017, where that balance of allocation of use of pool funds shakes out between a new and used, just put it into context versus history for us, if you don't mind?
Sure. Yes. And I think there can often be confusion around pool funds. When we refer to pool funds, at least in the U. S.
And Canada, those funds are only for used equipment. They earn them on the sale of new equipment, but it's really the funds that are available for them to provide incentives for the sale of used. So we often talk about one way they can use those is for helping to subsidize the floor planning that they have of used equipment as well as actual retail. And so we do tend to manage that. There was a period of time where we were starting to see a shift towards more use of wholesale financing and floor planning, but that has shifted back to a very attractive use on actual retail and pretty much in line with what we would expect.
So that's been a positive trend that we saw really early in the year and it's continued through the year on pooled funds. So, another question around there that I'll throw in as a bonus, if you look at pool funds in aggregate, we would say certainly as we look at that relative to used inventory, we would be comfortable in aggregate that as we said before, there are clearly some dealers who we would look at and say their pool funds are too light relative to the used equipment that they have and that's when we have those individual conversations with those specific dealers. But in aggregate, still at healthy levels.
Appreciate the bonuses. Thanks. Thank you. Next caller?
Our next question is from Laurence De Maria from William Blair. Your line is open.
Thanks. Good morning, guys. Hi, Larry. Hey, I want to ask specifically about the Finco and some of the headwinds that are potentially going forward around residual values. I think if we look at the book, they're set around 64%.
It's up significantly from a decade ago around 40%, 42%. So I'm guess I'm kind of wondering what kind of risk you guys see from that declining given the weaker market prices we've seen over the last couple of years and what kind of headwinds to think about from that over the next maybe year or 2, I guess?
I mean, if you think about the operating leases, just kind of in general, I think, hopefully the read through as you look at the quarters, things seem to have stabilized at least in the short term in terms of the losses that were recognized, no additional impairment, those sorts of things. Obviously, the forecasted income for financial services stayed the same, all positive. But to your point, I would say, in the near term, short to mid term, there's still certainly risk. As we look at future maturities, we continue to work hard to reduce the return rates on those maturities as well as finding more effective ways to dispose of those when they get returns, so that the loss rates are not as significant. But as long as we stay at these lower levels, as long as used equipment prices continue to be at more depressed levels, I think that continues to bear watching and certainly has risks.
So while we take some comfort in the short term with the stabilization we saw in the quarter, it's going to be a while before we're willing to say we're out of the woods there. And so to your point, stay tuned and certainly we would be in deciding some additional risk.
Right. So to that point, Tony, if I could just follow-up, when would we expect some of the biggest returns to occur given the peak few years ago and the duration of some of the leases on there? Would that kind of the returns for a peak in 2017 or 2018 or are we going through that kind of bell curve now?
You're hitting some of that now. We'll hit some pretty strong maturities in the Q4 of this year. And then certainly as you move into spring next year, I think another kind of wave of maturity. So think about timing of when you tend to see a fairly healthy level of retail activity that's when you're going to see some of those peaks. So, let's go ahead and move it.
I appreciate the question. Next, I'm going to move on to the next caller. Thank you.
Thank you. Our next question is from David Raso from International Strategy and Investment Group. Your line is open. Really just a kind of
big picture question about all that you know about your new and used inventory in the channel and how production is this year versus retail. Just for a generic framework, if hypothetically retail was flat next year for ag globally and maybe the same question for construction, how would Deere's production be in that environment? Up, down, in line with that retail environment? Just trying to think through all the underproduction versus inventory drawdown needs. Just wrap it all into that one question.
Yes. I think in both cases, I would say in line with which would imply higher year over year sales. Can you
repeat that on flat retail?
In line with retail. Yes. Which would imply higher sales. So just Because we're under producing this year. That's what I'm trying to say, just
to be clear. Your production would be higher than retail? Correct.
Yes. And when it comes
to the mix of that?
No, no, no, no. Our production would be in line with retail, but it was less than retail in 2016. Okay. But let's not confuse it
with the comp. Just straight out, if retail is flat.
Yes. Deere's production year over year is flat or higher? Our production is higher because we will produce in line with retail. So our year over year production will be higher.
Okay. And a follow on that, the mix within that, if retail is flat, but Deere is up because you're under you underproduced last year, this year, I mean, next year you want it underproduced. Is that particularly a HarvesterWorks Waterloo comment or how should we think about that on the mix of flat rigs?
Certainly, our greatest underproduction would have been on large ag in the year. So mix would be favorable year over year.
And does that comment hold for construction and forestry
as well? That I don't have the details on as well. So I have a hard time answering that. So But yes, all right. Very helpful.
Thank you.
Our next question is from Joe O'Dea from Vertical Research Partners. Your line is
open. Hi, good morning. On the construction front, could you just talk about kind of where your demand levels stand relative
to what you see in
the end market activity? And if
some of the challenges from oil and gas or some of the dealer destock if you see some potential near term relief from that such that your demand could improve?
I think in the short term and what you're seeing reflected in our outlook on construction is our dealers do continue to destock. So, as the market continues to decline as we would expect them to and hope that they would, they're bringing their inventories down in line with that. Some of that actually is related to the lead times we're able to have right now on in our factories with the lower production. They can get replenishment equipment pretty quickly. And as a result of that, they're able to do more of that destocking and make sure that they're putting their inventories in a good kind of low level type of environment.
So, I turned around a little bit to the extent you start to see positive turns in that market. Our dealers are likely to in our state would respond maybe a bit more aggressively as dealers who need to do a little bit more stocking up. So it does have some negative now, but more positive when the market does eventually rebound.
Great.
Thanks very much. Thank you. Next caller?
Our next question is from Ann Duignan from JPMorgan Securities. Your line is open.
My one question, I hate to waste my question on this, but it's one that wrecking my brain over. Did you actually record a mark to market gain on your 9,500,000 remaining shares at Site 1 in the quarter?
No, we did not.
Okay. That's my question then. Thank you.
Thank you, Ann.
Our next question is from Seth Weber from RBC Capital Markets.
Your line is open. Hey, good morning. I want to ask about Brazil. I mean, I know you didn't update your outlook for South America for this year, but some of the data points that we've been getting, the shipment data out of Brazil for the last couple of months has been a little bit better. Do you think that that's a market that could be up next year?
Certainly, I mean, if you ask me today which market was likely, if I had to pick 1, which one had the best likelihood of being up, I think I'd have to say Brazil or South America in general. One of the things to keep in mind is and we talked about this throughout the year is a lot of the downturn there been related to the uncertainty around the government and the overall economy. Farmers have been pretty profitable. As a result of that, with the new government at least today, there appears to be a more positive sentiment. The inflation is coming down as an example.
So the overall economy seems to be showing some level of improvement. And in the short term, we're seeing that in the order books as well. Now the question there is, remember, there is a conversion to Tier 3, will be considered Tier 3 on January 1 in Brazil on large ag equipment. So that will dealers know and customers know that will come with a price increase. So undoubtedly, some of the at least short term order book activity we're seeing is strength around that buying equipment ahead of the Tier 3 conversion.
So, the real question remains, will we continue to see that demand surge as we go into calendar 2017 or not. But again, I think there's some fairly favorable signs that would indicate that that could possibly be the case.
And have you been building inventory for that, the emissions change?
Our order books would reflect demand related to that, but we have not built inventory ahead to have on our dealer lots to lead kind of further into 2017.
Okay. Thanks very much guys.
Next caller. Our next question is from Robert Wertheimer from Barclays Capital. Your line is open.
Hi, good morning. Did you see any sequential materials cost reduction that was meaningful to margin? I mean the margins were very strong in Ag and Turf on revenues that was down sequentially materially. So seasonally, obviously. I'm just curious about if you can bridge whether materials is a big part of that or whether it's something else?
It was actually if you look, obviously, we don't give the actual number any longer, but it would the benefit in the quarter for ag would have been slightly less than the 2nd quarter for material. And that's on a
year over year basis, but yes, okay, fair enough.
Yes. So it's again, it's starting to come down a little bit, which you would expect as we're looking at some slight increase going Q4. It was really certainly it was a contribution, but it was holding other costs and finding ways to operate again as efficiently as we can at these low levels. And so, they just did a great job working through some of those costs. Great.
Thank you. Thank you. Next caller?
Our next question is from Michael Slifky from Seaport Global Securities. Your line is open.
Good morning, guys. Just checking out your slides towards the back, you update your outlook for the 2016 cash receipts, I do see that. But I don't see in there a 2017 outlook, although at this time last year, in 2015, you gave us a 2015 outlook. Just kind of wondering if that's just a reflection of the uncertainty out there or could you at least give us maybe a base case scenario or directional view for next year's receipts for both crops and livestock? Thanks.
Yes, that was you noted correctly. That's actually a change we did make this year. Historically, we would have provided the first look at a cash receipts forecast out into the future year. And candidly, it's just to in our view at this point, it's just so premature and preliminary that we decided that we would make that change this year. I'll note the USDA doesn't provide won't provide their first 2017 cash receipts outlook until February of 2017.
So, historically, we were almost 6 months ahead of the USDA. And so, as a result, we've decided that we will wait. We do expect in November that we'll have, again, it will still be pretty still be very preliminary, but we will have our first 2,007 cash receipts outlook. I would tell you, if you looked at our number, I would call it flattish at this point year over year. But again, I can't emphasize enough, it's very, very premature.
Okay, fair enough. Thank you.
Thank you. Next call.
Our next question is from Mark Dobre from Robert Baird. Your line is open.
Yes, good morning. This is Mick Dobre with Baird. A quick question back to Becca and Turf. Tony, can you give us any color at this point how much turf and maybe smaller equipment contributes to operating income? And I'm also wondering how you're thinking about smaller equipment and inventory in the channel.
Is there any risk of destocking here into next year? Thanks.
We don't provide any profitability breakdown by large and small. We do on an annual basis provide some sales breakdown as you know. But I think the second part of your question is worth noting, especially when you think about small ag. I mean, I'd say the higher end of that small ag business, so what really is attributed to livestock, we have seen some softening in the retail environment around some of those product categories as the livestock margins have gotten squeezed a bit. And you'll actually see that reflected a little bit in some of the inventory levels that we report in the appendix.
So, the 100 horsepower and above, you'll see and I forget what slide
that is, Josh, if you
want to look at it, look that up quick. But if you look there, you'll see it still in the mid-thirty percent range. 47. Slide 47, where we'd be back down typically in the 20% range. Really what's driving that is the 100 to 200 horsepower, the 6000 series tractors are a bit elevated.
And if possible, last quarter, we talked about this and said that it was likely that our expectation is we would have those in line year over year. With some of the weakness in livestock, it's possible that that number will be a bit elevated. It should come down, but it may not hit quite the same level that we were at as we ended 2016. But again, that product is coming from Germany. So, there's longer lead times, not building to retail order.
We're building to forecast and that retail sales forecast has slipped a bit in the quarter. And obviously, it's not wasn't dramatic enough for us to change the overall retail sales outlook, but it did soften some.
But Tony, isn't there a bit of an issue with under 40 horsepower as well?
From an inventory perspective, I don't believe that is the case. Now you're seeing ours come up, but remember our sales our inventory levels are coming up, but our sales are too. So it's really coming up more in line with the sales at this point.
All right.
Thanks. Thank you. Next caller.
Our next question is from Steven Fisher from UBS Securities. Your line is open.
Thanks. Good morning. So it looks like your leasing exposure went up in the quarter to about $5,600,000,000 It's up around $100,000,000 Can you just talk about how your efforts to effectively discourage some of that leasing activity is being received? And when might you expect to see that lease exposure actually start to come down? Yes.
I think you are right in the sense that the overall lease activity has continued to increase. But I think what's also worth noting is the short term leases and the activity there is down significantly. And so, a lot of the actions that we were taking at the end of Q2 and into Q3 were focused on reducing those short term leases. And that has been effective. And so, we're pleased with that.
Certainly, I think again, we've said this before, our preference would always be a retail note over an operating lease, but to extent our customers continue to prefer an operating lease, our obligation there is to make sure we're structuring those in a way that John Deere Financial continue to be profitable. So, that's what we're focused on. Last quarter, we did raise residual values. Can't say across the board, pretty much across the board, not just on short term leases, but I'm sorry, we reduced residual values pretty much across the board last quarter to try to correct some of those challenges that we had been facing. All right.
Can you quantify what the percentage of short term leases is now? How much it kind of declined in the Q3 versus I don't have that number off hand on, but it was a significantly lower number in the quarter. Okay. Thank you. Thank you.
Next caller?
Our last question is from Joel Tiss from BMO Capital Markets. Your line is open.
Just snuck in there. I'll make it quick too. In Financial Services, it seems like the debt is rising roughly about $2,000,000,000 while the portfolio was shrinking. I just wonder if you could explain what's going on
there? So, Joel, I'm not sure you're tracking. Our debt to equity ratio, we try to maintain a 7.5 to 1 and that's been close to that. So we still maintained it around 7.5 to 1. And our portfolio overall has been slightly lower.
And even if you take a constant FX, it's about flat. So the portfolio has not grown.
Yes. I know, but the debt is up 2,000,000,000 dollars over since the end of the year. All right. I'll ask you later. Okay.
Yes. That sounds good. And I think we did have one more come into the queue, so we can go ahead and take that.
Our next question is from Ann Duignan from JPMorgan Securities. Your line is open.
My question is more on the European end markets. We saw German registrations down 21% last month, which I don't know if we've ever seen a drop like that in 1 month, and I recognize it's registrations, not retail sales. Can you just talk about the environment in Europe, in France, Germany, U. K? And also how you're feeling about dealer inventories in the region?
Yes, I mean, certainly, and as you track things like there's the FEMA business barometer and so on, we started seeing even a quarter or so ago that's starting to track more negative. A year ago at this time, that was actually moving a more positive direction and we had some relatively positive hope for Europe as we went into 2016. I think in the short term, certainly, you have a lot of factors like Brexit and so on that are causing some uncertainty. There were some challenges and as you look at some of the eastern part of the EU 28 with subsidies and timing of when subsidies were released again. And then when you look at France, I mean, you're starting to see some indication that the crop there is certainly not what many had hoped.
And so you've seen some weakness there. So I think that certainly you're seeing the sentiment get a bit weaker here in the latter part of the year. J. B. Or Raj, I don't know if
you have
anything to add. Okay. All right. But beyond that, I'm not sure there's much more. I'd say, and to your point, it's 1 month, it's registrations.
I wouldn't read too much into a single month.
And dealer inventories? Yes. Dealer inventories,
I think we're reasonably comfortable with. That's one where, again, we would cite used equipment, not an issue at this point, but one we certainly have our eyes on and I'd say cautionary. Actually one of the bigger challenges there had been Great Britain, U. K. And with some of the FX and it was because the FX had held up pretty well with Brexit now and the FX changing that's actually in the short term created some benefit for their used equipment to move, because most of that, of course, comes to the mainland and gets distributed kind of in the eastern part of Europe.
So that's been a positive, again, very short term impact of Brexit. Okay. Thank you. Thank you. And before we close, Raj has a couple of comments he'd like to make.
So there have been some questions around our 3rd quarter margins and 4th quarter margins and around 2017 what to expect and I just wanted to make a few comments along those lines. We mentioned in the past that each of our units plan for the mid cycle trough peak scenarios in addition to the following year's forecast. And you will have noted our decremental margin performance in the last 3 years show how well we have executed in this downturn. Now as a result of our disciplined process, our margins have improved about 300 basis points at mid cycle volumes now compared to mid cycle volumes in 2010. So we have been working on reducing our S and G, overhead expenses and also structurally reducing our material costs.
We have diverted more of our R and D resources to focus on cost reductions in the last 2 years and we have increased focus on efficiency improvement and structural cost reduction activities broadly and in general. Now with such structural cost reduction activities, we expect to improve our pre tax income by at least $500,000,000 by the end of 2018, if large ag downturn persists at current levels. Now, I should also say our internal goals and targets are even larger. Having said this, you should also note that we are balancing structural cost reductions with investments for the future and we remain committed to maintaining manufacturing capacity to support an eventual turnaround. Thank you.
All right. Thank you, Raj. And with that, that will conclude our call. We appreciate the questions and we of course will be around throughout the rest of the day to answer any follow ups. Thank you.
That concludes today's conference. Thanks for participating. You may now disconnect.