CNH Industrial N.V. (CNHI) recently reported a disappointing set of 4Q19 numbers, missing out on revenue and EBIT targets across all of its Industrial segments. A lower tax rate added $0.04 per share to the adjusted earnings, which came in woefully low at $0.20 per share. Further, for FY20, management expects revenue from Industrial activities to be flat to slightly down and lowered the EPS range to $0.78-0.86, which, at the midpoint, is ~16% below the guidance provided at the Capital Markets Day in September 2019.
While CNH stock has been underperforming, I believe the company should see a momentum shift heading into FY20, as management executes on the strategic plan to drive margin improvements amid the planned portfolio transformation to divide the group into on and off-highway entities, which I expect will drive improved investor sentiment on the stock. With the stock currently trading at a discount to peers, I believe current prices represent an attractive entry point into the longer-term CNH story.
A Closer Look at the Results
Sales continue to be impacted by deteriorating end-market conditions: Total revenue for 4Q19 declined by 6.2% to $7.7 billion, as net Industrial segment sales fell 4.2% YoY on a constant currency basis and came in at $7.4 billion for the quarter on lower volumes and dealer inventory actions in the Agriculture and Construction Equipment segments.
The Agriculture Equipment segment net sales were down 5.3% YoY to $2.9 billion, while the Construction Equipment segment continued to lag behind expectations and generated net sales of $707 million, down 11.9% YoY. Commercial and Specialty Vehicles net sales also saw a marginal decline of 1.3% YoY to $3.0 billion, driven by reduced wholesale volumes in medium and heavy trucks in both Europe and South America, greatly offset by increased deliveries in the bus and specialty vehicles segment, sustained aftermarket activity and positive pricing. Powertrain sales came in at $1.0 billion, down 12.7% YoY, with the decline more pronounced due to stronger customer engine stockpiling in anticipation of the Stage V introduction.
Source: Company Presentation
Industrial Segment Volume Trends
Agriculture Equipment: Worldwide unit deliveries were down 3% YoY in tractors and 15% YoY in Combines in 4Q19. Accordingly, tractors unit inventories ended up higher by 22% YoY, but down 21% QoQ, while Combines inventory increased by 11% YoY, but down 25% QoQ. In the US, dealer inventories were too high in low HP tractors, and management believes the soft commodity prices will have to recover before farmers make equipment purchases. In the EU, Combine sales were extremely weak as the crop and dairy farmers remain conservative. The South American market was weaker than expected despite the expansion of planted acres during the season (benefits likely to accrue from 2020 onwards), and with 3,000 tractors excess, inventory was highest in ROW. Management expects to be able to liquidate the majority of the inventory build with YoY lower production front-loaded into 1Q20 and 2Q20.
Worldwide production decreased 16% YoY with production in the row crop sector in North America down 30% YoY in the quarter, and leading to a large YoY decrease in total production for Agriculture Equipment. Going forward, in 2020, CNH expects to under-produce retail by a further 10%.
Construction Equipment: Worldwide unit deliveries in 4Q19 were down 12% YoY, across different product lines, with production down 17% on a more pronounced decline in general construction. Inventory units were up 42% YoY (down 15% QoQ), mainly in North America and the ROW. Management highlighted that dealers continue to destock in North America and Europe, and while infrastructure projects continued in both regions, they were not leading to incremental contract demand. Compact and service equipment saw a notable improvement in South America as the market continues to recover from low levels, but demand remained weak in Europe from Brexit uncertainties and pockets of residential and infrastructure projects.
Going forward, in 2020, CNH will under-produce retail by 10%, with North America underproduction vs. retail at around 15%. Importantly, 2020 is set to be a transition year for the segment as restructuring plans are implemented under a new management team, with a focus on the reduction of product cost and addressing quality issues.
Commercial Vehicles: Worldwide trucks production in 4Q19 was down ~13%, with inventory units down 6% YoY. Light-duty truck deliveries were down 15%, while medium and heavy were down 8% YoY. European LNG/CNG truck demand increased 50% in 2019, and Iveco had a 53% share (compared to ~70% in 2018). In 2020, management expects LNG truck demand to grow by 50% and predicts sales volume of 4,500-5,000 units.
Bus deliveries increased 6% in Europe, as demand for alternative propulsion buses rose across the city bus and intercity segments. The company’s market share for buses in Europe increased 240 bps YoY and now stands at ~20%. Going into 2020, bus production is expected to be in line with retail, with South America underproduction vs. retail at 20%.
Source: Company Presentation
Bottom-Line Weakness: Adjusted EBIT for the quarter on a consolidated basis was $419 million with a margin of 5.4%. Industrial activities’ adjusted EBIT was $301 million, down 30.3% YoY, representing a margin of 4.2%, a decline of 140 bps YoY. The decline was driven by unfavorable volume and mix totaling $160 million, as well as raw material headwinds, which negatively impacted EBIT by $29 million and a material one-time negative impact of $90 million from re-measurement of certain provisions, and FX transaction impact. These negatives more than offset the positive pricing and savings from cost management initiatives.
Source: Company Presentation
FY2020 Outlook: Disappointingly, management’s guidance is for flat to muted end markets for 2020 across the various segments industries, though this should be somewhat offset by market share growth in the segments and subsegments where CNH has launched new products and is implementing growth initiatives. Accordingly, Industrial activity net sales are guided to be flat to slightly down in FY2020 on a constant currency basis, and the segment is expected to generate $400-600 million of free cash flows. EPS expectation for the year was also lowered to a range of $0.78-0.86, compared to $0.95- 1.00 guided at the analyst day in September 2019.
Though the guidance adds little to the near-term bull case, I believe CNH is in the midst of a longer-term transformation and, with the bar lowered, should see operational momentum in 2020 from accelerating restructuring tailwinds, positive price realization, and a stabilizing Agriculture Equipment market towards the second half of 2020. Hence, the new guidance looks conservative, in my view.
Deployment of Capital: CNH continues to maintain a shareholder-friendly capital allocation policy through dividends and share buybacks and recently reduced the duration of its $700 million share buyback to 12 months from ~18 months earlier. I see ample strength in CNH’s ability to generate solid free cash flows, going forward, and expect management’s cash deployment strategy to revolve around five key areas:
- Maintaining an attractive dividend/share buyback policy
- Bolt-on acquisitions, primarily in the high-tech and mix-accretive precision agriculture space
- Improving its relatively lower credit rating to lower its interest costs
- Structural value creation
- Reinvestment into organic growth
An Attractive Entry Point Into the Longer-Term CNH Story
While I acknowledge the near-term end market level headwinds facing CNH, the company’s stock has been a persistent underperformer relative to its international peer group (comprising of Deere & Co. (DE), Caterpillar (CAT), Cummins, Inc. (CMI), Navistar (NAV) and PACCAR Inc. (PCAR)). With the market assigning little credit to CNH on its longer-term “self-help” initiatives and with longer-term fundamentals intact, I remain confident in management’s ability to cut costs and improve margins through the successful execution of its strategic initiatives, driving longer-term valuation upside.
Source: Yahoo Finance
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.