CNH Industrial: Why I Replaced It With A Better Option After Leadership Change (NYSE:CNHI) (2024)

CNH Industrial

CNH Industrial (CNHI) recently reported earnings, beating its Q1 estimates. Yet, while CNH shares didn't drop, neither have they gained in price since the report. The expectations were rather low after the company had already been torpedoed by the market two quarters ago when it first reported YoY declines coupled with a grimmer-than-expected outlook.

Agriculture equipment demand peaked between 2022 and 2023 and has since seen steady demand softening. The reasons depend on several factors: higher interest rates, declining farm income due to lower commodity prices, and an uncertain outlook of the economy all rank among them.

With this scenario, no wonder the industry has not been able to keep up with the general market, and all its major players - Deere (DE), CNH Industrial (CNHI), and AGCO (AGCO)- have underperformed.

In the past three years, I considered CNH Industrial particularly interesting in 2022 and 2023, when it actually outperformed the index and the industry. At that time, Deere was having challenges with pent-up demand, that shifted towards CNH Industrial. The result was obvious: CNH Industrial's margins increased thanks to wealthier customers and pricing power.

Now, things have moved towards a so-called normalization. Though bullish on the industry, I don't see CNH Industrial as the most compelling pick right now. In this article, I will explain why.

CNH And The Macroeconomic Environment

In a recent analysis on Deere, I updated my research on the macroeconomic environment agriculture equipment manufacturers operate in.

As a reminder, three main trends are working in favor of the industry.

1. Increasing world population, and improving standards of living. This implies a greater need for (healthier) food
2. Arable land is decreasing due to urbanization. This means the need for equipment yielding more than before is great.
3. Labor scarcity pushes towards the development and adoption of autonomous solutions.

In particular, as the U.S. Department of Agriculture shows, in the U.S. (but this is true more or less for the whole world), while total farm inputs have been flat if not declining from 1948 onwards, the total agricultural output has steadily and significantly increased, at pace with total factor productivity.

This is why I keep forecasting a greater need for the type of equipment CNH Industrial manufactures.

However, in 2024, we also have some headwinds. In particular, as the U.S. Department of Agriculture shows, gross and net farm income are declining. We are still above pre-Covid levels, but if we factor in inflation's impact, farmers seem poorer in 2024 than they were a few years ago.

As I explained in my article:

In particular, as per the USDA, U.S. crop cash receipts, which make up almost half of the gross cash farm income, are heavily impacted by corn and soybeans (total cash receipts are worth $278.2 billion, and these two have a value of $87.1 billion and $61.4 billion, respectively). Although these two are still priced above their pre-pandemic levels, the graph below shows the reversion to the mean we are currently witnessing.

CNH Industrial Q1 Earnings

Keeping in mind the bigger picture, let's now dive in and take a look at CNH Industrial.

Here are its main Q1 2024 financial highlights:

• Net sales were down 14% to $4.13 billion
• Adj. net income declined 11% to $421 million
• Adj. diluted EPS decreased by 5.7% to $0.33
• FCF of industrial activities was down by over half a billion to $-1.21 billion.

Now, FCF is almost always negative in Q1 for industrials, because Q1 is the time to purchase raw and unfinished materials that need to be assembled during the year. The YoY comparison was also particularly tough because Q1 2023 reflected a higher amount of unfinished products due to supply-chain hiccups. So, overall I am not concerned by this quarter's FCF.

As I said, estimates were lower and CNH beat by $180 million which analysts were expecting for its revenue, but also beat its EPS forecast by $0.07.

At the same time, agriculture saw its EBIT margin down by 200 bps to 12.5%. Construction, on the other hand, though making up barely 20% of the company's sales, saw positive momentum, with its EBIT margins up 150 bps to 6.7%.

Markets are weak, however, CNH Industrial's profits seem to be more resilient than expected. And yet, its margins will soon see further pressure as the company's inventories are quickly building up:

During the CNH earnings call, the resigning CEO Scott Wine, did stick to what CNH Industrial had already communicated to investors in the past two quarters:

We said the first quarter would be challenging from a demand perspective, and that is how it played out, especially in South America and Europe. We also noted competitive pricing pressure where dealers are working hard to reduce their inventories. Nonetheless, we’ve maintained much of our pricing and profitability gains with construction even increasing both their absolute profit level and their margin percentage year-over-year. Cost efficiency remains a priority for us in this environment. [...] Competitive pricing pressure was the most acute in South America. [...] Combines are where we’re seeing the most pressure. There’s used inventory building up. Demand is down quite considerably.

However, it must be acknowledged that CNH Industrial was truly ahead of the curve, compared to its peers, in instituting cost-cutting programs that have already been effective starting Q1 2024. This choice, though it did hit some people's jobs, was able to preserve the company's profitability, up to the point that CNH Industrial still posts double-digit margins, as it had never been able to do before the pandemic.

Therefore, Scott Wine proved to be a good manager, anticipating the need to implement effective measures on the company's costs. As we can see below, COGS reduction impacted positively by around $25 million, but through the year, the program should lead to over $310 million in savings. SG&A was also restructured, and was 12% lower YoY, generating another $45 million in savings during Q1, with the overall target for the fiscal year to reach at least $140 million. This means that we are before a program that should help CNH Industrial save around $500 million between COGS and SG&A. Considering the company's operating income could be around $2.5 billion at the end of the year, it is impressive to see 20% of this coming from savings.

Moreover, being disciplined will help CNH Industrial with its debt. In fact, in 2024, $4.2 billion of debt will come to maturity and the company will either need to refinance it or pay it down. So far, CNH Industrial has been able to reduce its industrial debt rather steadily, but I don't think the company will pay down $4.2 billion all at once because it only has $2.6 billion in cash right now. It might be prudent to keep some cash on hand during the weaker part of the cycle. So we might see CNH Industrial needing to refinance around $3.5 billion at higher rates, compared to the past. Surely, cost-effective measures will lead to higher operating cash generation, which helps in facing debt obligations.

In addition, higher interest rates are starting to cause some delinquencies, especially in South America. As Oddone Incisa, the company's CFO, explained during the earnings call:

You will note that delinquencies ticked up in the quarter, which is normal when the market contracts. Higher delinquency is in pockets of our portfolio and mainly in South America, where we are seeing more frequent late payments, but no increase in credit losses so far. The delinquency rates we are seeing now are at the same or lower levels than in previous downturns. Our credit reserves are properly set to protect our future profitability.

CNH Industrial's CEO Steps Down

While we realize how Scott Wine was able to improve the company's efficiency, we also need to know that he recently announced he is stepping down from his position, starting July 1. The new CEO Gerrit Marx comes from Iveco Group. Formerly, CNH Industrial had an off-highway business and an on-highway one. In early 2022, CNH Industrial spun off its on-highway - and less profitable - business, and Iveco Group (OTCPK:IVCGF) was formed. Since then, Iveco's financials have improved. But what has always concerned me the most regarding this company are the following two issues, which I have covered in a few articles in the past:

1. Iveco is a strong regional player in Europe, but it doesn't have the size and the profitability to compete worldwide. Therefore, .
2. During the favorable part of the cycle, Iveco's margins kept on being the industry laggard, while peers such as Traton (OTCPK:TRATF) rushed to catch up with the industry leaders such as Volvo (OTCPK:VLVLY) and Paccar (PCAR).

The second issue, in particular, makes me a little critical of Iveco's leadership. Therefore, I saw the resignation of Scott Wine and the appointment of Gerrit Marx as a potential issue for CNH Industrial. Hopefully, I am proven wrong, but what I have seen with Iveco doesn't make me confident.

CNH Industrial Shareholder Returns

CNH Industrial recently completed its de-listing from Euronext Milan, to be a U.S.-only publicly listed company. This should help its visibility and the liquidity of its shares. In a few days, the ticker symbol will be changed from CNHI to CNH.

Now that CNH is listed only on the NYSE, I believe a dividend policy change will be due soon. CNH currently pays an annual dividend. To become more aligned with the market, I believe we will soon see a quarterly dividend instead of an annual one. This could bring a particular fact to the attention of many investors: CNH is a good dividend payer, with a 4.1% yield and a payout ratio just below 28%. In the past five years, its dividend growth rate has been almost 18.5%. However, CNH has started paying out nice dividends in the past three years, with a CAGR of 52.6%.

When we look at CNH Industrial's dividend grades, we see that, although its yield is higher than AGCO's and Deere's, it is behind its peers when considering safety, growth, and consistency. After all, CNH Industrials' consecutive years of dividend growth are not many: only three, so far. This has an impact on the growth grade, as well as its consistency and safety.

If we expect CNH to become seriously committed to shareholder returns - and I do - we should soon see CNH's grades more aligned with its peers. After all, a payout ratio below 28% shows a well-covered dividend, with ample room to grow and become consistent over time.

Last year, CNH Industrial launched a buyback program and Mr. Incisa explained that:

We repurchased over $580 million worth of stock in the first quarter as we completed our $1 billion extraordinary buyback program and moved on to the new $500 million program in March. We continue to buy shares now, and we pay our annual dividend of about $600 million in the coming weeks. CNH is a cash-generating business, and net of any M&A needs, it is our goal to return to our shareholders, nearly 100% of industrial free cash flow through dividends and share buybacks.

So, for income-seeking investors, assessing CNH would mean understanding how steady and reliable is its industrial free cash flow generation.

As I said, while its top line is linked to the general replacement cycle, there are signs that CNH has so far been able to offset part of these ups and downs through effective cost management.

However, I expect more. CNH Industrial could develop its services business (software updates and/or upgrades; spare parts; maintenance, etc.) just like Caterpillar (CAT) already does and as Deere is planning on doing.

Valuation

If we compare CNH Industrial to its two main Western peers, we see the following Quant Factor Grades.

Deere is more expensive, reflecting, in particular, a much higher profitability grade. However, I consider profitability as the most important metric, because it shows how strong a company's earnings are and what returns it earns from its capital employed.

Here, CNH sports a 5.13% return on total capital, versus a 13.34% of AGCO and Deere's 11.73%. At the same time, Deere's EBIT margins are in a league of their own - 25.17% - while CNH and AGCO come in around 11.5%.

Unsurprisingly then, Deere trades at a fwd PE of 15, while CNH is at a 7.7 and AGCO at a 9.5. And yet, the EV/EBITDA ratio shows CNH more aligned with Deere, with a 15 vs. a 15.5.

When considering Deere's size and footprint, together with its brand recognition and strong and steady cash flow generation, I believe the premium is warranted. Moreover, in tough economic times, I'd rather stick with well-established industry leaders because, when the cycle upticks once again, I have often seen the leaders being the first ones to gain traction before the others.

As a result, I am currently downgrading CNH Industrial to hold due to uncertainty about this fiscal year and the leadership change. As far as my portfolio goes, in the past few months I have replaced my CNH shares with Deere and I plan on increasing my stake in Deere unless I see more convincing signs of a leap forward from CNH Industrial.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Luca Socci