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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning, and afternoon, ladies and gentlemen, and welcome to today's CNH Industrial 2018 Full Year and Fourth Quarter Results Conference Call. For your information, today's conference is being recorded. [Operator Instructions]
At this time, I'd like to turn the call over to Federico Donati, Head of Investor Relations. Please go ahead, sir.
Thank you, Emma. Good morning, and afternoon, everyone. We would like to welcome you to the CNH Industrial Fourth Quarter and Full Year 2018 Results Webcast Conference Call. This call is being broadcast live on our website and is copyrighted by CNH Industrial. Any other use, recorded -- recording or transmission of any portion of this broadcast without the express written consent of CNH Industrial is strictly forbidden. We are pleased to have here with us today CNH Industrial's CEO Hubertus Mühlhäuser; and our CFO, Max Chiara, who will be hosting today's call. They will use the material you may download from the CNH Industrial website. After their presentation, we will be holding a Q&A session. As a final comment, please note that any forward-looking statements we might be making during today's call are subject to the risks and uncertainties mentioned in the Safe Harbor statement, included in the presentation material. Additional information pertaining to factors that could cause actual results to differ materially is contained in the company's most recent report 20-F and EU Annual report as well as other periodic reports and filings with the U.S. Securities and Exchange Commissions and their equivalent authorities in Netherlands and in Italy. The company presentation may include certain non-GAAP financial measures. Additional information including reconciliations to the most directly comparable GAAP financial measures is included in the presentation material. Please also note that starting from Q1 2019 onwards, as a result of the new GEC organization, we have consistently updated the geographical composition of our regional sales information as indicated in supporting material of this earnings release.
I will now turn the call over to Hubertus.
Thank you, Federico, and good morning, and good afternoon to everybody on the call. The last time that we spoke I stated that one of our top priorities that would guide us over the next quarters was the continuous profitability improvement and as you have seen from the press release, we have met or even exceeded our financial targets in 2018. Despite all the global uncertainties, we closed the year with strong Q4 results and have been able to exceed our own expectations. For the fourth quarter, industrial sales were up 3% in constant currency and adjusted EBIT for Industrial Activities was up more than 20% with adjusted diluted EPS up more than 60%. For the full year, industrial net sales were up 7% with adjusted EBIT up 40% and both adjusted net income and adjusted EPS were up by over 70% to $1.1 billion or $0.80 per share, and that marks a historical record for the company since its inception in 2013.
On the back of margin improvement across all segments, we were able to achieve a consolidated adjusted EBIT margin of 7.1%, also a record high since company inception. This was accomplished through our focus on disciplined cost management, targeted pricing strategies, and operational synergies. Operating cash flow for the full year was also strong at USD 1.2 billion, which contributed to reducing our net industrial debt by 1/3 to USD 600 million and allowed us to move another step towards our long term goal of a net industrial debt free position. Additionally, also in the quarter, Moody's Investors Service upgraded CNH Industrial to investment grade with a Baa3 rating and a stable outlook. With this, we are now finally investment grade by all 3 major rating agencies, which is a major milestone, our commitment to strengthen our rating position going forward and to close the funding cost gap with our major peers.
Furthermore, due to the strong results and the solid cash position at year-end, the Board of Directors is recommending at the next Annual General Meeting of our Shareholders a dividend of EUR 0.18 per common share, which is a sizable increase of 30% versus prior year dividends. This would translate into a total cash impact of approximately EUR 244 million, approximately USD 278 million at the payout date.
Lastly, as you probably have seen, CNH Industrial has been recognized by the Carbon Disclosure Project or CDP as a global leader in sustainable water management, naming it as 1 of only 27 companies out of a total of 2,000 companies under consideration. Included in the CDP water security A-list and we scored an A- in the overall CDP climate change rankings. Our high score in the climate change program reflects our significant progress in this area. The recognition together with being named the industry leader in the Dow Jones Sustainability Indices World and Europe as well as FTSE4Good Index Series member confirms our commitment to ensuring continuous improvement and sustainability performance.
Moving now on to Slide 4. Let me provide you with a high-level industry update for full year 2018 as well as some color on the last quarter. I won't go through line by line but would like to highlight that in the AG segment, NAFTA row crop continues to trend positively with good performance as customers replace dated equipment especially in Combines with the market in the fourth quarter up 5%. EMEA tractor demand was down 8% for year mainly driven by slowdown in volumes during the fourth quarter, down 19% due to last year's prebuy effect ahead of the introduction of the Tractor Mother Regulation in Europe.
Construction Equipment was positive in all regions as the global construction trends we have been seeing during the year continued and in some cases, have gained strengths in the last quarter, up 15% in light and 7% in heavy on a worldwide basis. An example of this strengths would be general infrastructure and also nonresidential in North America. For Commercial Vehicles the European truck market was up 8% year-over-year with light-duty trucks up 11% and medium and heavy up 5%. In the last quarter, European markets for light-duty trucks was up 12% and flat in medium and heavy. While the EU truck markets remains generally at healthy levels, December was weaker than normal with medium and heavy volumes down double digits. This trend seems to be partially reversing in January and we will monitor it closely going forward.
LATAM was up 24% with Brazil up 46% and Argentina down 17%. Please remember that while the Brazil figure seems large and it is, this is still coming off a significant downturn that started in 2014. Overall, while there have been some weaknesses during the last quarter in certain markets like EMEA, AG and LATAM CE, the key markets for us were generally positive and we expect that to continue but at a slower pace. I will go into this in more detail later in the call.
At this point, I will now hand it over to Max for the financial overview of the presentation. Max?
Thank you very much, Hubertus, and good morning or good afternoon, everyone on the call. Moving now to Slide 5. The key figures for the fourth quarter and full year. In summary, we finished the quarter with strong earnings and improved operating profitability across all our segments after most end markets remain healthy during the quarter. Net sales in our industrial segments were up 3% in constant currency for the quarter and ended up 7% for the full year. Importantly, adjusted EBIT was up 24% in the quarter and 40% for the full year, leading to an adjusted net income for the year of $1.1 billion, up 72% from 2017. EPS was up $0.34 to $0.80 per share for full year 2018. The tax rate for the year was 27%, down from 38% in 2017 and we expect it to remain stable at this level during 2019. We were able to lower net industrial debt by 1/3 to $0.6 billion by focusing on improving cash flow and reducing overall debt levels. Available liquidity was $8.9 billion, down $0.4 billion compared to full year 2017. The liquidity to revenue ratio was maintained at 30% with a third-party industrial debt-to-EBITDA ratio at 2X, down from 3X last year.
This performance is a clear sign that we remain fully committed to further improving our credit rating from the current levels as well as achieving a net industrial debt-free position. Turning on to Slide 6. Let's discuss the full year performance in our Industrial Activities net sales, excluding the impact of foreign exchange translation. For the full year, net sales increased $1.9 billion, up over 7% with all businesses up year-over-year. Agricultural Equipment contributed $1.1 billion and was up 10.4% as a result of a favorable cash crops subsegment in North America, a recovery in the Brazilian market and strong pricing performance across the board. Construction Equipment sales increased more than $500 million or over 20% as a result of increased demand across all regions and commercial vehicle sales increased $140 million or 1.3% mainly as a result of positive pricing and favorable product mix. Powertrain was up $60 million or 1.4% year-over-year.
For the fourth quarter, net sales were $7.7 billion, roughly flat with last year but up 3% on a constant currency basis. Looking at the quarterly performance all segments were up except Commercial Vehicles, which was down 1% on a constant currency basis, mainly from lower sales volume in heavy-duty trucks in Europe and other geographies, partially offset by an accelerating favorable pricing performance. In terms of regional segment mix, on a full year basis it was largely unchanged from 2017.
Turning now to Slide 7. With an overview of our operating results at the Industrial Activities level for the full year and the fourth quarter compared to prior year. As you can see here, all segments delivered positive results, both for the quarter and the full year period, resulting in an adjusted EBIT margin improvement of 130 bps to $1.6 billion for the full year and 110 bps to $432 million for the quarter. This was driven by favorable volume, strong product mix, and pricing as well as our efficiency gain from our world-class manufacturing program. Increased R&D spending on product development as well as raw material and other trade-related cost increases partially offset these gains especially in the back half of the year.
Moving on to Slide 8. I'd like to discuss our net industrial debt and net industrial cash flow performance and provide an update on the balance sheet. Net industrial debt was $600 million at the end of December, down more than 30% from last year. As you can see, our effort to reach a net industrial debt-free position is intact and demonstrated by a continuous improvement on a year-over-year basis. Net industrial cash flow for the full year was $556 million as a result of a solid Q4 performance of $1.4 billion coming primarily from a positive change in working capital. For the full year, our working capital was a net use of cash of about $500 million, mainly due to the inventory increase year-over-year. Some reasons for the increase include in NAFTA to support the stronger end markets and the solid order book and in Europe to mitigate the potential risk of Brexit and to prepare for the Stage V transition in 2019. As a result of the consistent cash flow performance over the last few years, we have been able to reduce our third-party gross debt to about $5 billion, half the amount of 2013 when we started our journey while maintaining a healthy buffer of liquidity.
Turning to Slide 9. Operating cash flow was $1.2 billion in the year as a result of the strong operating performance of the company, which funded the dividend payment of $243 million and allowed us to repurchase $156 million of common stock corresponding to 12.5 million shares. The current share buyback authorization allows us to repurchase up to $700 million. Additionally, as we stated last quarter, we have started to increase our CapEx on new products and technologies and have increased the spending across the business segment, with a 2018 spending of $550 million, which is up over 10% from 2017 and sits now at 2% of net sales.
For 2019, we expect R&D and CapEx spending to increase to 4.0% and 2.5% of sales, respectively, with a growing portion of this spend to support development on key megatrends, digitalization, electrification and automation, and engine regulatory capital. Later in the presentation, we will provide an overview of some of our new product initiatives that will occur during 2019.
Moving on to Slide 10, our Financial Services Business. 2018 net income was $385 million an increase of 15% compared to 2017 when adjusting prior year for the one-time tax benefit of $180 million related to the write-down of deferred tax liabilities in connection with the enactment of 2017 U.S. Tax Cut and Jobs Act. For the full year, retail loan originations were $10 billion, up $0.9 billion compared to last year with higher volume in all regions except APAC. The managed portfolio of $26.3 billion at year-end was up $0.7 billion at constant currency. Credit quality performance is improving on the back of a healthy environment in our primary end markets with delinquencies tracking on average at 3.1%, down 20 bps from one year ago.
Turning now to the individual segment performance on Slide 11. Agriculture equipment increase in net sales of 9% was primarily due to a sustained price realization performance coupled with favorable volume. Worldwide deliveries were up 8% both in tractors and Combines versus last year. Production was up 10% versus last year with NAFTA row crop up 24% year-over-year. Worldwide inventory in units equivalent was up 27% in Tractors and up 4% in Combines. We closed the year with a solid order book in NAFTA row crop with coverage going well into Q2. It is also worth mentioning the favorable industry conditions in Brazil are driving a sustained demand with book of business up 30% year-over-year. In the fourth quarter of 2018, agriculture equipment net sales slightly increased compared to the fourth quarter of 2017 due to favorable volume and positive net price realization in North America, partially offset by a decrease in volume in other regions. We have been working successfully to improve our margins and were able to increase EBITDA margins to 11.5% and EBIT margins to 8.9% for the full year. The increase was mainly due to positive net price realization, favorable volume in all regions, favorable industrial absorption, coming from the underproduction in 2017 to a more balanced production performance in retail -- to retail in 2018, partially offset by the increase in product development spending, up 11% related primarily to precision farming and compliance with Stage V emission requirement. In the fourth quarter of 2018, adjusted EBIT margin was 8.2%, up 50 bps. All in all, the segment realized a good operating leverage in 2018 with 25% of incremental margin year-over-year.
Turning to Slide 12. Construction Equipment net sales increased 19% primarily due to increased demand in all regions. Worldwide deliveries were up 14% in light and 20% in heavy with production up 18% versus last year resulting in a slight overproduction versus retail with dealer channel inventory levels in line with the favorable industry trend. Inventory was up 4% with order books flat in heavy across our geographies but NAFTA which was down 10% as a result of the realigned dealer channel inventory. In the fourth quarter of 2018 net sales increased more than 7% compared to the same period in 2017 driven by sustained end-user demand across most regions. In addition, we were able to grow profitably with margins up 310 bps for EBITDA, now at above $150 million for the full year and up 360 bps for EBIT closing with a margin of 3% to sales. We are proud that in 2018 the business turned from a loss of $60 million in 2017 to a profit of $91 million EBIT in 2018. We would like to note that this is prior to applying any benefit related to our 80-20 initiative, which we assume will start to contribute positive results in 2019 and beyond. We will report more about this in the course of 2019. The year-over-year improvement was primarily due to operating efficiencies, higher sales volume, favorable mix, and positive net price realization, more than offsetting raw material cost increases. In the fourth quarter adjusted EBIT was $32 million with an adjusted EBIT margin of 3.9%, up 310 bps from the same period last year.
On Slide 13, Commercial Vehicles net sales increased almost 4% for full year 2018 compared to 2017. As a result of positive pricing and favorable product mix primarily in Europe. Total deliveries for 2018 were down 5% year-over-year as increased volume in light commercial vehicles as a result of increased end-user demand in Europe and Brazil were more than offset by the impact of lower volumes in heavy-duty vehicles. The decline in heavy vehicles sales is attributable to the previously announced strategy shift, which focuses sales on a more profitable product portfolio, including LNG and CNG vehicles. We are expecting a mixed shift toward natural gas engines and a continued demand growth in that sub-segment going forward. As a result of the strong order book in LNG and CNG, up almost 50% at the end of the year, partially offsetting the general weakness in the diesel order book, down 11% in truck, EMEA. In Q4 of 2018, net sales decreased 4% compared to last year as a result of lower volume primarily in heavy vehicle trucks in EMEA attributable to an unfavorable industry trend particularly in December and to the continuation of the strategy shift to a more profitable product portfolio. Partially offset by favorable pricing. As with the other segment, it is important to know that we focused on profitable growth, which can be seen in the increased margins for the year with EBITDA margin up a 110 bps and EBIT margin up 90 bps to 2.7% of sales. The increase was mainly due to a strong positive product mix in light-duty trucks and buses, and to the shift to alternative propulsion solutions in heavy-duty trucks as well as positive pricing and manufacturing efficiencies. R&D spending was up 9%. For Q4 2018, adjusted EBIT was $90 million with an adjusted EBIT margin of 2.9%, up 100 bps year-over-year. The market share for trucks in Europe was 11.6%, down versus last year mostly in heavy. As we anticipated when we announced the new customer refocusing sales program, inclusive of the reduction in sales with buyback commitment, which was down approximately 40% for the full year in terms of lower originations. Trucks book-to-bill was 0.98 in EMEA and 1.07 in LATAM. Bus order book is solidly up 70% in Europe.
Turning to Slide 14. Powertrain net sales increased 5% for full year 2018 due to higher sales volume in engine applications. Sales to external customers accounted for 50% of total net sales. For Q4, net sales increased 3% compared to the fourth quarter of 2017. Fourth quarter adjusted EBITDA was $536 million, up $50 million compared to full year 2017 with a margin of 11.7%, up 50bps. Adjusted EBIT was $406 million, up $46 million from full year 2017. Adjusted EBIT margin increased to 8.9% mainly due to favorable product mix and manufacturing efficiencies partially offset by higher production development spending which was up almost 20% year-over-year. Adjusted EBIT margin was 10.2%, up 150 bps compared to the fourth quarter of 2017 -- obviously in the fourth quarter of 2018. This is a record margin for FPT representing a milestone achievement for the segment.
I have concluded my section of the presentation and will turn it back over to Hubertus for the outlook and his final remarks before opening it up for the Q&A session.
Thanks, Max. Please join me now on Slide 16. Let me first point out an administrative item here which has to do with the regions and how we will be referring to them going forward. In line with the announcement of our new organizational structure, we have amended the composition of our regions that will become effective starting from Q1 of 2019. At a high-level, we have changed NAFTA and LATAM regional naming to North America and South America, respectively. EMEA will change to Europe, now excluding from the region Middle East and Africa. Rest of world will include all others Asia, Australia, Africa, and Middle East. We have put the old regional split in the appendix of the deck if you're interested in seeing our 2019 industry outlook as it would have been under the previous format.
When we turn to the market outlook for the full year of 2019, we need to understand that continued trade and geopolitical issues make it hard to forecast precisely what will happen this year. As you know very well, 2018 has been a period of great market volatility and political uncertainty that has yet to abate in many ways. While we have done a very good job in offsetting most of the incremental costs inflation, this gets somewhat more challenging as we move into 2019 as the trade dispute and other issues which are beyond our control persist. Some of our key customers have been struggling to figure out this volatility and hence the optimism that we sense at the beginning of last year has gradually faded. We expect to get more clarity and see a resolution to the core issues as we progress through the year. But not being able to predict when this may happen has caused us to build in some caution when putting together the 2019 outlook and estimates particularly in the first part of the year.
I won't run through all the segments by region here but while the outlook for AG is based largely on the current steady state market conditions, comparables in the first 2 quarters of 2019 are challenging. I would say that while AG sentiment has softened during the back half of 2018, this has not translated into storing replacement demand as commodities have stabilized and government support in North America has shifted the conversation more to yield improvement and put precision AG front and center in many of the customer and dealer conversations. This is mainly why we're looking for a fairly flat to slightly upmarket in North America. In terms of construction equipment, we are looking for 5% to 10% up on light and 10% up on heavy as end markets in North America continue to demonstrate growth driven by solid economic footing and state and local investments in infrastructure. In South America and Brazil, in particular, we are calling for flat to slightly up generally as the current geopolitical environment is conducive to recovery. The interest rates are low and elections last year have resulted in a progrowth administration, reducing some of the uncertainty around infrastructure and other projects. The commercial vehicle market in Europe for heavy and light is expected to be flat to slightly down, with a negativity more skewed towards heavy with some positive trends in Eastern Europe and growing LNG and CNG demand in Western Europe. The South American market and particularly Brazil, demand recovery should continue. Driven by attractive borrowing rates, old fleet renewals and increased AG freight and hence, we're expecting a 10% growth rate.
On Slide 17, we highlight our guidance for the full year of 2019. The performance achieved in 2018 demonstrates that the company is on track with a profitable growth trajectory and despite a softer geopolitical and macroeconomic environment in some region, CNH Industrial 2019 guidance is as follows: Net sales of Industrial Activities at approximately $28 billion, modestly up year-over-year with favorable pricing across segments offsetting raw material headwinds and positive operating margin leverage; adjusted diluted EPS between $0.84 and $0.88 per share with the growth of between 5% to 10% year-over-year; net industrial debt at the end of 2019 between $200 million and $400 million moving us closer to a net industrial debt-free position. In order to facilitate your projections on our full year 2019 guidance, we would also provide an indication on the following items. Increased investments in organic growth with CapEx and R&D, up year-over-year reaching 2.5% and 4% of sales, respectively. Operating cash flow will be about $200 million higher than in 2018, helping to fund incremental CapEx and dividends versus prior year. Net industrial cash flow will be slightly up year-over-year.
Now I'd like to discuss a few quarterly highlights in terms of product developments, key product launches for 2019 and then I'll conclude with my final remarks. On Slide 19, you can see that we had another great quarter in terms of product introductions and awards. In the area of precision agriculture, we are now firmly moving into the agronomy space with the recent announcement of a commercial agreement with Farmers Edge. This agreement will give our customer solutions that offer greater control of their machine and agronomic data and the ability to apply this information in numerous ways to significantly decrease operating costs and drive higher profitability through greater yield and a far better use of their resources.
Also noteworthy is an initiative we started in Europe under the header of AGXTEND. We have partnered with promising startup companies that focus on innovative and unique aftermarket solutions and services in the agricultural industry. From an innovative soil sensing technology to IOT environmental sensors to a device that kills weeds electrically without any chemicals. We have opened our dealer network to these start-up companies to jointly grow our aftermarket business while providing our end customers the latest technologies that allow them to be at the experimental so-called forefront of farming.
AGXTEND is also a good example of how our open partnership approach that we started with our digital platform also applies to products and services from a innovative start-up companies. We anticipate rolling out these products and services to other regions in the near future. You will hear more as we move through the year on the evolution of these products and services but for now, let me say I'm very excited about their potential for our dealers and end customers alike.
Separately I would like to discuss a promising new consortium developed to ensure the long term success and mass scale adoption of LNG as an alternative fuel for heavy-duty trucks in Europe. Partnering with IVECO will be Shell, DISA and Nordsol to form the so-called BioLNG consortium which covers the building of a pan-European network of 39 fueling stations covering key trucking routes every 400 kilometers from Southern Spain to Eastern Poland as well as the building of a large BioMethane plant. We have been at the forefront of this movement and we lead a market which is growing rapidly. On top of this, we will finance the establish of several mobile LNG stations at strategic endpoints in Germany to support our customers fleets in a country where the LNG infrastructure is still underdeveloped. These investments will help speed up the adoption rate of LNG technology in Europe.
In terms of awards, the Stralis NP 460 won sustainable truck of the year 2019 and Case IH Maxxum 145 MultiController has won tractor of the year 2019. Additionally, the MethanePowered Concept Tractor was recognized for its reimagined design features and its pioneering alternative fuel technology. The good design award recognizes the most innovative and cutting edge products from around the world and we also believe you will see more LNG, CNG adoption in the off-highway market place.
Moving now to Slide 20 from a product launch perspective. 2019 is going to be a very busy and exciting year for CNH Industrial with over 100 new products and upgrades in the 3 main themes of alternative drivelines, automation, and digitalization. I want to emphasize just a few highlights. To further improve our offering in commercial vehicles, we're launching new electric versions of our 12- and 18-meter city bus, and new and improved LNG and CNG truck offerings. We will also roll out on and off-road products that include best-in-class advanced diesel engines that are stage V and Euro IV (sic) [ Euro VI ] Step D compliant. These products will offer improved total cost of ownership while simultaneously lowering emissions. In addition, we are launching new Combines and tillage products as first steps towards autonomous operation. The Combines automatically make many of the adjustments on-the-fly that a farmer previously had to do manually ensuring high productivity and grain quality. In addition, we will expand our Construction Equipment machine control offerings.
In the digitalization space, we're investing in high horsepower machinery mostly tractors and solution that will assist farmers in making more informed decision based on next-generation connectivity and precision solutions that will cut costs while leading to a better overall yields. We also will launch a new telematic solution for our Commercial Vehicles while refreshing the Construction Equipment telematics offering.
Let's also briefly talk about our organizational changes that we announced on January 14 and that are highlighted on Slide 21. During the first quarter, we've started to implement a new organizational structure with the objective to remove the group's complexities, streamline operations, delegate decisions to the front line and put us on a quicker and more profitable growth trajectory. The 5 operating segments will now be fully responsible for the global profitable growth, end performance of their respective businesses, increasing customer focus and accountability. The Global Functions will leverage synergies between the segments and will help the company to focus on the megatrends that transform our industries.
In this new and leaner structure, we have appointed 2 new global executive company members to strengthen our global leadership team. Gerrit Marx will lead our combined Commercial and Specialty Vehicles segment; he has held various leadership position at Daimler Trucks and Volkswagen and will help us to reposition our IVECO businesses and to continue to drive the turnaround of our CV segment.
Andreas Weishaar was brought on board to lead the combined group functions of strategy, digital, and talent and to support us on our transformation journey over the next years. Andreas has proven to be very effective in similar positions at AGCO Corporation and Welbilt in his prior professional life. We firmly believe that this new organization and leadership team will have an increased customer focus, fostering entrepreneurship and agility at the segment level combined with greater leverage of our global supply chain and innovation efforts around our highlighted megatrends.
Moving on to Slide 22. You have probably seen that we have recently published a corporate calendar for 2019. At our Capital Markets Day event during the course of 2019, we will be presenting our new strategy business plan and that we're currently developing under the new leadership structure.
As a final remark on Slide 23, let me convey our main priorities that will guide us over the next quarters. Priority number one is to continue to improve profitability. In 2019, we will continue to drive profitability improvements to expand our EBIT margin and returns in our invested capital. World-class manufacturing will drive annual productivity improvements and our group-wide 80/20 initiative will be showing results starting later this year. Further, our new organizational structure will allow us to rethink and resize the organization and to look at our manufacturing footprint to support our growth strategies as well as the continued turnaround of our Commercial Vehicles and construction businesses. The priority number two will be to conclude our strategic business plan. Our industry is experiencing an ever-accelerating rate and growing magnitude of change, fueled by the mega trends such as digitalization, automation, electrification, and servitization. Companies need to adapt to change and revitalize themselves continuously in order to meet these business challenges and successfully generate long term value. Our strategic business plan will embrace these mega trends and will built on our successful market positions to allow us to deliver industry-leading products and services at a competitive profitability that will help us to generate long term value for all stakeholders and we will position our business segments at the forefront of these trends.
Our third priority is to maintain diligence in our capital allocation. We have a solid balance sheet and as we highlighted before, we are getting closer to a net industrial debt-free position. By continuing to increase our investments credit ratings, we can improve our funding cost and overall margins, which will help close the GAAP with our higher-rated peers. With this and other aspects in mind, we are committed in maximizing shareholder value through the identification of organic and inorganic growth opportunities to support our segments while maintaining our dividend policies. To sum it up, we are extremely happy with our strong results achieved in 2018. I'd like to thank all of my colleagues and our dealer partners for their outstanding performance. We are cautiously optimistic for 2019 and are confident that we will continue to deliver value to our stakeholders.
I have completed my presentation and now I turn it back to Federico.
Thank you very much, Hubertus. This concludes our prepared remarks for the full year results. And we can now open up for questions.
Operator, over to you.
[Operator Instructions] We will take our first question from Steven Fisher from UBS.
It sounds like you assume more or less the current conditions in AG but maybe with a more challenged first half on tougher comps. Could you just talk about what you assume for the second half? And kind of what were the various trade scenario possibly -- possibilities mean for your outlook?
Sure, this is Max. So the answer is yes, we maintain a very cautious approach in AG. And as you know, the resolution on the trade dispute is still up in the air and which doesn't allow us to make any particular confident statement about the back half of the year. So I would say that we continue to maintain cautious throughout the year for now.
And as we've said as between -- this is Hubertus, between flat up 5%. Obviously, if the trade issues are resolved earlier, this can go higher but for the time being to everybody that we're talking right now, this seems to be the reality that we're living in right now in 2019.
Yes, but a status quo in your mind would still support enough of a replacement demand market to...
The replacement, the replacement is...
Your outlook, it sounds like...
Yes, currently, currently that demand is driven by replacement demand that is there. Commodity prices could come a bit better, they're not really helping right now. They have stabilized but they're still below what they have been last year. So if we see a positive sign there, which we should if these trade issues abate, then it could go higher. In the absence of that, in the absence of a resolution, we are living through replacement demand right now which would give us flat to 5%.
Okay, great. And then on construction, I think you said your order book on heavy construction was flat but you are looking for 10% industry growth in North America, which is your largest segment of course. Can you just talk about what you assume there for 2019 to drive some acceleration? Or is your North American order book actually up and how much?
Yes, the order book is reflecting a much healthier position at the dealers in terms of having restocked their inventories to support the larger demand. So I think we are kind of -- now that the inventory positions at the dealers is lined up with the new industry, we are seeing an adjustment to the order book for the first part of the year. And this is a comment that is valid for NAFTA. In the rest of the geographies, we see a solid order books in line with previous years.
And just how are you thinking about...
And of course, we're hopeful. Sorry, I said we are hopeful that we're going to have a huge infrastructure within NAFTA that can drive even higher numbers but we have -- we don't have that right now.
Yes, I was -- because I was just going to ask about how you are thinking about the first half versus the second half in construction overall? And whether anything like that factors into how you might think about the second half in your guidance?
Same comment, that's an uncertainty. If it comes through, it's going to be very, very good if it doesn't come through its going to be what we have said. That's the cautiousness in our guidance right now.
We will now take our next question from David Raso from Evercore ISI.
I was curious, the scope of what we should expect to hear at the Capital Markets day, shall we expect business targets for each division? And maybe give us some sense of -- you obviously went through enough of a strategic review to change the organizational setup. Maybe just give us some sense of where we stand today versus sort of completing that strategic assessment if there's bigger portfolio decisions or things of that nature we shall also expect to hear at the meeting?
Yes, well, as you've seen, we have made quite some significant changes to our organizational structure and taking complexity out. And with that new announced team, we are in the midst of developing that strategic plan, which we will announce in the course of the year. That plan obviously is going to have margin targets per segment with the underlying strategic initiatives that will get us there over the next years. And that's what we're going to share with our investors. We will also of course look at the portfolio and as said in earlier statements, we basically want to bring each of our business to a full potential and we have heavy investments into the mega trends, and then, however, we also have a lot of synergies between the different divisions and total investments minus synergies is then going to drive the portfolio strategy, which of course we're going to share at that capital markets day as well.
And while you are expecting -- please go ahead.
Rest assured we are -- Pardon. Yes...
Sorry, please go ahead. With the step up in CapEx and R&D -- sorry for the delay on the phone. Go ahead.
No, it's okay. Ask your question, it's fine, it's your time.
I was curious, the meeting in the strategic assessment. I know we want both revenue growth and margin expansion. Just trying to think through the step-up in CapEx, the step-up in R&D, if we're trying to digest a -- I wouldn't say tone change -- but really just trying to understand where you're looking to take the company. When we think of pruning any businesses, where we're looking to focus, would you argue this is more of margins overgrowth if you had to say where we're trying to lean? Is it more of an operational improvement angle? Or would you say the step-up in CapEx and R&D would argue, it's very balanced trying to find acceleration of growth and margin? Just trying to get a sense of if it's a tone change of how we [look at that] going forward.
Well -- we're going to look at our business from an operational lens and from a strategic lens. Needless to say the operational lens, a lot of the different items are already in play. I mean, we're rolling out 80/20, we are de-complexing the organization, we're driving continuous improvement with world-class manufacturing. We just basically have to put everything on the table and then see where that leads us operationally, and then we're also going to take a strategic lens, where do we want to ring those business. Just evolution is not going to be enough. So we're going to look, where can we grow. And in other areas perhaps beyond our classical equipment business and as the AG scene, for example, is changing dramatically and so is the Construction Equipment we will look also into other segments where we can basically find pockets of growth and that might lead them to M&A activity. But let's not jump to conclusion at this point in time. It's just very clear we're going to have an operation and a strategic lens when driving our strategic plan and looking at our strategies and we will share all that with the investor community later in the year.
That's helpful. One last quick question, the 2018 sales guide -- sorry, 2019 sales guide of essentially flat. Can you help us with which segments you expect to be up and which ones down to net to the flat?
Well, we said flat to modestly up. I guess you can assume that construction is going to be continue to grow. So will AG. And Max, anything to add on that?
No, just I would like to add a comment that the segment that is going to be kind of seeing a little bit of headwind's next year on the top line is probably Powertrain because of the stockpiling activity that went through in 2018. There's going to be some stockpiling going on next year but at a much milder pace, it's going to affect engines below 56-kilowatt.
We will now go to our next question today from Ann Duignan from JPMorgan.
My first question is around the whole notion of flattish to slightly up demand in AG in Turk for next year or agricultural versus the build-up of inventory. I mean, why we're overproducing this year particularly tractors up 27%, combines up -- I mean, was that just to boost Q4 profits and absorption? Or we now sit with 4% more inventory, date on hand is extraordinarily high versus a year ago and our outlook is for flat at best with no visibility?
There has been no particular push on the Q4 earnings -- Ann, this is Max speaking. The 27% number for the tractors in unit equivalent is 4,000 tractors in total on a worldwide basis and is evenly split among the regions. We're actually producing to kind of bring the inventory up to the level that is required by the slightly sustained demand that we have seen vis-à-vis historical comparable periods. So I mean, in general terms for tractors, there was a step-up in inventory to support demand. For combines, the inventory is actually almost flat and we have recovered the underproduction that we went through in 2017 on row crop NAFTA in 2018 and now we expect to produce in line with retail going forward.
For Combines and tractors?
Yes.
Okay. And then as a follow-up on the commercial vehicle business, the trade-off between diesel products and the loss of market share in the heavy and medium-duty diesel business versus the ramp-up of CNG, LNG and any alternative fuels is probably going to lag the decline in your current market share. Can you describe what -- how bad could it get for margins in that business as we try to transition away from scale, heavy-duty, medium-duty diesel to alternative fuel vehicles which could ramp slower?
Well, we're not going away from diesel completely, we've changed our commercial policies and reduced our buybacks, which was basically a goal in reduction of market share by design. And this has been mostly compensated by an increase in LNG- and CNG-driven vehicles. And we see this trend to continue but it's more -- less driven by us and more by the demand because the business case for an LNG heavy truck is just so much better than for a diesel truck that despite us having a very, very competitive diesel offering, our customers are moving and switching over to LNG because specifically in Europe, diesel has a lot of uncertainties these days. And now our customers fear that they're not allowed with their diesel trucks into the Metropole city areas and so, therefore, the LNG is a credible alternative. And that would, of course, help us also to fill our factory specifically in Madrid. So I think that's going to be good and it's going to help absorption. Yes. And on the infrastructure I think that's also noteworthy Ann, because I think you have been at last year at the IAA in Hannover and Germany is lagging a good infrastructure and I think we are making a mega push this year with that consortium and also with our mobile LNG stations that by latest midyear, I would say, we have a grid that is supportive of large truck fleets. And as you know the autonomy on LNG is fairly remarkable. I mean, you drive from London to Madrid with one fill, it's around 1,600 to 1,700 with only one fill up, which is really good in terms of autonomy and independence, plus, all the other benefits, economic benefits that you have.
Okay. And just finally, any idea around when the Capital Markets day might take place? You gave us calendar for '19 and it's conspicuously absent.
It will not be at Christmas, okay. It will be before and it will not be a supreme event. It's going to be mid of the year. It's going mid of the year and we're trying to find a very nice place to hold you guys, okay.
Our next question today comes from Rob Wertheimer from Melius Research.
So maybe this is a question you're going to defer but I want to ask it anyway is when you came in Hubertus, and you looked at where you stood on some of the megatrends that you highlighted and that we've been talking about, was it an obvious conclusion that you felt like you are behind? Maybe it's a multiyear race and it's just getting started. And then do you have any comment on whether partnering is adequate or whether you need to be doing more internally?
No, actually and I think I said this last time. I mean, the more I get to know the company the more positive surprises we see and sometimes, we had been shy talking about what we really do. So if you take the digital revolution in AG, I don't think they were that bad. I think if you look at the rollouts that we have done last year and this year, we're absolutely competitive with our digital AG offering but our objective is not to catch up with some of our competitors is to leapfrog them. And I think if you look at our moves into agronomy space, I think that is actually setting the pace here in AG and if we drive now jointly with Farmers Edge these agronomy solutions further, I think we're going to be in a very, very competitive spot in AG.
The same goes for the truck market. I mean, everybody is talking about electrification but make no mistake, electrification for a heavy-duty truck, battery-powered that's going to be 8, 9 years out and what do you do in the interim. And I think we have invested the last decades into the LNG and CNG technologies and we are the market leader by far on that area. And I think investors need to understand that, that we have really a very, very competitive advantage there. So we're not behind, we're ahead of the industry. And Daimler and Volkswagen would be happy if they had a comparable LNG truck that we have with the same economic data. So we are not that bad.
If you look at Construction Equipment, we have to make some investments, it's a smaller business for us but I think so we're absolutely competitive. Are we competing head-on-head with Caterpillar everywhere? No, we're not. But that's also not the intent, this is for us a nice buy industry jointly distributed with the AG side so I think we're doing good there. And at the end, with FPT via Powertrain, a remarkable business. Again, our competitors would be happy if they had a business with those features. We are after Cummins the second largest independent engine producer. For the regulated markets we're the best. And if there's nothing that we have to be shy of or be afraid of. So I think we are actually pretty really strong and good base to build on. And again, our objective is not to catch up, our objective is to continue to lead in the areas that we operate in.
We'll move to our next question today from Joe O'Dea from Vertical Research Partners.
Can you talk about price cost assumptions for 2019? I didn't catch whether or not you're assuming pure neutrality? Or whether you think that price can offset cost I think based on what some peers have talked about with AG pricing and some construction pricing it could be a more favorable backdrop?
Sure. So as we said last quarter, the situation has not changed. We continued to see headwinds into raw material particularly in the first half of the year, including also the impact from the tariff now that in absence of resolutions remains an estimated impact of between $50 million and $100 million for the full year 2019. All of those more than offset by pricing performance expected in 2019. Some of that pricing performance is already in the market, some of that is being announced and it's going to be rolled out in the course of Q1. So we expect in the course of the year to be able to wash the 2 impact one with the other.
Okay. And then on Commercial Vehicles, your expectations for performance relative to the end markets and I guess, primarily Europe and as you talk about being more focused on more profitable product lines and clearly, more proactive on the pricing front in the quarter. Do you think that translates into some underperformance? Or it doesn't look like in 4Q there was any apparent underperformance versus the end market but I'm just wondering, what you think that means in 2019?
So the game plan is, obviously, we are taking into the neck from a volume/negative absorption point of view when we reduce our deliveries that are primarily associated with those buyback transactions. The expectation is that we recover that impact from a better pricing and a better product mix and that is what has happened actually in the last 2 quarters. We expect to continue to be, let me say, in that race particularly in the first part of the year when we're still going to have tough comps to compare against from a volume point of view. But as we move into the second part of the year, the expectation is that we should actually have a tailwind on the -- potentially a tailwind on the volume/absorption as we continue to build our book on the LNG, CNG applications.
Our next question comes from Chad Dillard from Deutsche Bank.
So the guidance bakes in a healthy amount of margin expansion. So I was hoping you could potentially unpack the drivers by segment and comment on whether you're seeing it as more of a first half or second half event?
Max, do you want to?
So we don't guide yet margin by segment. The expectation as we said during the call is there's going to be more tough comps in H1. So probably let me say, the stronger improvement is backloaded but yes, the expectation from the management team is to continue to look at year-over-year margin progression as we move along the course of the year. So...
That's helpful. And then just going back to your comment about building inventories across the business. Maybe can you help us think through where inventory should land as we exit 2019 by segment?
So again, it's going to be painful to go by segment on the inventory. Let me say that we expect inventory now that we have ramped up company inventory to be kind of in good shape from end market point of view. There are certain uncertainties as an example associated with the situation in the U.K. with Brexit. So we are kind of putting together countermeasures to protect our businesses in case of a no deal situation. So we are kind of affecting our inventory right now with some buffer to protect the market uncertainties. And depending how those unfold, we may be able to release the inventory buildup or not but it remains to be seen.
Our next question today comes from Ross Gilardi from Bank of America.
Hubertus, if you guys are going to come out with margin targets across the different businesses, should we presume that you're going to really strive to hit those targets before you make any big portfolio changes?
That's -- well, first of all, we don't put our targets that we don't want to hit, that's the first thing. And we're going to show you how we're going to hit it. So it's got to be not only fantasy it's going to be very, very clear steps how we're going to get to those margin targets. And on the portfolio question, let's cross the bridge when we get there by midyear and then we're going to answer the question then.
Do you have a view right now if we're at a peak in the European truck cycle?
I mean, we are -- yes, I think that is very clear and the question was always when is the industry going to go down a little bit. I mean, and there was the fear in December that that would happen because December was a bad month. It somehow abated, was more positive in January but we're trending at very, very high levels there. So the industry will not grow -- significantly grow higher. At one point in time, it will basically end the cycle and we go down. When this is going to be we will see but as you see in our guidance on Commercial Vehicle, we had been minus 5% to flattish, this is kind of where we see the industry trending this year.
And then just on IVECO, I'm not asking like what you're going to do with the business but as you've gotten to know the assets I mean, can the truck business in and of itself be -- is it separable into different pieces, is that even an option? I mean, can you separate any of the heavy versus medium duty versus light business because you seem -- or you seem to have more of your strategic advantages more on the light and medium side versus heavy where maybe you don't have the scale of some of the other players. Are there any other ways where you could -- the assets could be separated from one another just within truck or -- I'm just asking if it's feasible?
I mean, if you look at our commercial and especially vehicles, it's basically a sum of very different businesses. You have a very, very strong bus business with order books skyrocketing by the way right now and with a completely different footprint in the distribution channel. Then you have the firefighting business, which is a completely different distribution business in the completely different footprint. And then within the truck segment, of course, there is also different assets around medium, heavy and light and the distribution, however, is the same. But again, whether we are subcritical or not, let us do the analysis right now and let us really see what this revolution right now that's going on with the megatrend around alternative propulsion and LNG, what this is going to bring to our volumes because we are seeing high 2 digits up to 3 digits growth in that segment and currently, LNG is at a 1% only in Europe and in Germany. And that can go easily, easily to a 10%, 15% share of LNG in the truck market in Europe and considering that we are the undisputed leader in that segment, that can be very healthy for our volumes. But let's do the analysis now in the next months and then we come back to you, we basically give you our conclusions, okay?
Got you, fair enough. I mean, the CapEx and the R&D, are you viewing this right now as sort of a 1 year step-up or do you view this as potentially a new multi-year run rate because fairly...
No, we view this as a run rate. Run rate could go even higher on the R&D side we would say. Again, we are putting a full potential plan out here. Our objective is to lead in the segments we operate in, okay, and that needs investment into R&D.
Is this new consortium with Shell and some of these other players on LNG, at part of that CapEx increase at all. Can you just explain a little more about what your role in that project is? And is there going to be an ongoing capital commitment that you have to make to that?
Let's take that offline Ross that's a longer discussion. We take that offline. We give you a call later on and give you some details on that and how the funding mechanism works okay?
We will now take our final question today from Larry De Maria from William Blair.
Hubertus, with the Farmers Edge announcement past year, just curious, Hubertus, how do you think about the commercial opportunities there and the potential for channel conflict?
No, we don't see channel conflict there. It is a platform, it is an independent company. It has many positive effects for our end customers. It also has a lot of positive effects for us, for example, the connectivity of our installed fleet because we move our customers over into Farmers Edge, we automatically connect thousands of machineries that are in the field right now and that are not connected. And obviously, the connectivity will then give the telematics aspects and FX positive for a better usage of their assets for the farmer and also positive for us because we're going to increase our aftermarket business with that.
So that's the reason why we're very positive around the Farmers Edge development and if you look at agronomy at large and you look how agronomy is now digitizing, if you look at the Farmers Edge business model, which we like very much, we think it's a very, very strong partnership and as you know they are kind of exclusive with our dealers. So I think we have a very, very good platform there, which is different to our main competitor it's an open platform. So there is no conflict. If somebody wants to continue to basically go in Climate Corp. this is not a problem. If somebody wants a continue using other solution that's not a problem. We are kind of having an android approach here and we can basically interface to any existing infrastructure that is there in the farm. And by the way, we are also working -- we're working very well also with Climate Corp. and we give the freedom to our customers, of course, to work with either AgDNA in Australia, by the way, it's a smaller company in the agronomy space or with climate Corp or with Farmers Edge. We just believe that the Farmers Edge solution right now is very, very competitive. We like the team there, we like the company, and we're supporting them.
Okay. And then your previous comment about being a leader in your industries. I guess agriculture is, obviously, the one you're closest to, you having the leadership position and the others are further behind. So I'm curious about how the uptick in R&D is skewed between the segments? And if it's particularly skewed towards AG? And maybe not so much towards the other segments which are much more difficult to get to that leader position?
Yes, I mean, the question is always how you define leader. I mean, obviously, and that was my comment on construction, we're not a market share leader in Construction Equipment. So the question, is, in this perspective segments you operate, you want to have leadership position in technology. And I think what also people have not yet realized is with the going down of diesel, and the emergence of electronic drives or also gas drives I also think that we're going to see in the off-highway market a lot more LNG and CNG powered equipment. And that for me is then a leadership position that you would then have in that specific segment because that's going to be a competitive advantage, it's going to be USB for us. So that's how I would define leadership, it's in the segments where you act that you have a leadership position in terms of a service or product that you offer. And needless to say, our margins today are not where they should be. I think they're very, very competitive in the Powertrain segment. I mean, we're industry-leading there. We are very, very competitive in AG but we have enormous room for improvement in Commercial Vehicles and on the CE side. And I think we can do this despite having the scale of some of our larger competitors, and that's what we're going to analyze in the -- in our strategic business plan. How we can basically bring those markets up, how we can increase scale where needed or how we can refocus in areas where we do have a competitive advantage, and where we basically get that innovation premium that will drive the margins. And talking about innovation premium, and we're not the largest CV manufacturer on the planet, clearly not. We're #5 in Europe, however, in that niche which is become a very, very prominent segment of LNG, we have a USB and we have a competitive advantage and also a margin advantage and people are paying for the innovation premium.
Thank you. That will conclude the question-and-answer session. I would now like to turn the call back over to Federico Donati for any additional or closing remarks.
Thank you, Emma. I wish to thank you, everybody, who participate today at call and have a nice day. Bye-bye.
That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.