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Operator
Good morning, everyone, and welcome to Deere & Company's fourth 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 Huegel, Director of Investor Relations.
Thank you, sir, you may begin.
- Director of IR
Thank you.
Also on the call today are Raj Kalathur, our Chief Financial Officer, and Susan Karlix, our Manager of Investor Communications.
Today we will take a closer look at Deere's fourth quarter earnings, then spend some time talking about our markets and our initial outlook for FY16.
After that, we will 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.
First a reminder, this call is being broadcast live on the Internet and recorded for future transmission and use by Deere & Company.
Any other use, recording or transmission of any portion of this copyrighted broadcast without the express written consent of Deere is strictly prohibited.
Participants in the call, including the Q & 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-K 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.
Additionally, additional information concerning these measures, including reconciliations to comparable GAAP measures is included in the release and posted on our website at www.johndeere.com/earnings, under other financial information.
Susan?
- Manager of Investor Communications
With today's announcement of our fourth quarter results, John Deere has completed another year of solid performance.
We did so in spite of further weakness in the global agricultural sector and a slowdown in construction equipment markets.
In response to this challenging environment, the Company moved aggressively, restraining costs, reducing assets, and seeing further benefits of having a broad-based business lineup.
As a result, Deere was able to deliver solid results, including our sixth best-ever year in terms of net sales and income.
We also maintained our strong financial condition, generated healthy levels of cash flow and returned some $3.4 billion of record amounts to investors in the form of dividends and net share repurchases.
All in all, it was a sound year.
One in which Deere further demonstrated its commitment to disciplined operations and the resilience of its business model.
Now let's take a closer look at the fourth quarter in detail, beginning on slide 3. Net sales and revenues were down 25% to $6.715 billion.
Net income attributable to Deere & Company was $351 million.
EPS was $1.08 in the quarter.
On slide 4, total worldwide equipment operations net sales were down 26% to $5.9 billion.
Price realization in the quarter was positive by 1 point.
Currency translation was negative by 5 points.
Turning to a review of our individual businesses, let's start with agriculture and turf on slide 5. Net sales were down 25% in the quarter-over-quarter comparison.
Lower sales were recorded in all regions of the world, but the decrease was primarily due to lower shipment volumes of large ag equipment in the United States and Canada.
Brazil accounted for most of the lower sales outside the US and Canada.
Also hurting sales was a negative impact of foreign currency exchange.
Operating profit was $271 million.
The decrease in operating profit was primarily driven by lower shipment volumes, a less favorable product mix, and foreign currency exchange, partially offset by price realization, lower selling administrative and general expenses, and lower production costs.
The division's decremental margin in the quarter was 27% and 30% for the full year.
Quite respectable considering that worldwide large ag sales were down approximately 35% for the year.
Before we review the industry sales outlook let's look at fundamentals affecting the ag business.
Slide 6 outlines US farm cash receipts.
Given the record crop harvest of 2014, and consequently the lower commodity prices we're seeing today, our 2015 forecast calls for cash receipts to be down about 8% from 2014's peak levels.
Moving to 2016, we expect total cash receipts to be about $394 billion, roughly flat with this year.
On slide 7, global grain stock [seed] ratios remain at somewhat sensitive levels, even after the abundant harvests of the past two years.
Global grain and oil seed demand remains strong, while supplies are now fully adequate.
Even so, unfavorable growing conditions in any key region of the world as well as unknown impacts from any geopolitical tensions, could result in prices quickly moving higher.
Slide 8 highlights the awards John Deere earned at Agritechnica, the world's largest agricultural equipment fair earlier this month.
Acknowledging Deere's ongoing research and development efforts, the innovation committee of the German Agricultural Society recognized innovations from John Deere and partner companies with three gold and 10 silver medals.
It was the most gold and most silver medals ever awarded to one company.
In addition during the show, the Waterloo-built 8R series tractors were named Machine of the Year 2016 by a German publishing house.
Our economic outlook for the EU-28 is on slide 9. Economic growth is gradually improving in the region.
Farm income is below long-term averages and remains under pressure.
Also, weakness continues in the dairy sector.
As a result, industry farm machinery demand in the EU regions is expected to be flat to down 5% in 2016.
On slide 10, you'll see the economic fundamentals outlined for other targeted growth markets.
In China, the government's continued investment in equipment subsidies and mechanization is supportive of agriculture; however, the economic slowdown there and lower commodity prices have lead to a decrease in the industry sales forecast.
Turning to India, positive consumer and investor sentiment are encouraging economic growth.
While the government continues to support agriculture, two consecutive below-normal monsoon seasons have taken a toll on the farm sector.
Shifting to Brazil, slide 11 illustrates the crop value of agricultural production, a good proxy for the health of agribusiness.
Ag production is expected to decrease about 2% in 2016 in US dollar terms due to lower global commodity prices; however, the situation is more positive in local currency due to the sharp devaluation of the real.
That's because Brazilian farmers sell their crops in dollars helping to keep profitability at good levels.
Although ag fundamentals remain positive, farmer confidence is lower due to uncertainty over government-sponsored financing programs, as well as economic and political concerns, all of which are leading to lower equipment sales.
Looking beyond these immediate concerns, however, long term fundamentals for the ag business in Brazil remain solid.
Our 2016 ag and turf industry outlooks are summarized on slide 12.
Industry sales in the US and Canada are forecast to be down 15% to 20% with large ag sales down 25% to 30%.
Low commodity prices and stagnant farm incomes are continuing to pressure demand for farm equipment with the decline being most pronounced in the sale of high-horsepower models.
As mentioned previously, the EU-28 industry outlook is forecast to be flat to down 5% in 2016, due to low crop prices and farm incomes as well as pressure on the dairy sector.
In South America, industry sales of tractors and combines are projected to be down 10% to 15% in 2016, a reflection of the factors already discussed.
Shifting to Asia, sales are expected to be flat to down slightly, due in part to weakness in China.
Turning to another product category, industry retail sales of turf and utility equipment in the US and Canada are projected to be flat to up 5% in 2016, benefiting from general economic growth.
Putting this all together on slide 13.
FY16 Deere sales of worldwide ag and turf equipment are forecast to be down about 8%, including about 2 points of negative currency translation.
The ag and turf division operating margin is forecast to be about 7% in 2016, due to lower shipment volumes, a less favorable product mix, and a negative impact of foreign currency.
Now let's focus on construction and forestry on slide 14.
Net sales were down 32% in the quarter and operating profit was down 72%, due to lower shipment volumes and the unfavorable effects of foreign currency.
The division's decremental margin was 27% in the quarter and 19% for the full year.
Moving to slide 15.
Looking at the economic indicators on the bottom part of the slide, GDP growth is positive.
Construction spending is increasing, and housing starts are expected to exceed 1 million units this year.
And yet, in spite of these encouraging signs, we are seeing weakness in our order books year-over-year.
Contributing factors are weak conditions in the energy sector and energy producing regions, especially in Canada.
We're also seeing a decline in rental utilization rates, sluggish economic growth outside the United States, and importantly, the mix of housing starts in the US skewing to multi-family homes, therefore reducing demand for earth-moving equipment.
As a result, Deere's construction and forestry sales are forecast to be down about 5% in 2016.
Currency translation is forecast to be negative by about 1 point.
Global forestry markets are expected to be down 5% to 10% from the strong levels we've experienced the last several years, primarily as a result of lower sales in the United States and Canada.
C&F full year operating margin is projected to be about 8%.
Let's move now to our financial services operations.
Slide 16 shows the annualized provision for credit losses as a percentage of the average owned portfolio at the end of the year was 13 basis points.
This reflects the continued excellent quality of our portfolios.
The financial forecast for 2016 contemplates a loss provision of about 19 basis points.
Even so, losses would remain below the 10-year average of 26 basis points and well below the 15-year average of 39 basis points.
Moving to slide 17, worldwide financial services net income attributable to Deere & Company was $153 million in the fourth quarter versus $172 million last year.
Lower results for the quarter were primarily due to the unfavorable effects of foreign currency exchange translation and higher losses on residual values primarily for construction equipment operating leases.
These factors were partially offset by lower selling, administrative and general expenses.
2015 net income attributable to Deere & Company was $633 million, an all-time record high for John Deere Financial.
The 2016 forecast is about $550 million.
The outlook reflects less favorable financing spreads and an increased provision for credit losses.
Also, remember that 2015 results benefited from a gain on the sale of our crop insurance business of about $30 million.
Before we leave financial services, especially with all of the questions we've been getting over leasing, let's take a closer look at the portfolio composition as shown on slide 18.
At 31 October 2015, operating leases made up 13% of the portfolio, up 2 points compared to a year earlier.
The vast majority of the impairment charge taken in the quarter was on a handful of construction equipment models.
JDF has not been encouraging customers to utilize leases in general or short-term leases specifically through pricing or residual values.
Leasing, however, is becoming more attractive to many of our customers.
That's because of an uncertain business environment coupled with the lack of confidence and clarity in tax incentives.
Meeting our customers' financing preferences continues to be our top priority.
We monitor the leasing portfolio daily, taking necessary actions to mitigate risks and expect to continue to see strength in our used equipment values.
Slide 19 outlines receivables in inventories.
For the Company as a whole, receivables and inventories ended the year down $619 million.
We expect to end 2016 with total receivables in inventory down about $650 million.
Our 2016 guidance for cost of sales as a percentage of net sales shown on slide 20 is about 79%.
When modeling 2016, keep these unfavorable impacts in mind: Tier 4 product costs, overhead spend, and an unfavorable mix of products.
On the favorable side we expect price realization of about 2 points, lower pension and OPEB expense and, to a lesser extent, favorable raw material costs.
Now let's look at a few housekeeping items.
With respect to R&D expense on slide 21, R&D was down 2% in the fourth quarter and full year, including about 3 points of negative currency translation in each period.
Our 2016 forecast calls for R&D to be down about 3%.
Moving now to slide 22.
SA&G expense for the equipment operations was down 17% in the fourth quarter with currency translation and incentive compensation accounting for about 12 points of the change.
Our 2016 forecast shown on slide 23 has in place SA&G expense being down about 1% with currency translation accounting for about 2 points of the change.
So essentially flat in comparison to 2015.
Turning to slide 24, pension and OPEB expense was up $20 million for the quarter and up $80 million for the full year.
Pension and OPEB expense is forecast to be down about $200 million in 2016 due to the fact that we are adopting a change in the measurement of service and interest costs, known as the spot yield curve approach.
On slide 25, the equipment operations tax rate was 14% in the quarter and 28% for the full year.
The lower rate resulted mainly from a reduction of a valuation allowance recorded during the quarter due to a change in the expected realizable value of a deferred tax asset.
For 2016, the projected effective tax rate is forecast to be in the range of 34% to 36%.
Slide 26 shows our equipment operations history of strong cash flow.
Cash flow from the equipment operations was approximately $3.1 billion in 2015 and is forecast to be about $2.6 billion in 2016.
Slide 27 outlines our use of cash priorities which are unchanged and familiar to many of you.
Our number one priority is to manage the balance sheet, including liquidity, to support a rating that provides access to low cost and readily available short- and long-term funding.
Thus, Deere is firmly committed to its A rating.
Our second use of cash priority is funding value-creating investments in our operations, mostly relating to CapEx and R&D spending, but also acquisitions.
A third priority is to provide for the common stock dividend, which has been raised 114% since 2010.
Over time, we want to consistently deliver a series of moderately increased dividends while targeting at mid-cycle earnings a 25% to 35% payout ratio on average.
In this regard, we are mindful of the importance of maintaining the dividend and not raising it beyond a point that can be sustained by our cash flow throughout the cycle.
Share repurchases are our preferred method of deploying excess cash, once the previous requirements are met, so long as such repurchase is value enhancing.
Since 2004 Deere has repurchased about 242 million shares, resulting in a net share reduction of 36%.
Cumulatively from 2004 to 2015, we have returned about 65% of cash from the equipment operations to shareholders through dividends and share repurchases.
The 2016 outlook for the first quarter and full year is on slide 28.
Net sales for the quarter are forecast to be down about 11% compared with 2015.
This includes about 2 points of price realization and about 4 points of unfavorable currency translation.
The full-year forecast calls for net sales to be down about 7%.
Price realizations and currency translation will offset one another with each expected to be about 2 points.
Finally, our full-year 2016 net income forecast is about $1.4 billion.
I'll now turn the call over to our Chief Financial Officer, Raj Kalathur.
- CFO
Thanks, Susan.
Thanks, everyone, for participating in the call today.
In closing, I'd like to summarize a few things, and also reiterate a few things that Susan mentioned about Deere's recent performance and the current ag downturn.
We have faced two years of lower equipment sales in 2014 and 2015.
We are forecasting a third year of decline in 2016.
Industry sales of large ag equipment in North America have declined by more than 60% over this time -- again, it's large ag in North America industry, relative to the 2016 forecast, okay?
This is 2013 to 2016 end.
In addition, all key ag markets around the world and construction equipment markets in the Americas were down in 2015.
Even with such a steep industry pullback, our businesses have remained solidly profitable delivering respectable decremental margins of 30% in 2015.
Now we also expect a solidly profitable 2016.
Now we also expect to continue generating strong cash flow.
Last year, Deere delivered third highest ever level of cash flow from operations and we are forecasting a very healthy level of cash flow of over $2.5 billion in 2016.
Our actions in proactively controlling expenses, costs, and managing assets have enabled us to deliver substantially better results than in any of the past downturns.
At the same time, I should stress that the trends that hold so much promise for John Deere's future, the ones we have told you about in the past, based on population growth, rising living standards and increasing urbanization, they haven't gone away.
They are still quite compelling in our view and have ample staying power.
In fact, the demand for grain has continued to grow and the supply/demand balance is even closer now than last year.
That's in spite of record production in some cases, corn as an example.
Recall that earlier this year, in the summer, corn prices shot up to $4.50 over worries about the weather in the US cornbelt.
So all-in all, we believe John Deere can continue to earn solid returns, even in a weak farm economy, deliver financial performance much improved over downturns in the past and longer term, see substantial benefits from the world's growing need for advanced equipment and technology solutions.
- Director of IR
Thank, Raj.
Now we're ready to begin the Q & A portion of the call.
The Operator will instruct you on the polling procedure.
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.
Carlos?
Operator
Thank you, sir.
(Operator Instructions)
Our first question will be coming from the line of Mr. Tim Thein from Citigroup Global Markets, Incorporated.
- Analyst
Thank you, good morning.
Just a question on the production in terms of the split between large versus small ag.
Just within the overall context of the projected $425 million of channel inventory reduction here in 2016, can you just give us a sense in terms of just how that split breaks out, even if it's just kind of directionally, again, between large versus small ag.
Thank you.
- Director of IR
Yes, that's an important part to understand as you think about the reduction in receivables in inventory this year.
And really in context of last year as well, because when -- I'll talk first about small ag, because in the case of small ag we were actually increasing as part of our strategy and the growth we were seeing in that business we were increasing our inventory in receivables on that part of the business.
So it did mute on our reported numbers the impact of the reductions that were being taken in our large ag product on top of the large reductions we took in 2014.
So as you look at 2016, what you're seeing again is some reduction in small ag, but you're also seeing some additional reduction in large ag relative to the lower markets that we're anticipating in 2016.
And I think maybe where you were going with this is production versus retail, last year we talked a lot about underproducing retail.
This year there will be some of that, but not nearly to the same level.
So we are getting some advantage in 2016 from all of the work that took place in both 2014 and 2015 and able to produce much closer to retail than what we have in the past couple years.
Operator
Thank you.
Our next question will be coming from Steve Volkmann from Jefferies.
- Analyst
Excuse me.
Good morning and thanks for the question.
I guess I'm just going to ask about your forecast relative to ag and turf being down about 8%, but you have North America down 15% or 20% and so forth.
It just feels to me like you must be assuming some market share growth or something other -- the numbers just don't quite seem to add up for me.
So any of your thinking there would be great.
Thanks.
- Director of IR
And really kind of goes in concert with the last question of it as well because keep in mind that the guidance that we're providing is on industry sales and that's more volume-based industry sales.
So as we get some advantage year-over-year, part of that difference that you're seeing is that last year, in addition to the lower retail environment, we were underproducing, undershipping that lower retail environment.
This year, especially on large ag we're actually able to ship much closer to that retail environment.
We also have the advantage this year again of pricing.
That would be the other major contributor in the sales.
- CFO
Steve, one other thing is industry guidance is for whole goods, so service parts now is a higher percent of our business and it is not down, okay?
So -- and other than the Americas, other markets are not down as much.
So if you put all those together, I think you'll get the right answer.
- Analyst
Thanks, Raj.
Operator
Thank you.
Our next question will be coming from the line of Joe O'Dea from Vertical Research Partners.
- Analyst
Hi, good morning.
Last quarter you had talked a little bit to early indications of things getting better in Europe.
It seemed like registration data over the last couple of months maybe showed some softening there.
So if you could just talk about, in general, what's kind of trended in Europe over the past few months, how that maybe influences your outlook there and any details by country you're able to provide?
- Director of IR
Yes, last year, or last quarter, and I think we had sufficient hedge around that statement of things starting to show early signs.
And I think this is why, in the sense that one of the anticipations there was around dairy.
At that time many were anticipating that the weakness in dairy would begin to moderate as you moved into 2016 and that isn't happening at this point.
So it appears that we'll continue to have some weakness in the dairy market, as an example, as we go well into 2016.
And that's a significant part of the business in Europe, so I think that is probably the biggest difference.
As Susan pointed out in the opening comments, we are still seeing some positive trends in the overall economic environment.
We would stress there certainly, as we point to in our slides, there's still some risks there and so we'll see if that continues to progress.
But we did see a little bit of weaker markets than what we had hoped to see as we move into 2016.
Operator
Thank you.
Our next question will be coming from Andy Casey from Wells Fargo Securities.
- Analyst
Thanks a lot.
And good morning.
- Director of IR
Hello.
- Analyst
Hi.
Happy Thanksgiving, everybody.
- Director of IR
Thank you, you too.
- Analyst
Thanks.
So a question on the margin.
If I work through all of the puts and takes, it's about a 5% operating margin outlook for 2016 and you've embedded about $200 million benefit of lower pension expense or about an 80 basis point margin cushion.
If I take that pension benefit out, it looks like your implied decremental margin is somewhere around 40%.
I'm just wondering why do you expect that to deteriorate from the reported 30% in 2015, especially given the lower gap between production retail for large ag in the US and higher aftermarket?
- Director of IR
Yes, and certainly -- and we would agree, if you take out the pension OPEB benefit, you'd get closer to 40%, be just under or just below that.
And I think we talked about this really on the last call is you look at large Ag, it is still down year-over-year.
Now we're getting some benefit, so it's not down as much as maybe the retail environment is, but the production is down year-over-year and is the major contributor -- from an agricultural perspective, is the major contributor to the lower sales would still be large Ag.
And so when you put that in perspective of where we've been from a capacity perspective, last year we talked about being at about 50% of capacity in most of our large Ag facilities and now we're further down from that, closer to 60% -- down 60%, so we're pushing 40% of capacity in some of these facilities.
And so the headwinds just get very, very challenging in that type of an environment.
And I'd point out, while the near 40% decremental margins may not be as appealing as the 30% of 2015, relative to what we were able to do historically, that 40% is very, very impressive, especially in light of where we're at within the end market.
So you're right, in the sense that it has grown year-over-year, but certainly is still, from a historic basis, pretty attractive.
- Analyst
Okay, thank you.
- Director of IR
Thank you, next question?
Operator
Thank you our next question will be coming from Jamie Cook from Credit Suisse.
- Analyst
Hi, good morning.
I guess just some color, because there's a lot of concerns out there, if you could just comment.
Sounds like you've made headway, but comment on Deere's used inventory levels in pricing and what you're seeing relative to, I guess, the competition?
- Director of IR
Sure.
You know, as you think about used equipment and I'll start with it's still a challenge, especially on large tractors.
We would continue to say there's more large row crop tractors in -- used low row crop tractors in the market in the US and Canada than we would prefer.
So it does continue to be a focus of ours as we go through 2016, but we are making progress so we are seeing that large ag inventory coming down.
In fact, if you look at the high point in 2014, we're down about 18% from that point, so, again, making progress.
The good news there, too, is our resale values are holding in quite well.
We talked last quarter about if you look over a two-year kind of horizon, down a small single digit.
tell you those used pricing -- the used pricing continues to remain very steady at those levels.
And versus competition, we're maintaining a very healthy premium.
And certainly from both an inventory and pricing perspective, when you put it in context of where our competition is, we're in a much more favorable position.
So there's some good news but, again, stress that is a continued focus of ours in 2016.
- Analyst
Is there a higher level of confidence you can rectify the situation by -- I mean, we were hoping we would be finished with this in 2015.
Do you think it could go past another year in terms of being where you want to be?
- Director of IR
You know, the challenge there is always around what happens in the end markets.
And so certainly our goal and the goals that we set with our dealers would be to get that used inventory in line, but it is not an easy process, especially in the sense that we're wanting to balance that inventory reduction with maintaining those strong values.
So those two goals are in conflict, obviously, with one another and we're trying to strike that balance and have done so pretty well to date.
So with that, we'll have to move on to the next caller.
- Analyst
Thank you.
Operator
Thank you.
Our next question is coming from the line of Nicole DeBlase from Morgan Stanley.
- Analyst
Good morning; thanks for taking my question.
So my questions are on the early order program.
I'm just curious if you can comment on what you've seen so far?
And then also just what you're seeing in Europe from an order perspective?
- Director of IR
Yes, you know, with the early order program, normally we tend to talk about year-over-year kind of changes and it is very difficult because, again this year, we've made some changes in that in some of the structures.
For example, the combines, some of the discount levels were different year-over-year, those sorts of things.
But generally, I think you're seeing reflected in our outlook for large ag, we're seeing those early order programs come in much weaker, again, from where we were last year.
And so what I would say is the outlook that we have is consistent with what we're seeing, both in the early order programs on the seasonal equipment, as well as what we're seeing in our tractor order book as well.
And I think you're aware with Europe, we don't have as -- our order book isn't as full.
It isn't as extended as it tends to be in the US.
And so it's a little harder to gauge the market the coming year.
But I think what you're seeing in our outlook, again, is reflective of what we're seeing in the order book that -- down a bit from where we were a year ago and that's where we landed on the current guidance in Europe of flat to down 5%.
- Analyst
Okay, thanks, Tony.
Happy Thanksgiving.
- Director of IR
Thanks; you too.
Next caller?
Operator
Thank you.
Our next question will be coming from the line of Ms. Ann Duignan from JPMorgan.
- Analyst
Hi, good morning, everyone.
- Director of IR
Hi, Ann.
- Analyst
Can we focus on the fundamentals for this question, just your outlook for the cash receipts for 2016?
Just quickly confirm that is a calendar year outlook not a marketing year?
And then the real question is that would then include an outlook for 2016, 2017, at least for planting in the US?
Can you talk about what your outlook is for major crop planting in 2016, 2017 in the US?
And have you contemplated in that what's happening right now in Argentina and what might happen in Brazil just given currency and what those farmers might want to do?
And just trying to get a sense of how you came up with the cash receipts for 2016?
- Director of IR
So which of those four questions would you like me to answer?
- Analyst
How you arrived at the 2016 outlook for cash receipts?
- Director of IR
Yes, certainly the 2016 cash receipts number is -- to your point, it is a calendar number, so it does reflect a bit at the tail end of 2016 relative to what we would anticipate for next year's crop year.
We have not, at this point, disclosed acres and so on for next year's crop.
I don't think -- we certainly don't anticipate a significant decrease in the acres planted.
And I'll follow up a little bit on the last question you had, though, because I think the situation in Argentina with the elections over last weekend could have some impact on that.
I think that the challenge there is it is very premature and a lot depends on how quickly some of these promised changes may occur in terms of both planting and situation in Argentina.
And then what impact that could have on the northern hemisphere in the US and Canada, so there is still time for Argentinian farmers to shift and plant more corn acres.
Planting so far has been running behind.
And the expectation has been lower acres in this current year, but that could change and certainly could then impact the pricing outlook for farmers here in the US and Canada.
But again, it would be fairly marginal and short-term.
And I think the similarly with soybeans.
We'll just have to wait and see how quickly things happen and in terms of any changes and what impact that has on some of those pricing.
Now I think to be fair, much of that, I think, was speculated and priced into current commodity prices in terms of the anticipation of this win and what that might have for exports coming out of Argentina.
With that, let's go ahead and move on to the next call.
Thanks, Ann.
- Analyst
Okay.
Operator
Thank you.
The next question will be coming from Ross Gilardi from Bank of America Merrill Lynch.
- Analyst
Hi, good morning.
- Director of IR
Hi, Ross.
- Analyst
Tony, could you just give us a little more color on how you formulated the South America industry guide?
Certainly you're running run rate is down more than 10% to15% and you got the uncertainties around fenami and so forth.
Do you really have any visibility on what that market is going to do this year or is that just sort of like we're down a lot, we're going to continue to be down double digit?
But I would think it's just very, very difficult to quantify the magnitude of the decline next year for South America.
- Director of IR
I think maybe the way I'd answer that is certainly when you think about risk and uncertainty, there is a lot of uncertainty in South America and I would say in Brazil specifically.
Now that uncertainty swings both ways, right?
And so there's a possibility things could end up better than this current outlook too.
But as you think about it, similar to -- and we say this about any region outside of the US and Canada.
Our visibility from an order book perspective is strongest in the US and Canada, especially on large Ag, and lesser in other markets.
So you certainly have uncertainty around fenami, while the expectation is that [motafroda] will come back around the 1st of December, that's what it's scheduled to do and anticipated to stay in place.
There's always uncertainty, certainly around that.
And then over the general economy, there's a lot of uncertainty that continues to exist there.
Again, the good news with Brazil is because of the FX rate and the fact that those farmers do sell in US dollars, and then when you convert into local currency, profitability for farmers and cash receipts in local currency have remained very strong.
And so we have -- under this weakness that we've experienced in 2015 and 2016, what's been forecast for 2016 in the equipment sales is a farmer base that financially again is pretty strong.
So if anything shifts and some of that uncertainty is removed from the market, there is certainly some potential for those farmers to step back in as well.
So, again, I think your point is well taken in the sense that there is a lot of uncertainty in South America, Brazil in particular.
We'll see how that develops as we go through the year.
- Analyst
Thanks, Tony.
- Director of IR
Thank you; next question?
Operator
Next question will be coming from the line of Mr. David Raso from Evercore ISI.
- Analyst
Hi, good morning.
Thank you.
- Director of IR
David.
You still there?
David?
Operator
We will be getting his line, sir.
One moment please.
- Director of IR
Let's go ahead and move on to the next caller and we'll come back to David after, if we can get him back on.
Operator
Sure.
Our next question will be coming from Mike Shlisky from Seaport Global Securities.
- Analyst
Good morning, guys.
- Director of IR
Hello.
- Analyst
Good morning, guys.
Are you there?
- Director of IR
Yes, we're here.
- Analyst
Okay, great.
Maybe you could touch briefly on -- I'm seeing some headlines on the used market in Europe actually over the last couple of months.
Are you seeing any headwinds there that are of the same magnitude you're seeing in the United States or is it a little bit more in line over there than we're seeing elsewhere?
- Director of IR
When you think about used equipment, I'll split it a little bit.
In the UK, certainly we're seeing some increased levels of used equipment and that's really coming from the -- again, it's FX driven, so the euro has been impacted more than the British pound.
And a lot of the used equipment from the UK goes to Europe and into euro-based countries.
And so obviously, now with that shift in FX, it is creating more challenge for the export of that used equipment out of the UK.
Outside of that, used equipment is not a significant issue in Europe, but it is one that we're working through in the UK.
- Analyst
Super, thanks.
- Director of IR
Thank you.
Next caller?
Carlos?
Operator
The next question will be coming from David Raso from Evercore.
- Analyst
Hi; thank you very much.
- Director of IR
Sorry about that, David.
- Analyst
No worries.
First a clarification on the answer on the order book.
Tony, did you say the order book currently is down year-over-year at the same rate as you're guiding the market or is that a generic consistent with how you're guiding the market?
- Director of IR
Yes, the order book, our outlook is consistent with what we're seeing in our order books.
- Analyst
So is it fair to say the orders are currently below that, but as the year goes on the comps get easier?
Is that how we're --
- Director of IR
Well, keep in mind with most of our large ag equipment, remember we're looking at the full year in that anticipation.
And, again, most of those, again, with the early order programs in particular, you're looking at full-year production.
- Analyst
And in that forecast, is there any period in the year where sales get back to flat?
I'm just trying to understand how you're laying this out, just so we understand the improvement in the second half year-over-year at a minimum.
- Director of IR
Well, again, we would have to get into the detail of product by product in terms of how that lays out in terms of the order books, but, again, to your point, you get a little bit easier comps as you go through the back half of the year.
- Analyst
My real question is the targeted dealer inventory changes for the year.
Can you give us some bogey how you're thinking about dealer inventory changes, new and used, for the full year?
And I guess it's more of a North American question.
- Director of IR
As you think about the inventory, again that's going to be almost all new inventory that you're seeing in our numbers, because the used inventory, even if it's financed within John Deere financial, that wouldn't get picked up.
- Analyst
I understand.
Just as you view the business, the whole channel obviously all feeds together.
- Director of IR
But the question is around receivables and inventory, certainly when -- the guidance we're providing on receivables and inventory is to the extent it's dealer receivables, that would be new inventory at our dealers.
- Analyst
I understand.
- Director of IR
And, of course, you have -- in addition to that, you have work going on that wouldn't be reflected in that number with lower used inventories as well.
- Analyst
And what is that target, though, was my question?
- Director of IR
Yes, again, that's not a number we've provided in the past, so that's more detail than we're going to be able to provide at this point.
- Analyst
All right, thank you.
I appreciate it.
- Director of IR
Thank you.
Next caller?
Operator
Our next question will be coming from Eli Lustgarten from Longbow Research.
- Analyst
Good morning, everyone.
Happy holidays.
- Director of IR
Hi, Eli.
- Analyst
Can we talk a little bit about your 2% pricing assumption for the year and how it's up -- talk between the two product lines and regionally and how it breaks down, particularly when you had trouble getting 1% in the past year and the market is weaker.
So just curious -- and, obviously, cost is still down, raw material costs.
So can we talk a little bit of what's behind the 2% assumption and the probability you think it will stick?
- Director of IR
Keep in mind that 2% -- and we don't provide the guidance by line of business or by geography.
But I would tell you that both divisions are contributing to that two points.
And, again, it's not net of price realization.
That's -- when we talk about price realization -- or not net of costs.
That's looking at year-over-year our pricing and not factoring in what's going on with raw materials.
What I will also point out is, similar to last year, the one point that we recognized in 2015 -- remember these are rounded numbers, rounded down to the 1%, so we were a little over 1%.
And the flip side of that is the 2016 initial outlook is rounding up.
And so we're slightly below that 2% price realization.
So outside of that, there's really not much more I can speak to in that.
So we'll move on to the next caller.
Thanks, Eli.
- Analyst
Thank you.
Operator
Thank you.
Our next question will be coming from Steven Fisher from UBS.
- Analyst
Thanks, good morning.
Really just want to come back to the question on inventory in the channel and just really to make sure I understand what your messaging is around there because it sounds like you said you're going to be producing pretty close to retail, maybe a little bit below on the large ag.
But you said you're also taking inventory out.
So just trying to really understand what your message is around where you think inventories, new and used, are in the channel relative to what they should be, given the environment that we're in.
Have we gotten through everything we need to get through and now you feel comfortable with where things are?
- Director of IR
So as you think about -- and let me talk about large ag specifically, because I think that's where most of the questions are targeted at is what's going on with large ag inventory.
As you think about 2016, there will still be some reduction of large ag field inventory, so dealer receivables in 2016.
That's in line with and reflective of the lower end markets that we're seeing as we move from 2015 to 2016.
So what we did in 2015 was right-size that inventory based on what we saw in the end markets in 2015.
So there's some additional reduction again in 2016, but when you look at the year-over-year reductions, it's much less -- again, for large ag, it's much less than what we would have seen in 2015.
So what I was saying earlier is as you think object our shipments to retail, we undershipped retail last year.
We will undership a bit this year, but that level of undershipping is much less in 2016 versus 2015.
- Analyst
And on the small equipment side?
- Director of IR
Small equipment will be just the opposite.
We overshipped last year, so we build some inventory again as planned relative both to the strength of the market as well as our strategy around some market share gains and so on.
And in 2016 you'll see some further -- you'll see some reduction off of those levels as we go through 2016 and get those shifted around a bit.
So that's distorting -- when you look at the reported numbers, distorting a bit of I think what most are focusing on in terms of what's going on with large ag.
Let's go ahead and move on to the next caller.
Thank you.
Operator
Thank you.
The next question will be coming from the line of Mr. Jerry Revich from Goldman Sachs.
- Analyst
Good morning and happy Thanksgiving, everyone.
- Director of IR
Happy Thanksgiving.
- Analyst
Tony, can you talk about your pool funds program?
Where did the pool funds directionally stand at year-end 2015 versus the past couple of years?
And based on what you're hearing from dealers, the direction you expect them to apply the pool funds going forward compared to what we've seen over the past year?
Any shift in mix between pushing used equipment sales versus conquest customers?
Any color you could share would be helpful.
- Director of IR
Yes, so if you think about pool funds, actually they remain at pretty high levels.
And actually we tell you we ended the year with pool funds at the highest level in two years.
So they are still very strong.
And the real question, I think, gets to dealer by dealer.
So that's when you think about it in aggregate.
And certainly, there's some dealers that have very high used inventory and have lower levels of pool funds.
So on a dealer-by-dealer basis, which is how we tend to manage it internally, we would have a few challenges here and there for sure.
In terms of how they are using it, again, I think that's consistent with what we're looking at.
It's pool funds are there to move used equipment and help incent that used equipment.
We'll continue to do that as we move through 2016.
It's one of the levers that our dealers have available to them to get -- again, especially on those large row crop tractors, get that used inventory down.
All right.
With that, let's go ahead and move to the next call.
Thanks, Jerry.
Operator
Thank you.
The next question will be coming from Vieshal Shah from Deutsche Bank.
- Analyst
Hi, this is Chad Dillard on for Vieshal.
- Director of IR
Hi, Chad.
- Analyst
Can you just talk about how much of your agriculture order books is covered for 2016 and how that compares versus this time last year in 2015?
And also in your currency in your guidance, is that spot or is that actually a forecast?
- Director of IR
So if you think about, again, our order books, what I would tell you is we don't disclose what percent is covered.
But, again, it would be comparable year-over-year.
That's really how we set the outlook is based on what kind of coverage we would have, so it would be comparable year-over-year.
And with the -- we don't forecast FX.
What we would use is the average FX in the month prior to the guidance, so it would be -- and, in fact, for original budget, we would have used the -- I'm trying to think of which.
Was it September?
- CFO
September.
- Director of IR
We would have used the average September rate is what's implied in our forecast.
Okay.
Next caller?
Operator
Thank you.
The next question will be coming from Seth Weber from RBC Capital Markets.
- Director of IR
Hi, Seth.
- Analyst
Hello?
- Director of IR
Are you there?
All right.
- Analyst
Hi, sorry.
Good morning.
I wanted to ask about the construction business.
Kind of the way we're coming out of the blocks here off the fourth quarter and relative to your full-year guide of only down 5%, are you assuming that the construction business turns positive in the back half of the year and what would be driving that confidence, I guess?
- Director of IR
Well, I think the bigger issue is certainly as you look at year-over-year sales, it certainly improves as we go through the year simply because the comp gets easier.
And so you'll see greater weakness year-over-year in the first half versus what you would see in the back half.
But again, it's more about the easier comp than it is about a strong return to the market at this point.
- Analyst
Right.
But is it -- but that's the trajectory you're thinking of is that the second half comps are actually positive for construction and forestry?
- Director of IR
The second half is up, correct.
- Analyst
Is up.
Okay.
Thank you very much.
- Director of IR
Which again -- thank you.
I think this will be our last question we'll be able to get in.
Operator
Thank you.
The last question will be coming from Mig Dobre from Robert W. Baird & Company.
- Analyst
All right.
Thank you for squeezing me in, guys.
Good morning.
And I think I'll ask you a question about the 50% of earnings that nobody asked anything about.
On financial services, what I'm struggling with a little bit is understanding how you view your overall finance receivables as you look at 2016?
Because I would imagine some of them are going to start rolling off.
And then, not related but still, why did you guys feel like it was appropriate to make a change to your pension accounting at this point?
- Director of IR
So again, which question would you like me to answer?
- Analyst
Well, I would like you to answer both if possible, but the first one is probably more important to me.
- Director of IR
You know, financial services, as you know, when Susan went through her year-over-year changes, she didn't mention portfolio balance and it's because there's really very little change in the average portfolio balance.
It's down very slightly year-over-year.
And again, that's more of a reflection of -- as we talked about last year, 2015, it was actually higher year-over-year.
And while you have fewer notes coming in because of the trade cycle slowing down, you also have fewer notes paying off early.
And so the notes are extending, and so it does help sustain that portfolio balance further into the cycle.
And so that's one of the -- again, one of the benefits we talk about with financial services.
And if you think about pension and OPEB, I think what I'd say is, candidly, it's a more accurate calculation, as you look at the method that we have chosen to change to.
And so that's the reason why we decided to make that change.
- CFO
And then was proposed by our actuarial company, so --
- Director of IR
All right.
- Analyst
Thanks.
- Director of IR
Okay.
With that, we'll go ahead and conclude the call.
I apologize to those of you who we weren't able to get on the call today, but we will be around the remainder of the day to take additional callbacks.
Thank you.
Operator
Thank you.
That concludes today's conference call.
Thank you all for participating.
You may now disconnect.