Cummins Inc. (CMI) Earnings Call Transcript & Summary

Yes. I think part of it goes back to last year, we're sitting here, and it was Mark on stage and I posed the question to Mark saying, "If the truck cycle comes in, name your date range." And Mark interjects back saying, "When the truck cycle comes?" So it just shows that they are very prepared as to what was coming to them in the industry really. So maybe let's dive into trucks in North America. So your truck estimates that you gave on earnings for the North American market, I would say they're a bit more conservative than some of your peers. So when you look at the business, how far in advance do you have the visibility on future builds and order schedules? And how has that shifted over time and -- based on the market and the different types of classifications?

We can't take huge confidence from that visibility. I mean, we're working on very short lead times to our OEM customers. And that's one of the advantages we bring. I think we've got the most flexible kind of supply base and delivery schedule in the industry. And that's one of the things customers -- our customers value. But our customers are free to change their build rates whenever they see fit. We move in line with their needs. But I think the most disciplined customers want to manage, whether they're on the way up or on their way down through the cycle, not making knee-jerk reactions. So we start off with cutting over time, weekends or extended holiday periods and then we get into the lower build rates. So I think there is consensus that we're in for a lower production year. I think that's fairly obvious. We've consumed 2/3 of the industry backlog over the last 12 to 18 months. It's too early to say what the new order trajectory is going to be for this year. But when you sit and look at freight activity in the U.S., we used truck prices. We go through these periods. And therefore, there's just not a lot of evidence to support a quick rebound in truck orders. You're right. We have a more conservative guide. It's not because we've got some brilliant insight. Firstly, it makes my job a little bit easier to push down on the expenses and kind of get everybody aligned in the same fashion. But we don't -- it'd be wrong to say we have -- we definitely do not have better insight than our customers. We just think it's more prudent for our business to plan for a little bit deeper. And then again, we're flexible. We'll be able to meet demand on the way back up. The key is getting the cost structure in the company aligned. But yes, there aren't many positive signals right now.

Yes. So to another market where there's been some -- certainly some fluctuations in the latest variable entry to equation would be coronavirus, and that's in China. So I wanted to ask a bit about, in China, I believe your sales expectations you're down, call it, a mid- to high single-digit number. Mining engine is down below 20%; excavators, down 25%. So getting back to that confidence and visibility, what level of confidence do you have in each of these, I guess, more so off-highway forecast? And then how, if any, has the coronavirus had any impact on your broader portfolio into 2020?

Yes. And the most -- the biggest contributor -- I can't say the most important or I'll upset a lot of people that are now coming there. The biggest part of our business is tied to on-highway. And I would say prior to the onset of the coronavirus and the spread, we probably would have started cautiously optimistic that China truck was demand, finished the year stronger than we anticipated in the fourth quarter. Again, it wasn't rip-roaring, which is not as negative as anticipated and sentiment was pretty good going into the start of the year. But I think, kind of all bets are off right now with regards to confidence in the outlook. So we're facing, as with many other companies, a couple of different types of challenges. #1, we're anywhere between 1 and 3 weeks delayed in the start-up of manufacturing in all of our facilities in China. We do have multiple operations in Hubei province and in Wuhan. So yes, our employees sadly have been impacted by the restrictive environment there, which is necessary to control the virus. But yes, we're talking about 1 to 3 weeks delay. We didn't factor any of that into our guidance because we just simply didn't know. And we still can't say with certainty. Just to give a kind of size and scale of the -- of our business in China, we're in the $2.25 billion to $2.5 billion of consolidated revenues in China. So you're talking $40 million to $50 million a week. And then on top of that, we have a number of joint ventures. As you know, Adam, which contribute about $200 million a year of after-tax earnings. That's our share. So it's an important part of the business. We're 1 to 3 weeks delayed. The bigger questions beyond the delays, assuming those start-up dates are all reinforced by the government, the permissions granted is, how do our customers start up? So Dongfeng, which is one of our -- is our longest-standing and one of our largest customers in China. They also have big truck operations in Hubei province. So they're also going to be impacted. And then the supply base, like many global customers, we're all examining the next layers of our supply base to say who exactly is buying what from China and what may be at risk. To date, we haven't had significant delivery issues outside of China related to sourcing plants, but the longer the delays go on, that risk does increase. And again, I'm just trying to give people fact. I'm not trying to overweight the risk or underweight it. I'm just trying to give people facts to kind of understand the scope. So we are ramping up. As like any start-up, we're starting up after the Lunar New Year holiday, so you don't start-up at 100%. But so far, we've been ramping up. Key is, can our suppliers move up? And then can we get free movement of goods because there'll be bottlenecks in freight and air freight and other things as we go along. Then the bigger question beyond the start-up is what's going to happen to the overall economy in China? The sounds coming out of the government are they're going to want to have a robust return to normal economic environment, in which case, we could have a lot of catch up late in Q1 and into Q2. But it's fair to say when you basically shut down half of the world's second largest economy and restrict the movement, there are going to be some challenges and unexpected events as we go along. So I'm not abandoning the guidance. I'm not sati with new guidance. I'm just acknowledging the facts that are out there at the moment, at least given me a framework to understand kind of how that plays into our numbers right now.

That's very helpful. So if I think about some of what you just said, and there's clearly, there's -- it's not just managing your own manufacturing base, but then also, it depends -- a bit of it's dependent on what your customers do. If you take that back to yourselves for managing cost, is -- are there abilities to recalibrate your utilization levels in the -- in your own factories based on the timing of when your customers are coming back up? Or if you're not quite there yet?

It's really hard because we're also, not just Cummins, but everybody else is dealing with the fact that you've got -- you've had the -- one of the largest mass migrations of people on the planet, with people in China moving -- returning to their home region. Many millions of people return to their home region to celebrate the Lunar New Year. So just getting people back then, in some cases, have been re-quarantined in the city they're returning to just means that you're just not getting all of your people back to -- through no fault of their own. So there will be inefficiencies and cost issues. I will say, though, that in our manufacturing business, material costs is, by far, the largest part. And not to say that labor cost and productivity are unimportant, but we're certainly continuing to pay people and looking forward and returning to work, and we'll manage through. But surely, there will be some unexpected cost somewhere in the system.

Got it. So switching gears a little bit. So in terms of some or one of your customers because it's certainly public between the ongoing discussion between Navistar and TRATON. Just curious as far as your perspective. I know it's been the view of the company that there could be some opportunities if there were to be some consolidation amongst your customer base. Maybe if you could talk a little bit or flush a little bit of that out as to what those opportunities are? And then, well, we can go from there.

Yes. Right. So just to level set everybody. For the 10 years I've been talking to investors and then probably the prior, 90 years, last year was our 100th year, the biggest concern for Cummins is that we operate in this unique space where a lot of the products, certainly in the engine business that we make, we supply to customers who will also make their own engines of some variety somewhere in the world. And therefore, there's this fear that we could simply be displaced by our customers investing in their own engines. And that, of course, is a credible risk to our business. We've been able to navigate that successfully for quite a long time, but it's an understandable concern of investors. But I think what's changing, now our CEO, Tom Linebarger, talked a bit -- about this a little bit at our Analyst Day here just last November that our customers, our global customers are facing growing investment needs, as is Cummins, as we adopt or look to some of our markets, look to adopt new technologies. And so the investment needs are growing just as we're entering into a cyclical slowdown in a number of global markets and many of those OEMs at least having to evaluate where do they want to put their next incremental dollar of capital. Is it in a new diesel engine platform for a new market where they don't have scale and market presence? Or is it expansion of existing substantial diesel engine platforms? Or does it need to go into electrification, with vehicles, powertrains, infrastructure? So there's no doubt that many of our OE customers are facing significantly increased R&E bills, and so they're having to evaluate where do they want to invest. And so Tom talked about the fact that there's more discussions going on between Cummins and major OEM customers about future engine production than there has been in the past. And so we haven't landed anything that we're able to talk about publicly. But that is a sign that the pressures are changing on the OEMs and just simply laying down more capital when there are some uncertainties about what is the size of the diesel engine population? What's the rate of change in that in certain markets over the next 20 years? 30 years? Is it worth the incremental investment? And so that's one advantage we have with a global-scale leader, particularly in medium-duty truck. We're also very competitive in heavy-duty truck. When you look at medium-duty truck for commercial vehicle applications, we're many times the next biggest participant. We've got a global footprint. We are kind of the Switzerland in our industry, maybe not Switzerland based on what I was reading last night, but we are the neutral. And so is there a role for us to play in helping support with our leading products, more of OEMs' needs in diesel markets, whilst continuing to develop the new technology. So I think that's -- investors are always wondering what's the latest signal? Is that a positive or a negative? VWs interest at TRATON -- sorry, TRATON's interest in Navistar is not new. We didn't take that as a new piece of information, and we'll be working hard to make sure we've got something relevant for all of our customers.

Got it. And you mentioned a bit about the increasing R&E, R&D cost for your customers. And certainly, that positions Cummins in a good spot where you can assist in that. So when we talk a little bit about some of this newer technology, electrification, alternative propulsion, certainly, it seems like Cummins has preferred a strategy in which you're dabbling into multiple different technology basis. So I guess, maybe if you could talk a little bit about how you guys are planning on the long-term shift in this sort of adoption that you're anticipating on these various technologies or electrification to keep it easy. And then I guess, the follow-up to that would be how -- given that you guys are in a bunch of different spots, how do you evaluate the trade-off between being a lot more wrong at a lower price because only some of them are going to work and some of them may not, to being right at what could be a high price if you need to buy up for scale later on?

So our general approach is always to try and find the right technology for the right market and application. So usually, yes, we always want to get scale there. We've invested in something. But if it's not going to be right for the market, then we will try and find that right technology. So our -- I'm just careful. My voice is drying up a little bit. So our view is there's not just one technology that's going to succeed even in a changing technology environment. There are still significant limitations to battery technology so far, long haul, line haul, heavy-duty full-load applications. There are other high-energy density applications where, in our view today as it was a couple of years ago, the -- all battery doesn't appear to be the most likely solution. So we're investing -- as you said, investing in a range of technologies. And again, we can accelerate or decelerate those over time. At least it appears to us the reality in our markets is there's very low levels of adoption. There's lots of people trying. There's some incentive money out here, but there are a number of important pacing factors that make the outcomes a little unclear. Infrastructure availability has just put one of those. At the end of the day, there's got to be an economic payback. And most of the markets that I'm aware of around the world, the profit per mile by -- earned by truckers is pretty modest. So they have to have economic solutions in the long run. So we continue with this path of investing in multiple options just as we invest in diesel and natural gas. It is putting some pressure on our engineering spend. Let's be honest about that. So even though we've cut costs across the company in the face of this global slowdown, we've targeted to keep engineering flat this year, which means it will go up as a percent of sales and likely it will -- that will at least keep pace with revenues going forward, but if we can sweep up more diesel in the meantime and continue to demonstrate very competitive technology in the new technologies over time, that's what's going to put us in the best position. Because even when we're facing potentially new competitors, there are many things involved in selling and supporting a powertrain. You've got to have distribution and service support. That's a big advantage Cummins has through its -- through our own distribution network. We've got a global footprint that just can't be quickly replicated and all of that field support for a new technology. So yes, we're in a good position. But yes, there are some -- clearly some uncertainties. And if we thought we have to spend quite a bit more money on something we were very clear on, if that's in the best interest of the future of the company, then I'm sure we would make that right call. But right now, we think we're on the right pace of investment for what we anticipate and know today.

And just maybe talking a bit about investment in M&A. It always is a topic conversation, given your balance sheet is in a pretty healthy spot. Thinking a bit more about like the off-highway side or even power systems, do those businesses have the size and scale that they need to succeed, you think, in what's been a pretty tough market, by and large, over a while?

Yes. So a couple of things. I'll answer your specific second part. But just like the investors see here today, we've been wondering about the longer-term growth rate of the company. Prior to 2015, we've been growing at about 7% to 8%. And whilst we still have some tailwinds from emissions regulations and other things, we could foresee that growth rate moderating a little bit. And that's why we'd start to talk about potential for inorganic opportunities. Since then, we've had enormous kind of global tailwinds up until last year, where the growth and earnings trajectory really hasn't been the big issue, but it's more about that kind of future growth rate. So we have been looking, but we haven't found the right combination of opportunity, value and good fit with our business to this point. And again, we're not compensated on the company being bigger. We're compensated on returns. So we've only got all the financial incentives to make the company stronger over time. If we can enhance the portfolio and increase the earnings trajectory, that's great. Going specifically the off-highway, I mean, we are in the top 3 in most of those segments that we operate in. The challenge has just been the lack of growth. Yes, mining will continue to grow over time for the foreseeable future. We just come off a fairly robust recovery, and it's easing down. Oil and gas, the part we participate in is we're in the #2 position in a segment that we operate in. It's a good business when there's demand there. It's just inherently volatile. And in power generation, again, we are one of the leaders. It's just been a relatively slow growth. So when we've had volume, we've demonstrated good earnings potential. In the meantime, I'll just say a couple of things. One, it wouldn't be more about scale in what we're doing, but could we get access to other parts of the market where we don't participate today? And that could be possible. But today, at least, the business is generating cash, it's not consuming a lot of capital. So yes, I wouldn't rule out any interest there, but again, nothing has come along with that combination. In the meantime, we're kind of going to manage through this slowdown.

Great. Well, that's very helpful. I'm a bit on overtime anyway here. So I think we'll wrap it up. Thank you, Mark. Thank you, James. And I really appreciate you guys coming out once again.

All right. Thanks, everybody.

Thanks, everyone.