Cummins Inc. (CMI) Earnings Call Transcript & Summary

[Audio Gap] directly to my right, the relatively recently appointed or newly appointed CFO; and then to his right, James Hopkins from the IR Efforts. So Mark, thank you again for coming. Good morning. I'm sure we got a lot of ground to cover here. So I maybe -- maybe I'll turn it over to you, just if you want to give kind of an opening -- some remarks just in terms of what you're seeing, the expectations for this year, and then we'll kind of go from there.

Great. Thanks, Tim, and good morning, everybody. And I'll try and keep it brief, so I don't repeat a lot of information that people already know, but it's probably just worth level setting. We came off the back of a really -- well, a record first half of the year in 2019 and then started to see broad-based slowdown in a lot of industrial markets in the second half of 2020. We still managed to generate record financial metrics on most metrics for the full year 2019, but with a sharp decline in truck production in North America, weakening resource markets and tough conditions in India, general slowing in most international markets. We took actions really to cut cost to prepare us for a downturn. At Cummins, looking back at the last 3 or 4 downturns, usually, when we have a broad-based slowdown like we've seen today, our revenues are down to -- by 4 -- 4 -- about 4 to 6 quarters in aggregate for the company. So when we see that coming, we take the opportunity to really reset our cost base, both to help mitigate the impact of the lower revenues and hopefully set us up on a leaner basis for when markets return. So we took a restructuring charge in the fourth quarter. We exited some unprofitable lines of business to kind of hopefully give us a reasonable base to operate and what looks like revenues being down about 10% for the total company for the year. Really, the only segments that are really booming, I would say, right now, pickup truck in North America continues to be very strong. Our overall aftermarket business is pretty stable. And other than that, we're seeing different levels of weakness in most end markets around the world. It would be hard for India to get much weaker than it is today. So hopefully, we're going to turn a corner there. We've got the new uncertainty around China that I'm sure we're going to get the chance to talk about. But otherwise, it's kind of -- get the cost base set right, continue to generate strong cash flows, return cash to shareholders and kind of work our way through the next few months. The comps are going to be much tougher in the first half of the year, hopefully ease in the second half of the year and then look towards, hopefully, revenue growth in 2021.

Got it. So the obvious area of focus being China, just given the -- your exposure there, maybe talk about recognizing it's highly fluid situation. But just kind of the lay of the land in terms of Cummins, the direct impact, and then what -- one of the -- not a peer, but another supplier recently had called out that the risk of supply chain impacts in markets like North America and Europe that rely on parts from China. And I don't think that's a big export market for you, but maybe you can just highlight, again, both direct as well as potential indirect impact.

Good. So happy to kind of size our business in China, just to kind of get everybody level set. So we have revenues of about $40 million to $50 million a week, consolidated revenues, in China on average. And then on top of that, we've got about $200 million of after-tax earnings from our joint ventures, which are unconsolidated in China. So that gives everybody a sense of the size. It's obviously an important market for us. I think most of the countries under some kind of disruption or just -- having planning challenges right now. But for us, yes, we definitely -- we have 9 facilities in the Hubei province. One of our largest customers, their headquarters is in Hubei province. So we are being impacted. Our operations are between 1 and 3 weeks delayed in starting up production following the Lunar New Year. So the first thing is getting our operations up and running. Situation is compounded by the fact that, during the Lunar New Year, a lot of people travel away from where they work to their hometown or home region to visit family and then have had to try and make their way back through all the different restrictions on travel. And so it's not been the most smoothest ramp-up so far of the operations that we've seen. Some of our customers haven't yet started up. So we're going to -- February is going to be tough. The question really is what's going to be the -- in China, the question is going to be what is the pace of kind of the reflation of the economy. And is this a temporary situation where demand recovers over time or is there a broader impact? And at least the signals we're getting in China is the government is very interested in the economy returning to its natural growth pattern as soon as practically possible. That's what's going on in China. But you're right, 90% of what we set -- sell in China, we make in China. The rest we import from other markets around the world. So what our performance in-country is going to be confined mostly to how we start-up in China. And then you're right, Tim, this -- these are the times when you find out where your suppliers saw some of their inputs, right? So there are -- everybody is living on inventory to a certain extent, which is really only a couple of weeks in our business. And a lot of work going on to see where can we reposition inventory, where can we move parts or supply from other areas to supplement what we need elsewhere. I mean, today, we haven't had any major shortages, but I think the longer it goes on, then our customers from their own supply chain, those will have some -- there will be some exposure. Probably, there will be some expediting costs and other things associated with ramping up. So I can't give a quantification of this risk right now. I'm just trying to be honest about what our exposure is and what we see. And we'll have a better sense probably when we report first quarter earnings, not just about what the impact was in Q1, but what's our best view of how things are moving forward. So I'm not here to change guidance or anything like. I'm just trying to honestly share what's been emerging set of developments over the last few weeks.

And it's -- and again, it's revenue, not from a cost impact. But -- I mean the revenue guide was almost $1 billion wide. So to start the year, is it safe to say there was some -- there was a bit of conservatism -- not conservatism, but kind of a little bit of flexibility built into the top line?

Yes. I mean it’s just one important market, of course. Most of our revenue comes from North America. So -- I mean all markets are important. But yes, this is too early to say. We need to -- certainly, it wasn't a factor in February. So -- in January, right. It's really been February where really the limitations on people, movement, et cetera, have escalated. So things were running as normal in January. I might even -- at the risk -- rare risk of me sounding optimistic at that time made a bet on a better start in China, absent the coronavirus. Q4 finished stronger in terms of truck demand than we'd anticipated, which is one of the reasons why our revenues were better than we -- they were tough, but they were better than anticipated in the fourth quarter. So it's -- yes, it's really tough for the people. Hopefully, we're on an improvement trend from here, but it's going to be a little bit bumpy. Again, it's tough, but it's not going to be a financial crisis for Cummins, but it's going to create some challenges. Probably our supply -- I know our supply chain people are working around the clock, monitoring thousands of file numbers right now.

Yes. Got it. Maybe we can -- and by the way, as we go along, we'll keep this interactive. So if anyone has any questions, just let me know and I'll get to you. But maybe switch to the North American truck cycle. In terms of, again, your visibility is obviously somewhat limited, but just update us in terms of your expectations for how the year from a build perspective, I would assume, second quarter is the toughest from a year-over-year comp. But just in terms of what you've seen from -- in terms of build schedules and updates from the OEMs.

Yes. So they're kind of gliding down is the way I describe it. And again, everybody has got a different view on the market. We don't have a special magic insight. The things that make us cautious are: One, obviously, the backlog of orders yet to be produced shrunk as build rates have stayed relatively high compared to weak orders, used truck prices aren't great right now. And then an internal indicator that I look at is the trajectory on our parts revenues because what we have -- what we see when there's overcapacity is that trucks get parked, there's deferral of truck renewal at some point as those older trucks get put back into use as we move up the cycle. The first thing we see is an acceleration in parts consumption before we get back on to the more robust truck order cycle. So right now, parts are flat. So that tells -- which is not surprising. I think looking at other industry data, it's not just for us, that tells me you're not -- we're not yet at the -- even if truck orders have bottomed or moved even off the bottom a little bit, I think we're not into that phase where we're going to start to call out reacceleration in orders yet with confidence. So best to plan, but tough, you're right. I think, unless we see a spike in orders, then there's a reasonable probability build rates continue to go down from Q1 levels and then we'll need to see a reacceleration in the fourth quarter in orders to give us some confidence into 2021. So best to plan cautiously, that's our view. And hope for better conditions as they come along.

In terms of the indicators, used prices seem to be getting a bit more discussion here of late. One of your larger end customers from the lease and rental sector was here yesterday. I'm just talking about how -- and they're a little bit more exposed to the older vintage vehicles, just given where they sit in a trade cycle, but just from your conversations with fleets, maybe just -- what are you hearing there in terms of, obviously, prices are down, but I think there's a big spread in terms of where you sit in that -- in where you're trading trucks if it's 2 to 3 years -- 3-year old trucks or 7-, 8-year-old trucks. There's quite a bit big spread just given the technology differences.

Yes. I haven't talked directly to the fleets, but at least the last check-in I had with Tony, our COO, was, they would like to see a clearing of used truck inventory as a barrier to -- it's a barrier to reacceleration at this point in time. So...

Okay. And then in -- on market share, I mean it is typical as global engine capacity frees up in a softer market, typically, your market share will come under some pressure. You'd have a little bit of an offset. I believe that the 12-liter is now, at least with one of the big OEMs, has been added. So just talk about the expectation in terms of share from a both heavy and medium-duty standpoint in North America.

Yes, I think that flexing plays out a little bit more in heavy-duty than medium-duty, Tim. So yes, some of our customers will protect their own engine production, own transmission production, manage their own fixed costs as they readjust to production schedules. And we typically see a dip in our share when we start down this kind of readjustment path, and we saw that in the second half of last year. Eventually, the market wins out and demand for 15-liter product remains very robust amongst our customer base. So I think we'll be fine. We guided around about 32% market share in heavy. Yes, you're right, the 12-liter will kick in this year, probably add 1 to 2 points of share or something like that this year.

And that's largely targeted at the vocational segment?

It has been, but now we've got over-the-road availability as well with one OEM. So now that is an engine that does have some parts that come from China. Its origins are in China. But right, -- obviously, we'll be watching that closely.

Yes. Got it. I want to come -- circle back to a comment you made earlier in terms of resetting the cost base, and you've been with Cummins what almost 25, 26 years. Just talk about the response time in terms of -- it seems to me -- I mean James and I were traveling with Rich Freeland in the middle of '18, I think it was. And he was just talking then about, hey, when these markets get above replacement, I start to get nervous. So maybe just talk about how the company is? How you're positioned today versus maybe prior cycles? And just again, in terms of that response time and the ability to go after cost maybe sooner than...

Yes, I think what we've done -- we had a reasonable -- I think most people had a reasonable view. There was a high probability that the U.S. truck cycle would weaken. Nobody could say exactly when, but it was due either at the back end of last year or this year. So we've been building that into our plans. It's one of our markets still, bigger single market. So we stopped net hiring about 15 months ago. So I think that was a change from the prior cycles. We managed well through the prior cycles but we tended to keep hiring right up until we could really see and feel the downturn, what we said this time. The consequences of that are, you're kind of hiring up until you lay enough people, which is not ideal from a morale perspective or kind of managing your cost base. We'd move quickly, but still a bit more disruptive. So this time, we move to not adding any people for about a year before the downturn really hit. We were adding in some areas like new technology engineers, shedding a little bit in some other areas, but basically doing a reasonable job of holding flat, even though our revenues were growing, our earnings were growing, and which made the adjustment a little less painful, still painful. And then we initiated a number of voluntary retirement actions in the second half of last year, which then had the impact of reducing the number of involuntary actions. So I think by and large, that was a little bit smoother than the last cycle. And we really started moving in the third quarter with some of our actions. So I would say, a little bit faster than before. What's maybe different, if you go back to the last few cycles, if you look at the distribution of the restructuring costs, which is a good indicator of where the cost is coming out. It'll be a bit less weighted to the engine business than in prior cycles. More weighted to distribution, corporate groups like my own group, administrative functions. We tried really to protect engineering. We tried to do that in the last downturn, but we pushed harder in some of those other areas this time where we think there's opportunity to kind of run a little bit lean, and not just the now but when we come back up the other side and really protect the engineering because as much as we've got new products coming in the new power business, we also have upgrades coming in the diesel and natural gas products in North America that play an important part in our role in appealing to OEMs that we remain their best answer for diesel -- source of diesel and natural gas engines as they wrestle with their own capital constraints in a heavy investment period for our industry. So that's what we've tried to do. Comps will obviously be toughest in the first half of the year, as I already said, but that's the kind of philosophy we've used.

Got it. And those restructuring benefits kick in circa, all in by the end of the second quarter then?

Yes. There will be some modest additional ones in distribution as we go along. There could be some smaller challenges in subsequent quarters. But yes, most of the actions were done by the end of January, ex-distribution. Distribution, only mostly done by the end of the first quarter. Some modest ones lately. Yes, Q2, you're going to -- we're going to start to feel the fuller impact of those. And again, there's always a lot of moving parts in any given month, but that's what you get overall.

I would switch to components. Before I do that, does anyone have any questions?

Can you spend a second on the road map, you think, Navistar will follow with the recent announcement of TRATON as it relates to -- they've been large customer of yours in North America.

Good question. I think that's -- I'll answer it from my, but I can't, obviously, determine exactly what customers are going to choose to do. But what I would say is, in general, we've got a very strong relationship with end-use customers in our end markets and on-highway, which we're creating a leverage and help our -- all of our OEM customers kind of benefit from, with 80% share in medium-duty truck and maybe 50% to 60% of the 15-liter market in North America. We are the engine of choice for many, many customers. And I think maybe what's been underestimated in some of the understandable [ bear ] cases that have been put against investing in Cummins, that the strength of those customer relationships has been underestimated. The resilience of those customer relationship is based on customer familiarity and confidence in our products. So our goal always is to try and be at the forefront of conversations with our OEM customers and providing them with the products that are going to make their truck sales most successful. So I can't speak to what other customers are going to do. I would just say, we're really well positioned. We're already in those markets. We're already serving all of those customers. And as a general theme, we know it's the case that with rising technology, all participants are facing rising engineering bills. We're also facing rising engineering bills as we introduce new technologies. And we are going to be clearly leading in North America and investing to stay ahead. So we'd like to think we're going to play a very important role in meeting all of those needs and take in -- we'd like to take the pressure off some of the investment needs of the OEMs as they wrestle with all these different technology conundrums and financial bills that they've got. So I think we're confident we've got the right product portfolio and we remain a leader for quite some time. But exactly what individual OEMs are going to do, that will be down to them.

Maybe just 2 quick follow-ups.

Yes.

If they adopted TRATON's own internal engine, I assume it would be the smaller liter engine for Class 8, not necessarily Class 4 through 7, which I think you're dominant in the larger engine. If you lost that component, what percentage of Navistar would just be that smaller liter engine? Or maybe it's just because they haven't had it, does that make sense?

Yes. I mean we -- in heavy duty, we're selling the 15-liter engine, right? We're introducing a 12 in certain applications with some customers. So I expect the demand for 15 liters as a share of the overall market hasn't really changed. So I think for any customer thinking about introducing an alternative, you've got to understand that, that's a preference or a significant color of the market. So I guess any calculus to bring new engines is going to have to incorporate determining residual values for new engines in the marketplace, which of course is important to the customer. First buyers of new vehicles because of residual plays an important part in the overall economics. So I think -- I don't want to be complacent. We're always pushing to provide the best for the OEMs. We'll see what things play out over time. But this is an important question.

And then a second subject to talk about technology road map, the prior percentage you discussed [indiscernible] what do you see some decisions will be in your [indiscernible].

Yes, our view is for the really long run and fuel cells could be a much more credible solution than fully electric, on heavy-duty long haul. I think we've had that opinion for quite some time. Others may have different opinions, but the biggest challenge is the size and weight of the batteries needed, the consumption of payload to carry the battery, and then you've got the whole challenge in a big geography like North America of the whole -- charging infrastructure. So yes, we're investing in fuel cells, could be -- and it depends where we are heavy-duty, medium-duty, light-duty. There are some segments of the market that could be electric diesel hybrid. So I think as in all cases, we're trying to assess different segments of the market and see what's going to be the best applicable solution overall. But yes, we have that low confidence in fully battery electric though.

And fuel cell, as you think, is over what time period before?

It's still an extended -- really still an extended time period. We think in North America for certain, but certain is a strong word, but high confidence that diesel -- maybe that some segments, natural gas could play a bridging role. But you're not talking in the next 5 years that's what [indiscernible].

Yes. Mark, there was a -- an axle provider that spoke yesterday and it competes and sells into the EV market. And one of the things they said was that they've actually seen an acceleration in RFQs from the truck OEMs and that -- basically, their backlog was bigger than they would have expected. So as the OEMs kind of rush to have a product to showcase and have in production, I'm curious, is that your experience as well in terms of the interest level and the demand from the OEMS? Obviously, you're competing a little different angle. But maybe just talk about the broader...