Cummins Inc. (CMI) Earnings Call Transcript & Summary

Okay. Good morning, everyone. My name is Andy Casey, I'm the analyst covering machinery and diversified industrials at Wells Fargo. Really want to welcome everybody to our fireside chat with Cummins. Joining us today are Mark Smith, Chief Financial Officer; and James Hopkins, Executive Director, Investor Relations. Again, welcome, everyone. Really appreciate your participation. Before we get started, for the investors with us today, your lines are on mute. If you have a question that you would like to be addressed, please send me an e-mail at [email protected], and I'll do my best to ask it. So with that, why don't we just jump right into it? Welcome, Mark and James. Thanks again for being here.

First, Mark, you guys touch a lot of different markets. Could you give a regional demand assessment? I'm trying to understand if China was a V-shaped improvement through mid-April and how you view the prospects for other regions, including North America? So have you seen activity improve sequentially from mid-April or the short-term demand recovery look more L-shaped in the non-China markets?

Okay. Good morning, everybody. I'll do my best, Andy. I'd say China is unique. I definitely would not want to try and extrapolate what's going on in China only because there's no data to support extrapolation. So hopefully, that's very clear to everybody. I'm not trying to overexcite people but as you've seen, maybe from some of the commentary from the passenger car participants, we've seen a very similar story in our business in that there's been a rapid rebound in truck demand, particularly heavy- and medium-duty trucks, which, of course, is our core market. And quite frankly, the pace of rebound has shocked us. So we've gone from, in weeks of February and March, hardly making any engines to making all-time record high numbers of engines for the heavy- and medium-duty truck market in April. So that's remarkable. The industry data, I'm not sure if it's fully released yet for all the segments, but we have access to data that says year-to-date heavy- and medium-duty truck market is flat year-over-year. So we've had a really strong rebound in industry-wide sales in April, and as I said, record production of engines for the heavy- and medium-duty segment in April. So that's -- we're not building to stock. We're building to OEM orders. The multimillion/billion-dollar question is what happens as we get through this recovery period and how long does this level of demand sustain? It's not uniform across all end markets, Andy. As you said, we touch various end markets. So we did see a rebound pretty much in most segments in April in China, but the year-to-date data on excavators and light-duty trucks, in particular, is not as good as heavy- and medium-duty truck. So yes, that's kind of the shining light. The question, I guess, remains how long does a battery stay on and how long does the light keeps shining that strongly in China? We don't have good visibility into what happens even in Q3 at this point in time. We're typically working on 2-week lead times. So that is the global anomaly at this point in time. I think for the rest of the world or most of the rest of the world, we're just trying to -- the industries are trying to -- I should add one thing, Andy. I think what's gone on in China has really demonstrated the flexibility of the Cummins supply chain. So going from close to 0 to all-time record in a matter of a few weeks demonstrates kind of the expertise of our people in really ramping up. And often, that's what our customers rely on. We have the most flexible supply chain in the industry, and so we've responded well. It's not always been pretty, but we've been able to keep up with this kind of record demand. Outside of China, we're kind of -- everybody's limping back to work, and so customers in various phases of opening up their operations. So I think there was -- maybe not everybody who follows our industry was entirely clear, the extent to which our customers and suppliers shut down in April. But we were talking 50%, 60%, 70% in some weeks of the customer locations that we shipped to were closed. So April is -- hopefully is an anomaly in history in terms of what happened in our industry, not just at Cummins. So what we're trying to deal with in terms of assessing the environment is -- going forward is, one, at what rate and pace are customers starting up. It appears to us as a general average statement, they're starting up at lower rates of production than they -- from which they descended in mid- to late-March. And then the question is how well can that global supply chain respond because it's faced a number of shocks in China, then we've had -- India is a big source of component supply for the world, India's shut down. So we're going through those gyrations. On top of that, as you know, we face a wave of, quite frankly, sad economic data that's not surprising when a massive chunk of the world's economy is being shut down. So truck orders, you're obviously very familiar with, Andy, in North America, general economic data is weak, but that's to be expected. I think we've got to wait for more data points to give us confidence about what happens from hereon in. Obviously, in the U.S., the rate of increase in unemployment and the knock-on effect's probably the biggest concern. And then we know that truck fleet age isn't -- is relatively young relative to prior years, has been a fairly strong buying cycle in U.S. construction. So we think a reasonable waiting period from customers before they get back on the accelerator even when the economic data starts to clear, we could be faced with an extended period of uncertainty about when demand starts to pick up again from the end users.

Okay.

Actually, one kind of secular theme that continues to be strong amongst all this remains data centers, whether that's in international markets, very heavy in international markets in Asia. And generally, customers are continuing there. But the pure commercial vehicle and industrial segment's pretty weak. Oil and gas is just -- there's no simple word that can describe what's going on, other than kind of down very heavy double digits on numbers that were already down, very heavy double digits. So the level of activity is the weakest in oil and gas for reasons, I think, we can all understand. Mining was already slowing as we kind of went into this, and the current environment hasn't helped a lot. So we're really waiting for the dust to settle, the economic data to settle. In the meantime, those customers who've got backlogs will build some proportion out of backlog until we get back on a clearer trajectory.

Okay. Thank you for that, Mark. So it sounds like in the short term, we should just look at it as an L. And on the call, kind of talked about planning for the worst, is that pretty much what you're planning for? And then now after the Q1 report, you'd padded your already good liquidity position with another $2 billion revolver. Is that precaution related to the L shape?

Yes. Just, as you say, we've got -- we could cover quite a long time with very limited revenues, indeed, probably a long period even with a lot lower revenues than we're about to experience. There's no sense in taking any risks here, Andy, given our strong credit rating, then we were able to get access to reasonably priced facilities. That just kind of boosted that liquidity. What I would say is the biggest signal to you about the lack of clarity, not to you, to all investors, is the fact that we made salary reductions across the board and even the Board volunteered compensation reductions here, in such a period of uncertainty. And so those actions are designed to reduce cost and preserve cash, not because we think we're going to exhaust our liquidity, just that it's a good thing to do to conserve cash in this environment. And quite frankly, allow the company more time to see really what does the demand trajectory look like as we come out of this and not make rash decisions about how we're going to continue to invest in the business going forward. We're fortunate in that we had anticipated in second half of last year, a cyclical slowdown in many of our end markets this year. We didn't anticipate obviously the current effect of the coronavirus, but we already had in place the restructuring plan, which you saw helped underpin pretty strong results given the 17% global decline in revenues in Q1. So that really helped us. It's -- and then combine that with our strong liquidity position, means we can afford to stay the course for now with our investments in technology and other things while we just take a little bit more time to assess the situation going forward. This is my 25th year at Cummins. Last time, we had a salary reduction temporary was in 2001. And even that wasn't across -- that was just in the engine business at the time. So it is unique. But when we weighed all the different options that the company could or should take, this was kind of the least worst option in terms of trying to manage all the interests and well-being of the stakeholders that we have for the company. And just as I say, highlight, even before the latest round of truck orders, et cetera, we anticipated that we would have even less conviction in the outlook in the short run. So those temporary reductions in salary we've said they're in place. They will run no longer than the end of the third quarter. But in the fourth quarter, salaries will be restored. And the question we have to determine ahead of then is, are we on a similar trajectory to the way we restructured the business at the start of the year? Is it stronger? Is it different? That's kind of we're in high surveillance mode, and preparation mode and scenario-running mode. But for liquidity, we're in really good shape. So hopefully, that gives a little bit of color. In designing and restructuring, we very much protected our engineering programs, our current products and future products. So you saw that in the Q1 results that even though we took a significant chunk out of our cost structure, the engineering spend year-over-year was -- let's say it's flat. So that's how our plans were designed. That's how we're operating today. And where we've got more color like I just did at the start on markets, we'd be happy to share that with investors, but the good news is we're in overall very healthy financial shape.

Terrific. And then just a couple of quick ones. First, outside of India, are all of your facilities back up and running in May or are some still closed? And then by producing, are they kind of on partial week single shifts or are we -- or are some of them even back to full weeks at this point?

Most are up and running. There are very few that are not operating at some level as we sit here this week. And some of the actions we've taken to even further improve safety and protect the workers in the short run will have an impact on capacity. We've changed line layouts and other things to enhance social distancing. And so it's not good news, but demand is probably going to start at a lower rate anyway. So it will give us a chance to kind of refine kind of new operating procedures. But yes, generally, it's -- we're coming up at a slower rate. And then obviously, there's high monitoring on the supply base because they've gone through significant gyrations. So yes, most up and running. All of our significant operations are up and running at this point in time.

Okay. And if we could key up the supply base comment that you made, I think your COO, Tony Satterthwaite, has made some comments about Mexico being a risk for the supply chain and then some of your truck OEMs produce units there that are shipped back into the U.S. What is going on in Mexico? And more broadly, outside of there, are you seeing a smooth restart or kind of more uneven as we go forward?

Yes. I haven't had an update on Mexico this week, Andy. So I need -- specifically, I need to check in. Just been working on some of the topics here. I think there was just a lack of clarity in our mind about which business is supposed to be closed down and which ones were opening up again. So that was causing -- that prompted some of Tony's comments to investors last week. But yes, because, as you know, even engines that we make here in Indiana [ push off ] sometimes in great quantities shipped to our customer truck operations in Mexico and then some of those trucks, of course, are pickup trucks or commercial vehicles end up back in the U.S. in quite significant numbers. So -- and it's just a critical source of supply base. But right now, I don't -- just because I didn't check, I should have done, I don't have the exact update on each of those facilities in Mexico, but I can follow up after the call and let you know.

Sure. And then from when we look at the industry demand, it's pretty weak. Could you gauge what the bigger bottleneck, the higher production really is? Is it the demand or is it the efforts to stabilize and restart the supply chain? And then for Cummins financial, is the margin really more a toggle of the volume levels or could it really be impacted by the uneven nature of what appears to be this recovery?

I think -- so I think several customers have gone into print saying they tried to keep going as long as possible, as long as the supply chain would allow them and of course, as long as their employees were safe. And some of the public comments have been that they ran out of supply. We've been a bit hand to mouth in certain areas. There's no question about that. But managed to keep up with pretty much all customer deliveries to that point. Some concerns about China since we have 1 or 2 engine platforms that have some content coming in from China, that started to alleviate then kind the situation with India. I think we're okay for now, Andy. I think the problem we run into is you need all the parts, as you know, to make the truck, whether the engine is there or the transmission or the tires or what have you. Only the OEMs know the full -- have a full visibility into that. So I think that may -- in addition to safety and caution and other things, that may be influencing these kind of slower start-up rates. If we get both the supply chain up and running and we get some more, what I call, real data beyond April, we'll be in a better position. And I would just say, April is just such an anomaly, even I've had to reluctantly accept that, with so much of the industry is shut down, the results aren't going to look good in the month of April. I'll see those here this week. But for our industry, that's just not going to be good. Again, that's not the future. We'll move beyond that. Again, we're really waiting on the data points. So what's happening with freight, we see a little bit is -- some changing patterns in parts usage amongst the truck fleets. So we're seeing more use of newer trucks, which are more fuel efficient. Older trucks seem to be going into lower usage mode, which we can track our on-highway parts by model year, et cetera, but seems to indicate rational behavior in the early stages of a slowdown that customers will prioritize utilization of the most efficient parts of their fleet. Usually, when we have the highest conviction internally on a rising truck cycle, is when the parts' consumption really starts to spike. People will run under capacity, they'll run the most efficient trucks, then they'll deploy more and more of the fleet, those repair costs will start to go up. We'll see it in very high levels of demand in parts. And then we kind of know we're on the upcycle maybe long before the orders have really rebounded. We're nowhere near that right now. Obviously, we're still on that down slope and adjustment phase. But that's one of the internal indicators, I guess, it's also an external indicator, that I look at, but you and your peers and investors can't necessarily see the same. So we're happy to share that when that's more exciting news, but it seems like everybody is in hunker down mode in different -- in low orders, prioritizing utilization of more efficient trucks, which is perfectly rational and reasonable and eventually will be followed by higher parts consumption and more truck purchases. How long, that's the question, yes.

Okay. And then if we could flip kind of quickly to short-term margin performance. As you said, Q1 was very good. And you've taken a few buckets of actions to reduce costs, first $250 million to $300 million annual reduction and then more recently, the temporary measures, $30 million per month, as you said, until September, if needed. Together, the actions, if I just boil it down to earnings per share, it's about an $0.80 cushion in the next 2 quarters to be reported. With these actions in place and assuming the China JV's contribution stays about constant with what you're seeing right now for the rest of 2020, is there a revenue level you could give us that your ballpark be breakeven or is it just dependent on the mix?

There's a little bit of mix, Andy, but once we -- don't pass out when I give you these numbers, but once we start getting below $3.5 billion a quarter, we're getting closer to that breakeven level. Yes, mix plays a part. The JV earnings boost the percents, as you know, relative to the dollars. But if we get into that kind of lower 3s per quarter, which sounds like a wild number, given that we were over $6 billion in Q2 last year, then yes, we could get down towards a more like a kind of breakeven number EBITDA. There are scenarios in which we could go negative on an EBIT perspective. So we've written all those. I'm predicting those. Yes, I think we have a pretty good handle on our cash costs, our liquidity. But yes, that gives you a kind of -- we're not embarrassed to kind of share that with investors. We understand the data well. I'm not saying that's where we'll be, but that is a reasonable kind of the range.

Okay. Great. And then...

Which would mean we were really operating more like a $14 billion or lower company relative to $23.5 billion last year, if you just kind of annualize that rate. So that would be an extraordinary level of decline over any reasonable period. But yes, we've done all that math. We've done all the preparation. And as Tom said, we're running all the scenarios, including the worst ones.

Okay. And then you mentioned April should be hopefully an anomaly. And if we get past that and uncertainty associated with restarting production, is the current cost structure supportive of, let's say, a 25% decremental margin in the second half or do you have any visibility on that?

I think with the temporary measures -- again, as you say, it very much depends on the revenue level, which is at the most uncertain certainly in the last decade and probably even more uncertain in the short run because of the rising unemployment, maybe even than periods of '08 or '09, not to say it's going to end worse, but the uncertainty is higher because of just all the shutdowns. So yes, I think we can't get kind of like obsessed with that. We're definitely -- those metrics won't work in April. But yes, we are mindful all the time in the downturns of trying to improve cycle-over-cycle performance. If we have extraordinary levels of revenue decline, that may come under pressure. But yes, that's always a benchmark we have in mind, but not on a month-to-month basis. I think the key for us when we get -- by the time we get to the fourth quarter, Andy, is really, what does it feel like the revenue range is going to be over the next 3 or 4 quarters, not just the fourth quarter, [ are the ] signs would improve in staying the same, hopefully not worse than April. That's really going to determine what we do from here because it's great that we had a restructuring plan. You can appreciate every time we do one of those, a lot of thought goes into both, yes, doing it in the most thoughtful way we can for the employees are affected and in the most thoughtful way in terms of the impact on the business because there are always consequences when you remove cost, not always bad. Sometimes you find ways to reorganize and come out better. But the more actions you have to do, then the more trade-offs you have to make. And if you can appreciate having done one restructuring, we already gave a lot of thought to that. So if we had to do more significant cost reduction, of course, we're already thinking about those scenarios, but you've just got to have the trade-offs. And therefore, just tie into 1 year or 0.5 year or full year decrementals, will have less weight than the kind of a future, probably, given that we've already taken a chunk of cost out. But certainly, if we were down in those really low levels of profitability, we wouldn't feel comfortable sitting there indefinitely, right? So that's the balancing act. But we -- if we need to take more costs out, we would do it if we determined we were in for an extended flat bottomed kind of [ scenario ]. So yes, we're working on all those, Andy, daily.

Okay. And with...

And again, I know all that doesn't sound very cheery Andy, it's just preparation. It's not prediction, it's preparations. I just want to be clear to investors. I know I tend to talk with a tone of caution most times because of the cyclicality of our business. But the preparation that we did last year has paid off, and we're continuing with that type of preparation. That's really the message I want to get across to people. And then whatever cost reduction we do, we put all our thought into making sure it doesn't inhibit the future and where possible can try and help.

Okay. And then with the couple of minutes we have left to summarize a big topic that's been a little bit of an overhang on your stock. It's really risk from vertical integration and some other stuff driving down your addressable market size. In the short term, it seems that the opposite is occurring. Q1, you outperformed the North American truck market due to share gains. Those can ebb and flow. But you have three catalysts this year that seem likely to drive some share gain. One is the X15 introduction, the engine; then midyear, the availability of the X12 on the Cascadia; and then later in the year, medium-duty engines to Mack. Assuming a full year impact, what kind of incremental market share opportunities do you think these represent? Is it something like 200 to 300 basis points?

I think what we saw in the second half of last year, we saw the typical reorganization I would see amongst the OEMs where they try and get their own fixed costs and production levels optimized and we tend to be -- flex around that. And typically, that means we go down in share or penetration in the short run with the OEM production decisions, and then we tend to rebound over 2 or 3 quarters. And then when things start to pick up, we are encouraged to move the other way to pick up a lot of the slack. In between all of that, of course, is customer preference, which is really driving the long-term market share. And I think overall, we'll feel good about that. But on a full year basis, we're not betting on a lot of full year increase this year. Of course, we're trying hard for all of that. I think the bigger theme, Andy, beyond these shorter-term gyrations is kind of the backdrop to the industry right now. So even prior to this year's slowdown and then the impact of the pandemic and the financial pressure that's put on a lot of companies, our industry, our customers are facing an unprecedented level of investment in new technologies whilst having to advance diesel. And I think, at least our view is, we're the best option for those OEMs in the event they need to find additional partnership in diesel and on new technologies. So I think like our view is there are more conversations going on today about who's going to invest in what over the next emission cycle. So yes, beyond the day-to-day gyrations of market share, tone of the conversations has moved less about displacing our engines or that risk in our eyes has gone down a little with the investment. It doesn't mean there won't be any bad news out there, but the investment needs of the customer base across multiple end segments are going way up, and they're going to have to make choices. Since our job is to try and convince customers, we could help with all that. We can pick up more share over time beyond this year. That's an aspiration. But I think the trend for this kind of overwhelming investment needs is clearly there. Many people are talking about it. You don't have to rely on comments from me. And then the financial pressures of this downturn, whatever the drivers of it, are not going to help those with more investment need and appetite than they can handle. So hopefully in all that, we can find a way to help our customers even more. So that's a very different environment than most of our history, I would say, or most of my history in talking to investors where the concern is kind of perpetual risk that will -- people are plotting to displace our engine. So again, none of that is a guarantee, but just kind of our perspective on what's going on out there. Nothing to announce today, just that risk of full displacement of our lineups, that risk seems to be diminished in its current environment relative to prior periods.

Okay. Well, thank you very much, Mark and James. We're kind of at the end and went a little over. And I really, really appreciate your time as well as all the investors taking their time to tune in. So we're going to sign off there, but thanks to everybody.

Okay. Thanks a lot, Andy, and good luck to everybody.