Cummins Inc. (CMI) Earnings Call Transcript & Summary

Good morning, and welcome, everyone, to today's discussion with Cummins. I'm Jerry Revich, and with us today from Cummins are Mahesh Narang, Vice President and President of Emission Solutions; James Hopkins, Executive Director of Investor Relations. Mahesh and James, thank you very much for joining us.

Thank you, Jerry, and good morning to you and everyone.

As a starting point, gentlemen, can we talk about the competitive position for your business today? What have been the most significant developments over the past cycle in terms of the company's positioning as you see it?

Yes. Absolutely, Jerry. This is James Hopkins here. So I think that Cummins has improved its performance cycle over cycle, which is one of the keys that we're looking to accomplish, whether it's peak to peak or trough to trough, and there's been some clear drivers of that performance improvements and I think increasing competitive position over time. So one of them has been our growing aftermarket business. So as we stand here today, roughly 30% of our revenues are now related to aftermarket, much more stable from a revenue perspective than some of our first-fit markets and a reasonable profitability profile as well. And that business has continued to grow strongly, I would say, over the last 10 years as we've seen both an increase of our engines in population and also an increase in the complexity of the products in the marketplace to meet emissions regulations. So that's driving increased content there. Then one of those drivers of an increased engine population has been continued growth in our market share across many of our different end markets. So if you look, for example, at the medium-duty truck market here in North America, a market that 20 years ago our market share was below 10%, we currently stand here today with market-leading share of over 80%. In the heavy-duty truck market, we've seen our share tick up over the last couple of years, now comfortably in the low 30s and excited to have some additional availability of our 12-liter engine later this year and some new regional haul chassis that we look to support and help increase our share over time. We've also seen an increased share in China over the last several years, both in the medium and heavy-duty market by increasing our penetration of engines at our partner Foton and through our new joint venture partnership on the light-duty side with JAC. So across many different end markets, we continue to build on our already very strong market share position. The third thing I'd point to, and Mahesh can talk to this is increasing content around the world related to emissions regulations. And Mahesh, maybe you want to talk about that for a few minutes.

Yes. Thanks, James. And this is Mahesh, and I lead Cummins Emission Solutions. And my business is in a really exciting state from a growth standpoint. We are experiencing growth with new emission norms, mostly in India and China. And we've been in those markets, but as we go to Euro 6 type emissions in those countries, we are growing content by more than 2x and -- for after treatment. And we are also well positioned to grow market share because as norms become more stringent, it becomes even more critical to have great performing products, and our products have got really good reception in the markets we work in. So we launched our NS VI products in China last year, and we are now in the growth phase this year. And we went to BS VI emissions in India at the start of the month -- actually, April, but April was shut down, so we started shipping some units in May. And together, we see about $600 million of growth for our business coming from Emission Solutions when the market matures, and we've gained some market share too. So yes, feeling really good about the growth story of Cummins Emission Solutions. And back over to Jerry.

Thank you, Mahesh. I would love to dig in a bit more on your last point regarding market share. So can you talk about your alliance partners, Tata in India, Dongfeng and Foton in China? Are they signing up for your Emission Solutions for their engines?

Yes. So Jerry, we do supply after treatment on the back of every Cummins engine. And for a large part Cummins engine business has been growing share as emissions become stricter. So our heavy-duty performance, for example, in China as a system has improved, and we are gaining market share in China through Cummins systems, which is engines and after treatment. But we do keep talking to not just Tata Motors, Dongfeng and Foton, we do keep talking to them about their own engines too. But the most significant growth though we've had is with Ashok Leyland in India, where we've got about 50% of their medium-duty business. And between Tata's and Ashok Leyland, they make up more than 75% of the market. So as we've launched good products, yes, we do continue to grow with Cummins. We grow on some other engines, but we are also getting outside OEMs.

And Mahesh, should be a data point, Ashok Leyland at 50% of their medium-duty business, is that a comment on Cummins engines plus after treatment or is that just after treatment?

That is just after treatment, Jerry, because they supply their own engines, and we are their after-treatment partner for Ashok Leyland engines.

And in China, you folks have an interesting relationship with Weichai and you supply them with a number of components. Are they signing up to be a significant customer for you for Euro 6 emission solutions?

Well, we keep talking to them. They haven't signed up as yet, but we keep knocking on their doors every time because we know we have an awesome product in China, but not yet.

Okay. Sounds good. And Mahesh, as you expand your light-duty diesel engine business below 4 liters, do you expect to produce matching Emission Solutions products or is that part of the market that's more automotive, more commoditized with higher volumes?

Yes. So that is an area we've been a little conservative in investing. So we look for partnerships in that space. For example, in China, we are doing that through supplying [ some ] components versus the entire after treatment and doing the integration versus investing ourselves. And primarily, Jerry, because this is the market we see will go to electrification the fastest, so what we want to do is as we invest in light duty, we want to make sure it has synergies with the other nodes that we see will continue to stay for a while. And markets where we see the risk of electrification, we prefer to supply fewer components where we can make the margins through value-added products and then enter partnerships where the risk of electrification is high. And I don't know, James, if you want to add anything as you may be seeing some more -- like in other parts of Cummins?

Yes. No. I think you summarized it well, Mahesh. So we've grown our light-duty engine business over, let's say, the last 10 years through partnership with Foton and then also our partnership now with JAC. This has primarily been in China, although we do utilize that ISF engine, as we call it, in different applications around the world. And as we do on all of our platforms, we look at what the key components are that need to be related to that engine to provide good performance and also provide the appropriate financial returns and make those appropriate investments. So those light-duty engines and platforms have been good drivers of profitability, and we see continued growth in general around those platforms going forward.

And you gentlemen mentioned EV as part of the conversation in the light-duty discussion. Tom, on the past couple of calls, spoke about vertically integrated customers evaluating new Cummins engines for the first time in some cases because of the electric vehicle budget pressures. Are there similar tailwinds in your Emission Solutions business with engine customers, for example, there are a number of engine manufacturers that have emission solutions essentially, private label to their specs as opposed to fully outsourced? Are you seeing any opportunities as the engine part business has those conversations or are the types of conversations that Tom has described only applicable on engine systems which will obviously pull emission solutions, but not emission solutions on its own?

We do have conversations with customers. One -- first, as you mentioned, Jerry, jointly with the Engine business any opportunity that Tom talks about, we are [ coating ] systems. So along with engines, we are [ coating ] after-treatment systems as well. And -- because we certify the powertrain. And -- so in most of those conversations along with the engine business, Cummins Emission Solutions is partnering. But beyond that, as I described earlier, we also continue to have conversations on [ some subcomponents ] of the after treatment as well as complete after-treatment systems with customers behind their own engines, especially when they use multiple sources of power. So some great examples are in the U.S., we sell after treatment behind Navistar engine and a PACCAR engine, and we are continuing to be their partner going ahead. In Europe, too, we sell a lot of [ dosers ] to -- we have incredible market share in Europe with our [ doser ] systems that is used in after treatment. In India, we are growing our share with Ashok Leyland. And again, in China, we continue to have discussions with customers behind their engines as well. With China, I think the market is still in -- is not entirely NS VI. It's only partially in cities. So we see those conversations will get deeper once we have panned China NS VI emissions. But yes -- to answer -- to summarize my answer, yes, we do talk to customers both behind the Cummins engines and for their own engines. And we -- when Tom talks about these opportunities, it's also for Cummins Emission Solutions.

And Mahesh, can you expand on the point regarding implementation of China regulations? What proportion of truck production is national VI today and when do you expect that to ramp up to 100%? And then can you talk about the time frame in India as well?

Yes. So in China, we launched in July 2019, and it's a phased ramp-up with city applications coming on first, and then all of China goes to NS VI by July 2021. So we are about a year away from all of China. Today, we sell -- about 15% to 20% of our mix has migrated to NS VI products. That's what we are expecting for 2020. In India, the entire market has migrated to BS VI products for on-highway starting April 1. And so every future platform that we sell will be a BS VI engine. So India has moved to BS VI faster than China, and then China comes on completely next year.

Got it. And in terms of the discussion on the last conference call, James, regarding CapEx and R&D budgets under pressure for the industry as a whole. Obviously, at the time of the call, everyone in the industry was making sure that operations were okay and supply chains were okay. But now that they have to deliver very real CapEx and R&D budget cuts, are you starting to hear more from customers of both engines and components looking to accelerate their CapEx and R&D spending potentially by doing more business with Cummins?

Yes. I think, as you mentioned, Jerry, so given the current economic environment, I think all industry participants are looking very closely at what they are looking to spend in terms of research and development and then the implications on the capital front. So for a lot of industry participants, that's a pretty long list, as you can imagine, whether it's diesel engines and needing to get ready for the likely ultra-low NOx standards that may come in the United States and Europe, whether it's electrification, fuel cells, safety systems on trucks. And so given the current economic environment, I think everyone is looking very carefully at what they want to invest in and maybe what they would like to partner on with other companies. As we take a step back and look at ourselves, I think when you look at our product portfolio, we have leading market shares around the world. We have regional manufacturing that can help support OEMs in any region that they might participate in. And I think as we discussed at our Analyst Day, we already have relationships through selling engines or components to 17 of the 20 largest commercial vehicle OEMs in the world. So we view ourselves as a natural partner for many OEMs to the extent that they're looking to partner more on the engine side. So nothing specific to share today, but we feel like our product portfolio, our global footprint and our long-standing relationships with OEMs definitely provides opportunities for additional partnership in this space.

And James, even before the CapEx and R&D pressures intensified here, you folks gained a number of new releases in the U.S. truck market. Can you talk about the X12, how the new release is going and Daimler platforms and update us are you expecting to roll out production on any additional truck platforms over the balance of the year for that engine? And it was nice to see the Mack's -- the Mack medium-duty opportunity as well. Can you just speak to how do you view the addressable market for the Mack product specifically?

Yes. Absolutely, Jerry. So our market share in North America has been very strong over the last couple of years, whether that's been in the heavy-duty space or the medium-duty space. And I think that's driven very much from the very strong product performance that customers are seeing from our products. And of course, the seamless relationship that we have with our distribution business that service and supports the engines. In terms of platform launches, we've mentioned a couple of really exciting items over the last 6 months. So we have our X15 or our 15-liter Efficiency Series. And that's kind of the -- what most people would call kind of the bread-and-butter engine here for Cummins. And that engine is kind of meeting the 2021 greenhouse gas emissions 1 year early, and those greenhouse gas emissions essentially are fuel economy. So to the extent that customers are purchasing that today, they're seeing an increase in their fuel economy, which is the number one expense that they face as a fleet. So that product is being received very well in the market today. We also announced the availability of our X12 engine in several different Freightliner chassis. So that engine has been available in a variety of vocational applications over the last 18 months. But the availability in regional haul models starting in the middle of the year is kind of a new piece of the market for this engine, so we're excited about that. It's a very low weight engine. So especially for weight-sensitive applications, we think that, that certainly has an opportunity to gain some market share in that space with a very trusted partner, Daimler. And then finally, you mentioned the medium-duty side of things. So we have about 80% share in that medium-duty market. Our products are very well known. Clearly, with 80% share, the performance is viewed very positively by the market. And as Mack has entered that market with a medium-duty product, and they've made the decision to enter that market and utilize kind of Cummins Power, which we're very excited about that partnership. So a couple of good wins there from an availability perspective. And then I think it also just shows that -- the value that our partners have and see in our Cummins products from the engine to the components and the distribution business as well. So looking forward to seeing the benefits on the market share side of some of those launches here over the next year or 2?

And James, how big is the availability on Daimler platforms? What proportion of sales, if you will, are covered, where customers can order the X12?

Yes. So it will be available in regional haul Cascadia models, both day and sleeper cab models. So its availability is not just one model, so we'll launch that this year. We're expecting it to be well received by customers and we'll kind of see what the market reaction is to it. But we have no reasons to believe anything other than it will be received very well.

Okay. And typically, these are customer -- end customer-driven decisions, which would lead to the conclusion that additional platform rollouts are likely because nobody wants to lose a truck share because of engine availability. Am I thinking about the industry structure and opportunity set as you folks are or is that confidence misplaced?

No. I think we maintain exceptionally strong partnerships, both with our OEMs who we've worked with for many, many years and also fleet as well. So we talk both to OEMs and also the end users to ensure that we're supporting both in providing the best products possible. And to the extent we're providing that product that is helpful and supportive of our very strong market share in North America. But yes, we work very closely both with the OEMs and also the people that are making the decision on which truck and powertrain to purchase.

And can we shift gears and talk about the margin performance that you folks are delivering. So as I look at in the Great Recession, the first quarter production cut was a very significant challenge for the organization. In this cycle, you folks delivered 20% decremental margins in the first quarter of really significant production cut. Can you talk about what drove the difference in performance in this cycle compared to what we saw a decade ago?

Yes. Absolutely, Jerry. So I think there's a couple of driving factors to that. So the one thing I would mention is that I think we got ahead of the curve on the cost side this cycle. So in the second half of last year, we were pretty publicly talking about our expectations for some of our major markets, especially North America heavy-duty truck to see declines in demand in 2020. And based on those expectations, we announced a significant restructuring plan at our Analyst Day last November. And the result of that was to look to save $250 million to $300 million in 2020. So we moved forward with that restructuring in November, completed it by the middle, let's say, of the first quarter. And so realized quite a lot of the benefits of that restructuring in the first quarter, where heavy-duty truck production did come down but certainly wasn't yet at trough. So I'd say that cost control and the restructuring definitely supported those strong first quarter results. In addition to that, we had very good warranty performance within the quarter. So we've seen improved product performance across our portfolio, and our warranty was about 80 basis points better than it was in the first quarter of 2019. So positive performance, I would say, both on the cost side, driven by getting ahead of things on the restructuring, low warranty costs and then very good execution, frankly, in our manufacturing operations, where we were dealing with the impact of the supply chain from COVID in China early in the quarter and several other items. Our manufacturing teams really came through, managed their costs well. We actually had premium freight down around $10 million compared to the first quarter of 2019, which I think was an incredible feat given some of the supply challenges that we were facing managing around the COVID situation in China. So strong execution, I think, well-timed restructuring plans and improved product performance were the 3 primary drivers of a very strong first quarter.

Yes. And in addition to what James said, the only other thing I would add is we've developed a DNA now where we regularly look at material costs, which is a big part of our cost structure. And we have a really good -- we have really good programs where we continue to innovate and do value engineering where we provide the same or better performance while continuing to reduce material costs. So I think some of those value engineering projects that we were working through have also come through and have helped us maintain our gross margins and everything else on people and manufacturing, I think, James already covered.

And in terms of opportunities to structurally reduce costs in the business as a result of restructuring or other actions, Mahesh, can you talk about any opportunities you see within your business? And James, can you chime in on any opportunities that you see across the enterprise as well?

Yes. So I think James can talk more about Cummins. But from an Emission Solutions standpoint, like Cummins, we did do a restructuring in the last half of 2019, and we came up with a better cost structure for 2020. My business, however, is in growth mode. Like I said, we have $600 million of growth ahead of us with Global VI emissions. So I'm actually investing versus restructuring. So I'm in a unique place in Cummins. So I'm going to let James answer more about how else -- what else we are looking at in other parts of Cummins. But we did do our bit in last half of 2019 for Emission Solutions too. James, do you want to add more on Cummins?

Yes. Absolutely, Mahesh. So I would say, Jerry, the $250 million to $300 million of restructuring that we announced last year, we view the vast, vast majority of that to be structural in nature. That included several different actions that we executed in Q4 and Q1 of this year. One of them was exiting certain lines of business that were not performing up to kind of our expectations. There was a light-duty product here in North America, which was modest in size and then medium-duty transmission. So those won't be coming back. And then in addition to that, pretty significant restructuring within our distribution business in North America. As you know, Jerry, we purchased those from a JV structure to wholly owned 5, 6, 7 years ago. And I'd say that one of our real focuses on that business since then has been to maintain the very strong revenue growth that we've seen and we've done that. So that North American distribution business has maintained and accelerated its revenue growth over the last couple of years, which has been a very strong focus of ours. I think now that we have gotten very comfortable with that and we've kind of moved on to looking to see how we can manage that business and increase the profitability. As we brought that business into the company, it was essentially managed in different regions. So 7 or 8 regions within North America and kind of the associated administrative functions along with those different regional setups. We're now looking and starting the transition to manage that more through a line of business structure. And through that transition, that's provided us an opportunity to reduce overhead costs and at the same time provide, I think, an increased quality of service for our end customers. So that's kind of the biggest piece of the restructuring that was included in the $250 million to $300 million, and we certainly started to see dividends with that. Our profitability in our distribution business was flat year-over-year essentially on around a 10% revenue decline, which shows the benefits of that starting to come through. So a lot of structural cost out within that $250 million to $300 million. We shouldn't be thinking about that as a temporary cost out with the costs to return when markets rebound.

Very interesting. And I'm wondering if you can just unpack a little bit more of the discussion there. Mahesh, you look at the growth opportunity set for your business that you're managing too. Can you talk about what that means for your manufacturing footprint? You obviously have strong operations in both China and India, to begin with. But are we meaningfully investing in the size of facilities? And you spoke about earlier in our conversation about the light-duty value train essentially moving towards EV. So as you think about where the cost structure needs to be for your business in the next cycle, any changes in the footprint that we should be thinking about, maybe not today, but in 3 to 5 years?

Yes. Thanks, Jerry, for that question. So I think in India and China, like I said, we've just launched brand-new plants. And we do see diesel, especially in medium-duty and heavy duty, which is the primary markets we've invested for staying and continuing to grow for a long time for Cummins. And we are also well positioned for market share with good performing products. Even in the U.S., what we find is that as we go to new norms of emissions in '24, both for EPA and CARB, and then for 2027, while it's not drafted, we do see some new norms on the horizon. We already have an existing footprint, and our focus is to optimize that footprint, not necessarily invest much more in it, but optimize it and continue to sell more content from the same facilities that we have. So the after treatment will get more content as more emissions comes or -- for both NOx in U.S. and for CO2 in Europe. And I think we have the infrastructure to just continue to put more content through it without having to invest more facilities. So I don't see any more facilities being put, but I do see optimization of the existing infrastructure we have globally as Cummins for my business.

And Mahesh, that's a really interesting point. Can you talk about how you folks expect to meet the 2024 standards, what additional product or dollar content should we be thinking about? And are you having conversations for that particular milestone? Are you having conversations to supply products to new customers in U.S. after treatment?

In the U.S., we have really good market share already. And so we are talking to the same customers about it. And Jerry, the regulation is still being finalized. The prototypes are still being rolled out. So the amount of increase is a little difficult to finalize, but we do know that there is increase -- the stricter the emission, the more the increase. For example, for California emissions, the increase will be significantly more -- probably double-digit for the after treatment, but may not be as much if the emissions are lower in other -- in the remaining 49 states. So we'll be able to provide more direction once the regulations are finalized probably towards the second half of the year.

Okay. And James, can we go back to the distribution discussion? So that was really interesting in terms of the line of business structure. Can you expand on that point in terms of the level of simplification in the organization? When exactly the reporting structures change, and say a bit more please around that strategy. It sounds like more than the back office integration, which we probably discussed at the Analyst Day.

Yes. We're in the process of changing that as we speak today, Jerry. So different responsibility structures, lines of leadership, things like that, et cetera. I think what we have found since we purchased the North American distributors is there's a lot of customers and a lot of different end markets that really appreciate kind of one face to the customer or to them across the United States, as you could imagine, whether it's large truck fleets, whether it's people in the oil and gas industry or construction fleets that having the ability to have a conversation with one person for the entirety of North America, simplicity in prices, consistency in service is really valuable to them. And so I think that's the driving factor around having some of these changes and how it really helps support the customer, simplifies things for them, provides them one point of contact and consistency in the service and support that we provide them regardless of where their product may be across the whole country.

And James, what's the timing on when you expect these changes to be implemented and deriving the cost savings from the simplification?

Yes. So there's cost savings coming through this year. There's also some additional costs that are associated with making these changes. So I think you'll see more of these benefits come through as we head into 2021. But as you can see from the first quarter results, we're already starting to see some of these benefits come through the distribution P&L this year.

Okay. And then in terms of the digital part of the strategy, you folks have now telematics across a wider range of end products and markets. Can you talk about what business intelligence you're able to gather now compared to 5 to 10 years ago and what that enables you to do?

So I can start and then James, you can jump in. I think telematics or connected diagnostic is still an area we are on a journey on. We are starting to get more information more promptly, and we are able to run algorithms and models to both improve the customer experience and be proactive about predictive failures. But we're still trying to automate them and prioritize and continue to talk to customers about improving their customer experience, improving the reliability, improving fuel economy. So these are 3 areas where most of our effort is spent for my business. And the -- this also helps -- like when we can predict failures, we can divert the customer to a Cummins-recommended location or a Cummins distributor and we drive more aftermarket sales through brand loyalty in that way. But it's a journey, Jerry. I think we've come a long way from where we were 5 to 10 years ago, but this pace requires constant innovation and we continue to invest in gathering more data, analyzing more data and then improving the customer experience. And James, I don't know if you want to add anything else?

That was a perfect summary, Mahesh.

And any interesting trends that you're seeing from a utilization rate standpoint? So obviously, you can track not only maintenance and performance, but utilization statistics. Are you seeing anything interesting in the data in April and May either from a regional standpoint or end market standpoint?

Yes. I can take that one, Jerry. I think we don't share that exact data on things like utilization for a variety of reasons. But as we go around the world, what we see today is that China has bounced back very strongly, so as a company, essentially record levels of production in China, both on the on-highway and off-highway side for us in April. So very strong in China. India is really just in the beginning stages of reopening, so very low volumes in India as we stand here today. And then generally speaking, in the United States and Europe, I'd say most OEMs are in slow ramp-up mode. And I think the speed of that ramp-up in the short run is being determined by the ability of the industry supply chain to also kind of ramp up given some of the differentiation and ability for suppliers to reopen, given their different geographic locations. So China, very strong. Rest of the world really starting to ramp up. And it is going to take a little bit of time as we see things ramp up to really understand what the true levels of demand are in a lot of our end markets into the third and the fourth quarter.

And can you gentlemen comment about the performance of the aftermarket business over the course of April and in May? How different has this downturn been for aftermarket demand compared to what we've seen in the past?

Yes. So I'd say, Jerry, on the aftermarket side, the first quarter remains very stable in our on-highway markets, and it's been stable for about 9 months now. We did see it come down in the second half of the last year, and that was, as we've kind of discussed before, really driven by lower utilization of truck fleets here in North America, especially on the heavy-duty side of things. In the off-highway space, especially in oil and gas, we have seen a reduction in after-demand there. And that's just been related to some of the weakness we've seen in the fracking markets, especially in North America. We'd expect the aftermarket to remain pretty stable going forward. As you can imagine, the second quarter is a little bit unique in some of the things that us and our customers are having to deal with. But fundamentally, as long as trucks continue to support the economy and deliver products, whether it's food to grocery stores or equipment to industrial manufacturers, those trucks will continue to need service and support. So it might be a little bumpy in the second quarter. But fundamentally, we feel confident of continued stability in that aftermarket business.

Okay. Terrific. Well, really appreciate the discussion. Mahesh, James, thank you so much for joining us for wireless chat this morning. And thank you, everyone, for dialing in. Have a great day, everyone. Thanks.

Thank you.

Thanks, Jerry. Appreciate it.