Cummins Inc. (CMI) Earnings Call Transcript & Summary

Great. Hello, everybody. Welcome back and thanks for sticking with us as we get through the afternoon of day 1 of the Jefferies Industrials Conference. And we're very pleased to kick off our presentation from Cummins, actually more of a fireside chat. You can probably see in Jennifer's background there that we're literally doing a fireside chat for this one. So welcome to both of you. Jennifer Rumsey is the President of the Components business for Cummins. And most people probably know James Hopkins, who looks after the Investor Relations function. And we are going to do sort of a fireside chat, but I would be quite happy to have a lot of help in terms of Q&A. And the best way for anyone to ask a question is just to type it into that box at the bottom of your screen, at which point it will show up on my screen, and I will refer it to [indiscernible] Cummins. So I think we're going to kick off. James is going to give us a few opening comments, and then we're going to kind of dive more into the Components business. So welcome, folks, and thanks for coming.

Thanks, Steve. I really appreciate the invitation again. Happy to be here. I think we've been coming for many, many years and really enjoy the invitation. So let me just start with just a couple of brief comments about the second quarter. I think as everyone is well aware, at this point, COVID had a significant impact on most of our markets throughout the second quarter, really starting in April and May and then start to see a little bit of recovery within the month of June in many of our end markets. So in North America, as we exited the quarter, truck production rates in June were pretty similar to what they were before the start of the COVID crisis. In some of our other end markets, we did see some improvement from the April and May levels to the June levels, although we're still below levels we saw before the beginning of COVID. And in China, which kind of was one outstanding area of demand performance in the quarter, whether it was construction markets or truck markets, we were at record levels of sales and production for the industry and for Cummins as well showing up, I think, some of the value of the diversification in end markets and geographies when you invest in Cummins. So a good quarter in terms of profitability given the level of demand, the largest drop in demand in our company's history year-over-year, and looking forward as we go into the second half of the year to see some improvement in those end markets and then continue the focus on cost as we go into the second half of the year while demand is improving in it's still at relatively modest levels right now.

Great. And maybe just a quick follow-up. I mean China has been booming for you guys, and I think you thought maybe it might fade a little bit going forward. But well, it still sounds like things are really strong over there. And our in-house team is not in the things are fading camp. So is that -- how do we put our heads around that? Is that some potential upside for the second half?

Yes, Steve, there's a couple of things going on in China. So second quarter, as we mentioned, record levels. A little bit of that was related to catch-up from Q1 shutdowns that most industries experienced in China, both on the truck side and the construction side. And we also started to see some stimulus coming through in China that was positively impacting the construction markets and also the truck markets. In the quarter itself, they were just shy of 600,000 trucks made in China for an annual run rate of about $2.4 million. That would be 75% higher than the largest year on record of China truck production. So we feel relatively confident that we'll see a bit of a moderation in demand. $2.4 million run rate doesn't seem reasonable. Having said that, the exact speed at which we see this decline and whether it's a stair-step or more of a smooth line down is a little bit to be determined. As you mentioned, the July numbers were still incredibly high in China, still very, very robust demand through July and nothing's changed in the first week of August. So to the extent we have strong demand in China, we will take advantage of that. We have a market-leading position in China on engines and components, and that will certainly help the profitability as long as the markets are strong in that region.

Good. Okay. Fair enough. I'm holding out for the $2.4 million rate, but we'll see. So maybe that's a segue, a good segue for Jennifer. Thanks for joining us. It looks very cozy there where you are for the middle of August. But can we talk a little bit about your components business? And maybe let's kick off with China. I think people sort of understand the truck and the construction equipment in China but don't necessarily focus as much as on components in China. So talk about what you're doing there and what you're seeing in terms of growth?

Sure. We'll do. So thanks. It's great to be with you, and I've been mostly working from home since late March. And so yes, my fireside chat is in my native environment, if you will. And I've been leading the Components business for about 9 months now. And just as a quick reminder, I think people are familiar, but of course, we have 5 businesses in total that are part of the Components portfolio: Emission Solutions, which is aftertreatment; the Turbo business, Filtration, electronics and fuel systems and then the Eaton-Cummins joint venture. As James said, we saw really strong performance in our business in the second quarter based on the record engine volume in China. And we also are experiencing growth in our China business because of the shift to the NS VI emissions regulation that's happening there. So that's really been a staged implementation. It's implemented currently in some major cities and also applications like natural gas, but the full adoption won't occur until next year. So for the Components business, that provides about a $300 million revenue outgrowth opportunity based on content that's getting added to the engines. And so our second quarter was very strong. As James said, we're continuing to see strong demand from customers there. And really, I think the success there reflects our ability to respond through adversity across our global supply chain. So we were able to as demand came back in late March and into Q2 in China, we were able to ship production, bring plants back up in China for one, our fuel systems plant, for example, is at Wuhan, where the virus originated and also shift production and really get our global supply chain to help support that high demand and capitalize on what's happening there.

Is your China business in China for China? Or is it also an export business?

Yes, it's a mix. So I mean, the strategy is heavily to be producing product in region. So we have large manufacturing plants around the world and also technical organizations and business teams that are working with local customers. Cummins strategy has been to really make sure we understand those local needs and develop fit-for-market product, which is part of what has enabled our success in China. We do, do some level of export at a component level to the global business, but it's heavily focused on China.

Okay. Great. And you talked about the changing emissions regulations in China being a driver. Let's just widen that out a little bit and think about it globally. What are the kind of key hurdles that are going to drive additional penetration around the world?

Yes. So those -- the components that are in our portfolio are all key components of differentiating engine system or powertrain. And really, that business has grown because of emissions regulations that drove the need for these high-tech components in order to meet emissions, and so it's provided a strong path for us to continue to grow content of these components and also where we bring market-leading components to grow share with our customers. We sell components both to Cummins Engines and also other engine customers. So we've got a really good scale in these key components. And there is still opportunity with emissions regulations in some of the Components businesses. So I talked about China. India as well with the BS VI emissions that just went into effect. We also have about a $300 million revenue outgrowth opportunity. We have, in addition to our partnership with Cummins, it serves Tata, of course, in India, a major player in the -- on highway. Truck market, we have a new partner in Ashok Leyland. They are on the aftertreatment business. So we're going to see a strong share of Cummins aftertreatment in the India market. Off-highway regulations are still moving around the world so that provides another growth opportunity for us. And even as we look to the future in the U.S. and in Europe with NOx regulation in the U.S. with Euro 7 coming in Europe and with CO2 regulations in both of those places, we still see some growth opportunity. So it really is different based on the different businesses. The biggest opportunity in front of us remains with the Emission Solutions business, which is about 45% of our Components revenue to continue to grow. And so we're continuing to make sure we're investing in the leading product there to capture on that opportunity.

So you talked about $300 million sort of outgrowth opportunity in China, sounds like another $300 million in India. Is that business that you've already won? Or sort of -- that's the pool you can fish in?

Yes. That's the current business that we've won based on NS VI and BS VI regulations. And then other off-highway and future regulations, we see providing an opportunity to go beyond that.

Okay. And those regulations, they tend to phase in fairly quickly. So that shouldn't be like a 5-year revenue opportunity, right? It's probably a year to 18 months?

Yes. I mean, there's some regulation changes happening in '21 in the U.S. The next major ones in U.S. and Europe are in '24 and '25 time frame.

And in China, we keep hearing that -- how should we say this, enforcement can be spotty. How do you feel still about the actual are they really going to do this?

Yes. I mean, it's been a key area that we focused on and bringing product to market and in our government relations with the team in China. And Cummins, of course, is going to ensure that we're complying with laws that exist around the world. And so to really be successful in the market, we need enforcement of those regulations. I think we see growing focus on that and even growing commitment to actually implementing these new regulations. So that also has been an issue in the past of pushing out implementation of regulations. For example, with the NS VI emissions, there's now a requirement for all operators to be reporting data from their vehicles on a regular basis through telematic systems. The more we see enforcement and real focus on that in China, I think the better it is for Cummins business and our ability to be truly market leading there.

Definitely. Definitely. This kind of begs 2 questions that I've always had longer term. One is, you wonder whether the kind of the domestic guys can catch up over time and sort of provide similar technologies. You tend to have a lead at first, but at some point, they tend to figure it out. So I guess I'm curious you're thinking about sort of the lead that you do have and the domestic's ability to kind of catch up? And then I have a second follow-up.

Yes. I mean the key is to continue to drive advancement, right? We don't stand still. We're continuing to invest in new technology and emissions regulations provides one way to do that, but customers' interest and fuel economy. And other things that make it easier for their business to operate, also provide an avenue. So we'll continue to look at ways that we advance the technology and don't stand still.

Okay. And then I've always sort of wondered, I think I've talked a little bit about this with some of the senior folks as well. But you guys do well, like you just said, in an environment where regulations are evolving and moving forward. And it feels to a lot of us I think that the -- we get to Euro 6, NS VI, BS VI, everybody is kind of at six. There's -- it's not totally clear what's beyond the horizon. But are we running out of runway where we kind of are getting almost as clean as we can be. And so there's not these growth opportunities in 5 or 10 years?

Yes. I think we're far from that. And fact that, as I became the Chief Technical Officer of Cummins in 2015, I think even in my mind, maybe I questioned if that was starting to happen. The reality is that, as I said, even in U.S. and Europe, they're continuing to focus on criteria pollutants like NOx and particulate and how we regulate those in some of the more challenging conditions like high load and low load and CO2 regulations are also occurring. So the real question, really, I think that will continue to provide an avenue of growth for Cummins, it's this transition from our core businesses to the new power business and when and how that happens because we still see and are making sure that we're positioning to capture those trends in our core business now. And I do you think in the 5- to 10-year time frame, those trends will still continue in some of our markets and businesses. And then you'll see this shift to electrification and fuel cells growing. And I think -- and so that is going to still take some time to play out completely. So I don't think the end is near yet. I will mention maybe one other thing related to the China business opportunity, our Eaton Cummins joint venture, which is one of our components business is another key growth opportunity for us in China. So that joint venture just celebrated its third year of existence, and we launched this Endurant automated manual product in the North American heavy-duty market and have seen really good success in that market. I mean, now we are in the process of bringing that product into China. We expect to sell about 1,000 units this year in China, which is pretty low, but really an indicator that, that market is starting to move from manual to automated, probably faster than we had previously anticipated. We feel like we're well positioned with the customers that we're working with there to the launch and grow the Eaton Cummins joint venture revenue with that product in China as well.

Yes. That's interesting. It was a little surprising because I think we always think of China as just wanting the lowest price, and that's -- I don't think the automated transmission is the lowest price.

Right. Yes. Yes, I think you're increasingly seeing fleets and more focus on efficiency in some of those markets.

Okay. Quick one from the field here around the $300 million opportunity is in China and India. Are those annualized numbers? And then I suppose the outgrowth kind of goes away once those emissions are sort of fully phased in?

Yes. So those are annualized for NS VI, BS VI. As I said, in China, it's been a staged implementation so next year will be when that complete implementation occurs nationwide. And then with that NS VI regulation, then we will look at opportunities to grow share as that product performs well through our customers in the market. So that would provide some additional potential upside as well. The EC JV transmission is not in those numbers. So that would be a separate opportunity that would progress over time. And again, future regulations there that may, like we see in other parts of the world still result in content being added.

Good. Okay. So it sounds like -- I'm going to sort of pretend COVID doesn't exist, but it sounds like the growth part of your business is kind of more of the Emission Solutions, I guess, relative to the others. Is there a margin implication from that? And I guess what I'm trying to go is where do margins kind of evolve to over, I don't know, 3 or 5 years as these things happen?

Yes. So we're continuing to look at opportunities to improve margin as well as revenue and doing things -- our strategy is clearly having market-leading product. And then we also want to make sure we're cost competitive and continue to look at opportunities to improve product costs or optimize our footprint. So just paying attention to what that does over time. EC JV is one good example, as we significantly increase revenue in that business. We have opportunity to try to get that business margin comparable to rest of our Components business, which it's not today.

So I guess that's kind of what I was asking, how much differential is there amongst the businesses today?

Yes. The differential is driven a little bit more by application in different markets and some of the cost pressure differences that we see there than by business unit itself, with the exception of EC JV, which is just still a maturing business. So the others are -- you see comparable variation that exists across different products and different markets there.

Okay. All right. And let's talk just briefly about turbo and the other ones. I mean fuel systems, it seems like kind of dedicated business. Is there any way to grow that beyond kind of what the cycle does?

Yes. So in fuel systems, of course, we have the joint venture with Scania, which is a great partner for us. And together, we've been able to invest in these key technology for both of our engines. We aren't selling to other engine manufacturers beyond Cummins in China. Cummins separate from Scania is also investing in some of our other fuel system needs globally. One opportunity we have in front of us is expanding into the large engine space with our own fuel system. So that's an opportunity. But yes, that business is generally fairly mature and stable as we continue to get a larger population of fuel systems in some of these other components, then we start to see aftermarket growing on as well. So you get a little bit of a lagging growth effect that comes in the aftermarket as well.

And turbo, I just think of turbo as having a little more potential in the sense that you can use those systems to drive better fuel economy, which everybody wants. Is there -- just describe your view of that over the next few years?

Yes. So turbos continue to be a key component in the system, and we're continuing to advance and improved efficiency on the back of that with CO2 regulations. That continues to be really important. We already sell to a number of OEMs globally in the turbo business. We don't really see a lot -- significant content growth on internal combustion engines, but still important IP and differentiation. And then we're starting to look at what happens as you shift to electrification and fuel cell and the role that you're handling might play in either hybrid systems or -- and fuel cells, actually, air handling is also important. And if we can leverage some of the capability that we've built into those businesses for the future.

Okay. Yes. That sort of segues into something else I wanted to sort of go through, which is you've added the Eaton Cummins JV to Components that wasn't there a while back. I'm curious, in 5 years, will there be additional types of components and components at Cummins?

Yes. Yes, great. Yes, I think we are continuing to explore if there's additional components that make sense, kind of consistent with our strategy of key components in the powertrain that we think are important in the system. So EC JV and the automated manual was a great example of that, doing deep integration with the Cummins powertrain with that and then also providing a market-leading product to our other key customers. And so we'll continue to explore as the market shifts, as we see technology move and just as we see others in the market making decisions on where they want to invest and diesel and beyond, if there's additional components that we include into our portfolio. So clearly, it's one of those will tell you when we can tell you, it's certainly something that we're thinking about.

Okay. Fair enough. And I guess the kind of destination here is that you could see a scenario where this -- a lot of this stuff is potentially stranded over some probably very long period of time. Are there -- can you imagine Cummins being a components manufacturer in alternative drive trains as well. And if so, how do the Components business kind of fit into that?

Yes. So at a Cummins overall level, I think we're still -- our strategy is still evolving in terms of the role that we play in the market, but something similar to what we do today, where we provide basically our customers need, could be complete powertrain, maybe key components in the powertrain, that is something that we are looking at in the future. And then, of course, if there's other adjacent businesses that may make sense. So within our new power business, we are doing a joint venture with NPROXX that makes tanks, hydrogen and compressed natural gas tanks that are another key component in the system and having a cost-competitive, capable tank can be key to adoption of that. The electrolyzer technology that we have also in the new power business for hydrogen generation. So there's also some adjacent things that we'll evaluate.

Great. And that's actually a perfect segue because I was going to see if I could take your brand a little bit on hydrogen because I know you had the CTO role. So it felt to me like you guys really sort of stressed hydrogen on the last call. And obviously, you've had some announcements recently that have been refocused on that. Are you guys sort of feeling like hydrogen is getting more viable and worth a bigger bet than you might have thought a few years back?

Yes. I mean we've been thinking about it for several years as we started thinking about these long-range future technologies where we have a true carbon-free world. We've seen that it would be a mix of electric vehicle -- battery electric vehicles and feel, electric vehicles that make sense and a long-haul application, for example, a battery electric vehicle is unlikely to ever be the right solution, just given the power and range requirement. So we've been exploring and looking for the right opportunity to start building our own capability. And as you indicated, we've done some acquisitions, joint ventures and other investments in key building block technology that we can combine with the capability that we already have and really build that for the future. We are seeing areas, kind of niche areas where there's more interest and opportunities. So China is doing a lot to create incentives for fuel cell vehicles. I see rail applications also where incentives exist. We have customer demand, and we're selling fuel cells today. By no means do we think that all of our markets are rapidly kind of moved to hydrogen and fuel cells. It's going to take -- takes some time and vary based on regulation and incentives and infrastructure development and also that technology advancement as well. While, it is becoming more cost competitive, the cost, both of the fuel cell system and the hydrogen can still be quite high.

So we have about 5 minutes left. If anybody else has any questions, feel free to go ahead and poke them into that box at the bottom of your screen. I've gotten through most of the ones we've had so far. Can you just -- expanding on this hydrogen question, can you just remind us sort of what you have done to date? I know there's been some rail applications. And is there a commercial product available now? Or are we still sort of conceptually testing them?

Yes. No, we have -- through the acquisition we did of Hydrogenics. Last year, we have commercial product in the market. And rail application, electrolyzers and hydrogen production application. And we're starting to also sell some in trucks and buses at pretty low volumes. So small-scale commercial adoption today that we will -- we'll build on. And the thing that we feel really good about our strategy because Cummins is so global and cuts across so many different regions and applications. We're still going to be heavily dependent on our core business for many years, and we think we're well positioned. In fact, maybe opportunities as others in the market face competing decisions on where they invest, to use our traditional diesel products. And then because we're in these different regions in the markets, so we can start to build capability and sell product where the markets are moving and then leverage that over time as these other markets adopt with our experience there. And our customers, I think, trust us to help them pick the solution that's right for them, right? We're not just selling one thing and be in it for the long-haul to stand behind and support the product, and many of them use the product for many years. So that's important.

Okay. Good. And then a couple of sort of random final questions. How much is the Components business is aftermarket?

20% of our business in total is aftermarket. Within the business, the filtration business is about 70% aftermarket. So the other businesses are a little bit lower. So that business is more heavily aftermarket focused and tends to be a little bit more resilient through some of the market cyclicality as a result of that.

And likely probably on the higher end of the margin spectrum, I would assume.

Well, we've done a lot of work in recent years to really improve margin performance in that business as well. So yes.

Okay. So another back to fuel cells for a second. We have 3 more minutes. Fuel cells have been around for quite a long time and really haven't gained traction yet. Seems to be more interest lately, but what has to happen for them to sort of become mainstream?

Yes. So I'd say 3 things: one, continuing to advance the technology and make it more cost competitive. Some of that comes from scale, but it does still require continued advancement, coupled with regulations, right? So if we want -- as we move to truly urban-free future, right? Regulation and incentives that will drive that adoption will also increase the adoption. And I think I don't think I said in this group, but I actually started my career was working on fuel cells more than 20 years ago. It was my first job out of graduate School at MIT was working for PEM, fuel cell company. And I left and came to Cummins because I wanted to work on products that were actually used by customers. So now 20 years later, we are actually seeing customers start to adopt that. I still think it will be a long shift. It will happen over time. And I think there's definite signs that the governments around the world are serious about the focus on the environment and driving that trend.

All right. And we have the obligatory question about how is the Components business trending in July and August?

So we're happy to be beyond where we were in April and May, where many of our customers were shut down, and we were trying to figure out where to operate and how to operate safely. I think we feel good that we've come through that. We feel confident about the processes we have in place to keep our employees safe. We're seeing pretty strong demand back in many places to pre-COVID level, still very strong in China, very weak in India. But recovery in aftermarket, recovery in the U.S. and Europe. And the big question is with resurgence of virus and some question around economic stimulus, what happens as we go into the fourth quarter and beyond. So we're making sure we support customer demand we have today and also preparing for a range of scenarios for what next year might look like.

Perfect. All right. Well, that takes us to exactly the right time. So it's almost like we practiced, but I want to make everyone we didn't. But thank you so much for joining us, both of you, Jennifer, James. We really appreciate it. And anybody who has any follow-up, feel free to e-mail me, [email protected], and we will -- one of us will get you whatever answer you need. And I wish you guys a wonderful rest of the day.

Great. Thank you so much.