Cummins Inc. (CMI) Earnings Call Transcript & Summary

Great. Well, thanks, everybody, for joining us for this 2:50 Eastern session here at the Barclays Industrial Select Conference. My name is Adam Seiden. I'm the U.S. machinery and construction analyst at Barclays and our equity research group. We're pleased to have with us in this session Cummins. Joining us from Cummins is Chief Financial Officer, Mark Smith; as well as from the IR team, we have Jack Kienzler. So just some administrative housing notes here. For those that have participated in person with us before in Miami, we generally do -- we normally do have an audience response system. That has been moved virtual and online, and you'll see that to the right side of your screen. If you could take a few moments during this presentation to fill up those questions, we would certainly appreciate that, and we'll be happy to share with you the results on the back end. One last thing also. [Technical Difficulty] Okay. Sorry about that, folks. Just some technical difficulties on our side. So for those that want to ask questions, please send a message to adam.seiden@barclays.com, and I'm happy to answer those questions -- or ask those questions for you. So with that, I wanted to welcome Mark Smith from Cummins. And Mark, welcome back again to our conference, albeit virtually. And for those that are new in the room, if you wouldn't mind just giving a quick a quick overview of what the company is, and then we'll dive into some Q&A.

Will do, Adam, and thanks for inviting us again this year. So Cummins is a global power provider, yes, in the ballpark of $20 billion-plus of revenue this year. Broadly, 70% of our revenue is serving commercial vehicle markets on-highway and roughly about 30% off-highway serving construction, power generation, mining, oil and gas, agriculture and other markets. I better mention them all, otherwise, I'll be in trouble back at base. Yes, but basically, we've been historically providing diesel, natural gas engines and related systems, and then over the past few years, also increasing our investment in battery electric and, more recently, in hydrogen-based technologies for the future. So that's -- we are basically supplying most of the largest global truck OEMs, some degree of product in most parts of the world, whether that's through our wholly owned operations or our joint ventures.

Great. Well, so first off, congratulations on a nice year, particularly given the circumstances. You guys deserve it. You picked up CFO responsibilities in 2019, and you're immediately created with the prospect of a truck cycle and then COVID. So welcome to the job. And it also -- you saw a pretty nice size decline in dollars for Cummins on sales. Now with that all, Cummins has handled it, I think, pretty admirably. But my first question would be about how did the preparation for an eventual cyclical turn do you think that helped Cummins prepare for what happened to be a very tough time for the industry and for the business as well in the last year.

Yes. I think you [ ticked ] an important point. I think the key was we'd already started preparing for a typical -- whatever typical cyclical slowdown is at least the core markets in North America, called that out, said we had a plan, executed that across multiple parts of our business. And what that meant is when we got to the depths of uncertainty here around about the end of March, April time frame, we pulled some extra temporary levers, but we didn't have to make any more kind of knee-jerk reactions to disrupt the overall kind of ongoing performance of the company. Because a key part of what we do is long-range engineering, right? If we disrupt those programs or our workforce too much, that can have longer-term consequences. So we were able to adapt. I mean, we've got a leadership team through multiple cycles now. This is my 25th year. That's not unique at Cummins, lots of long tenure. We know what to do. And the principal challenge, how do we reprioritize and what do we go faster on and what do we go slower on so that we don't shut up all the future opportunities while we're managing through. And on top of that, we had some particular issues within the distribution business. We've had momentum for a couple of years. We've seen nicely growing margins there as well, which were separate to the broader restructuring. So overall, yes, we reacted well. Remarkable that we went from shutdown in operations in China in February and March, to all-time record performance. And yes, we have a lot of operations in Wuhan itself. So to think that we could end up with a remarkable set of results that we had, hats off. It's been a tough year for many employees, and particularly our people in supply chain and manufacturing basically shutting down globally, and then ramping back up at the fastest pace in company history. As you said, it was the largest decline in the company's history for the full year. But then in the second half of the year, the fastest rate of ramp-up. Yes, challenge, better [ class ] of problem to have going into 2021, and we can count up with our global employee base, kind of look upwards now and onwards. And yes, it took some extra actions to push that over the long-term liquidity and financial strength as well. So overall, it seems more orderly now when we booked all the numbers. But yes, March and April was the most unknown period we've had, I think, in our history of what was going to happen next.

Got it. So the company has certainly made a point of growing -- or being able to grow earnings trough over trough and has done a great job. For now, though, with the market trending up, I just want to take a look at the other direction because, like you said, you've seen a very nice size snapback. So when -- if you start looking at peak on peak, I mean, how much is -- I don't know if you can answer this, but how much above prior company peaks should we be thinking about Cummins being able to grow the business, having done what you've done on the ops end of the spectrum here?

Yes. So I think we're always trying to drive those incremental margins as strong as we can. We've talked typically about trying to drive 20% plus over the long run. It's ironic, we finished 2020 with $12.01 EPS. $12 used to be some of the peak estimates right among some of your peers for our performance. And again, we didn't know that. Back in '15, we were being asked if we could ever get back to $9 again. I think the key is we found ways to keep growing at it. So when the truck sit, even if when they're really deep, we're troughing -- even if the markets themselves are troughing at similar levels, the overall revenue level for the company is troughing it. The trucks are getting shallower for us. And so therefore, we've got more potential on the upside to keep growing. The emerging markets have been an important part of our story, never more seen than last year with record performance in China. Still a few more late legs to go with -- particularly in the Components business here. And then I'm sure we'll get on the new technologies in a moment, but we've believed for a long time that we've got a compelling economic case to convince customers to have us make more of the combustion engines. Again, as also the new technology, and you saw recently the announcement with Isuzu, found a way to convince them. There's a win-win there. And we're hoping to do that with more customers so that we can keep growing in the combustion engine space for quite some time to come because, today, that's what's paying all the bills. That's what's generating more than 100% of the cash. We don't need all of that cash in our core business. We can fund the investment in the new technology and return cash to shareholders. So yes, we are definitely trying to squeeze more out. The big push and pull in the company is really squeezing more out of the base and enhancing its future prospect while funding that new technology. And now those discussions are a lot harder when the revenue is down. And it's the easier when the revenue is up. You still have to make good decisions, but it's a little bit easier. That's the basic formula. So as the revenues go, the incrementals and decrementals, little odd last year, was extraordinary because of some of the measures we took. But I think if we look over a multiyear period, we'd set by those longer-term trends. I think that, that's 20%-plus incrementals on the way up. And hopefully, we keep growing that top line of the company in both various cycles. That's the way I think about it.

Got it. And you were talking about squeezing more out of the business in the base business and so forth. And certainly, on the call, you were talking about the potential to get back to that low 30% range incrementally if you get a 5%, 10% kicker in sales. So I guess the question is, from your view, what will it take to get sales higher? Because like I think about from like -- you mentioned Isuzu earlier, product wins, is that too -- is it too late to get new product wins that affect 2021? Or like, is it going to be a matter of the supply chain and clearing up for some of your customers? Just trying to get a sense of like what are the different avenues that ultimately would make you more constructive on some of the growth in the business.

I think right now, we're in the eye of the up cycle, right? We laid out our different assumptions, but the honest answer is we've just come up a couple of quarters of the record ramp-up. So yes, it's really the markets themselves -- we can add to that, but the markets themselves are going to drive most of the growth. We've already positioned our products and our Components business now with the new regulations. So really, it's a battle with the supply chain. And I think I'm imagining it's not only Cummins that's seeing some tightness in the supply chain right now. Part of it is specific. Part of it is just general absenteeism of restrictions on COVID-related work environments. Again, we battled through. Our Q4 revenues 2020 annualized were $23 billion, not far up, kind of in a record pace. It's hard to imagine, 6 months, but that's where we were. And yes, a lot of markets are moving up, so that is putting pressure on supply chain. So far, we've managed through. It hasn't been perfect, but it's added a little bit more cost to our business, quite a little bit more stress on the supply chain side. But I think that's the barrier to going significantly higher. And it feels like demand is pretty robust in a number of markets as we speak today.

Got it. So maybe just to dive into some of the regions on China. You guys gave your assumptions. You gave plenty of great forecast for us to model off of and think about. And one of those was in China. You were talking about a second half slowdown, partly regulation driven, and then potentially lower government stimulus for some of the off-highway stuff. So given how that business has defied expectations over the last couple of years, just when do you feel like you guys have true visibility on what the order flow could be for that? Or is it not until it kind of happens sort of thing in that region specifically?

Most of our on-highway markets, we're operating on like a couple of weeks lead time. So we're very much -- backlog doesn't really exist. And that's one of the things our customers value from us, is the flexibility of our supply chain. But I would say sentiment is cautious in the second half given China has been on such [ tear ] on multiple end markets of what we might call the older economy, industrial economy. But those are not facts. That's an assumption. It's a big one. We made it visible to investors. It's not here yet. And so partly, it's driven on just every time we stare at the chart, it's gone to levels we've never seen before on the back of a couple of strong years. We know what usually happens in most of our markets [indiscernible] or the leveling off in the need for extra trucks. And then there were incentives last year for scrapping vehicles. We think that added about 300,000 units to the market size. And then the price of trucks should be going up in the middle of the year to account for the new emissions regulations. So generally, that's a combination of factors that suggest to us it's plausible for a significant reduction. But probably China, more so than any other market, the government stimulus has an effective way of impacting parts of the economy more than we see in other parts of the world. So that's kind of the [indiscernible]. But for now, you can see from the industry data, January remained fairly robust.

Fair. And just -- maybe just on the emission standards, I think it was helpful on the call, you guys gave some good color as far as what after-treatment revenue could mean, and it's around $250 million. So could you give us a sense of like what type of [ time line ] this creates? Or like what -- how many $250 million opportunities are there? Or just in general, how long does this take to play out over time for folks like yourself?

I think between China and India, that's probably another 12 to 18 months before we get back to reasonable market sizes again and then see those markets fully adopt. And yes, one of the great things about most of the emerging markets, when they enforce a regulation and technology is being adopted, I think social pressure has changed in developing markets, just like it's changed in developed markets. And so there's a big push to clean up the environment through cleaner technologies like we provide. I think beyond that, we continue to see progression in vehicle and equipment development. So we've got high hopes for the automated transmission business and our joint venture with Eaton. Again, that was the goal. We thought we had good strong partnerships in China and technology in the JV. We thought that would be a good combination, and we're starting to see a lot more interest there, sophistication and move towards total cost of ownership increase. So that's definitely one area where we continue to grow. And then again, we'll talk more, I'm sure, about the New Power. We've got a lot of relationships in developing markets. So maybe we can't call China developing market anymore. It's a big market, maybe more so than a lot of the Western players, and we -- our Components business, I think, stacks at very favorably compared to others in our industry, partly because we've got these big engine partnerships. And that's leading here. You've seen -- maybe saw a little bit about our ongoing discussions with Sinopec. So as China starts to build out alternate energy economy, can we be a good partner in facilitating that? Certainly for international companies, we think we've got as good a prospect as anybody else to help combine with some of the new technologies that we acquired over the last couple of years.