Cummins Inc. (CMI) Earnings Call Transcript & Summary

Great. Thanks, everyone, for joining. Tim Thein here from Citigroup. Again, thanks for attending our industrials conference. We have a great lineup of global companies here presenting over 3 days. And continuing on that, we're very happy to again have Mark Smith, the CFO of Cummins, who's been a very consistent and long-time supporter of our conference, alongside Jack Kienzler who has the enviable task of filling the shoes of all the great Cummins IR leaders that have come before him. But -- and as we go through this, there should be something on the left-hand side of your screen. If you want to ask a question, just jot it down and I'll try and put that to Mark. So again, with that, Mark, great to see you. Crazy to think that 12 months ago, we were sitting in Miami and I just remembered 80 -- 90% of the conversation being around China and how much it was costing you as factories were down. And then, of course, you go on to put up record numbers in China, so what a year.

Yes, crazy. Again, thanks for inviting us Tim, always a pleasure. Yes, really, on the one hand, the mood now, it's a different -- it's a higher class of problem that we're dealing with, quite frankly, dealing with the rising demand in most end markets around the world and facing tight supply chains. As you say, there were shut down supply chains this time last year when it was really just starting to unfold. And with having multiple facilities in Wuhan, we definitely felt the brunt of it early on. And yes, the response from our employees and then the demand in that economy just phenomenal last year and, right now, remaining pretty strong. So we're very grateful for all the flexibility our employees demonstrated under extreme uncertainty for a period there.

Yes, for sure. For sure. Yes. Maybe -- my first question I had relates to kind of the cycle-to-cycle earnings growth and the margin improvement that you've delivered. And I was just jotting this down the other day that you've grown your -- over the last 20 years, peak earnings have compounded at a 16% CAGR over the last 20 years. If you look at trough -- from a trough-to-trough perspective, it's compounded at a similar high-teens rate over the past decade. And I think that clearly puts you in some pretty unique company within industrials. How do you think investors should think about the sustainability of this, Mark, going forward? And whether you think, I guess -- and again, not to ask for multiple out-years guidance but just how to think about the achievability of that while committing a similar level of capital that you have here in the past decade or plus, how do you think about that?

I think the landscape has changed quite a bit, Tim. So if we went back to around about 2015, we were feeling -- we've grown the top line around about 8% a year for 10 to 15 years, and that cost have been an important contributor to that earnings growth, but obviously, we grew margins faster than sales. But around about 2015, we started to have some concerns about the pace of organic growth, not that it would disappear but we could start to see a downshift maybe more towards the 5% range as global emissions regulation is harmonized. And at that time, we introduced the idea that we'd start to look more inorganically. You'll remember that quite clearly. And we did that because, well, number one, we were looking; and number two, we don't like to surprise investors. And I think as I sit here today, I feel like we've got renewed confidence in the growth rate of our base business. And I think there's a number of important themes why that's the case. Number one, the emerging markets' advancing technology, advancing emissions regulations continues to play out. We're comfortably capturing our share of that, there's still more to come. And I think we're really potentially here seeing a big change in the landscape with some industry participants, customers, peers considering whether they really want to now increase their investment in diesel to take their platforms to the next level. And so I think we, potentially, without guarantees, have an opportunity to further increase our growth in the engines and components business, particularly around combustion engines that could set us on a multiyear outgrowth track. So I would say that's really been a swing in sentiment, and it's kind of been a twist on this increased focus on the new technology that many companies are evaluating where do they want to spend their dollars. Now you know well, we've got an enormous scale advantage and global footprint that anybody else making engines just for commercial vehicle, diesel and natural gas, really struggles to match. So I think that's something that's changed. You've heard us talk a little bit frequently about that, Tom, on our earnings calls. So some of that, with the recent announcement from Isuzu, a customer we've never had access to before where we're going to start supplying them with engines here and in Japan and other parts of Asia, so that's exciting. And we hope there's more of that to come, which really -- whilst there's question marks about how long the diesel market or combustion engine markets can grow, we can see a potential path here to reopening our growth rate. And of course, as we sell more engines, we're specifying our components that yields more aftermarket. And so it becomes kind of self-reinforcing in our favor. So that's really a feature that's changed. And I think beyond that, the components business clearly has continued to do well on the rising global emissions regulations, rising market share. Still more to run in China as we move -- advance with -- vehicle systems become more sophisticated, more opportunity for transmission sales, which we're just starting to see now. So yes, all those things point to, yes, positive outlook. And of course, that feels better when you run the upswing. It's a little harder to feel and touch when you -- everybody is kind of retrenching in the face of an economic downshift. So yes, those all feel good. And then I think in the last couple of years, we've really started to demonstrate some traction on improving the margins in our Distribution business, had some very focused initiatives that are ongoing. And you can see in our guidance for this year that we're tweaking up those margins again this year. So all those things point to, yes, pretty good feeling about the core business. And as you say, it's not just the revenues and the earnings, the cash flow has really stepped up as we've grown the margins. The CapEx as a percent of sales really hasn't gone up a lot. And so we're generating more cash than we need for the core business and have continued to generate more -- to deliver more cash returns to shareholders. It's a pretty good model that we've got going right now, and we're hopeful we can add to it over the next 18 months as some of these decisions are made.

Yes. Interesting. I'm curious on the Isuzu example, are there other -- and again, I understand the sensitivity about talking about individual customer agreements or relationships. But are there other -- for a customer of their ilk, would there be other collaboration opportunities potentially beyond, I know in this case, medium-duty engines? But could that particular example or one like it extend beyond that to other components, other engine types, et cetera?

Again, with our engines, then we will be -- we are specifying those components where it's a Cummins engine design. And so there are jointly developed engines, I guess the company, some collaboration there. But yes, generally, our engines are going with our components. And again, medium-duty, that's, I think, a lot of people have said that's where we've got a massive scale advantage globally, right? We're well known in North America for our very high market share, having come from a low share over 10 or 15 years to a high share, that's been a big driver in improving performance of the company, one of several. But also internationally, we've got a lot of footprint and scale as well and more regulations coming in those markets, more investment needs. So yes, we're up to -- medium duty is where the clearest scale advantage shows itself. We think we've got other advantages as well, but that's where we've got the biggest scale advantage relative to all peers' scale.

Yes. Got it. On this notion of technology transition, this is one of the other -- another point that we talked about back in, I think it was '19 or '18, at the last Investor Day. And there was a chart that or a scenario that kind of walked through -- and I forget over how many years it looked out. But it's basically this is how we see the penetration across diesel, natural gas and EVs and hybrids across some of the major markets. And again, I recognize that predicting where adoption rates go a week from now is difficult, let alone a decade or more. But I'm just curious from your seat -- a lot has changed on the regulatory front since that point globally. Then of course, you've got some of these proposals from CARB. Do you think that if you redrew that scale, does it look meaningfully -- or that scenario, does it look meaningfully different than it did back in whatever that was, '18 or '19?

I'd say the OEMs, certainly in Europe and other parts, have made more definitive statements about the future, right, this saying that I'm not -- we're not going to be making combustion engine powered vehicles in 2040 or whatever the date is. So I think there's been more statements in that regard. I think -- by and large, I think we'd be happy to revisit that at the next Analyst Day. But by and large, the markets where we thought there'd be early adoption, that has been the markets where we thought there was less prospects for the same, being the heavy-duty truck. There really hasn't been -- so I think where the growth come is kind of as expected, but the enthusiasm, some of the future statements of conviction have increased, yet we're left in this middle ground where the economics still favor the combustion engine. So you've got socioeconomic interests, governmental interests. And at the end of the day, whether it's the operator of a truck or a piece of construction equipment, to the best of my -- they don't have a lot of dollars to invest in the new technology. New technology has to get to the point of stand-alone cost competitive. It's not surprising. That's not a ding on new technology. There's lots of examples in history where new technology costs come down a lot over time, but we're not there yet in a lot of these markets. And we use the term, [ we're out of the money ]. So in this interesting phase where conviction is rising, yet economics remain a little elusive. And then on the fuel cell side, for on-highway at least, there's more to be done. And infrastructure still is a significant question as it was 2 years ago. There's been -- in certain countries and regions, there've been more incentives being laid out to support it, but still yet the pathway remains a little bit unclear. Nevertheless, we're investing with enthusiasm in those new areas. But I don't think there's been like anything that's taken us by a surprise like where these new technologies have shown up. And I think we said -- I know we said at that time, we viewed like different pace and different paths in different regions. So we've seen steps by China to maybe start thinking about how to build out the hydrogen economy. We've had some discussions with Sinopec about how we might help that. And I think that's one of the advantage of Cummins. We've got footprint connections, reputation in multiple markets where we can -- along with product portfolio that mean we've got a few different ways to try and get different options of growth around the globe. But yes, we're in this middle ground where the economics don't yet support the conviction, not close, yes.

Yes. Interesting. Maybe we can shift more further -- more to the near term rather and...

Yes, well, I guess more within the next decade, I think, when you mean near term to...

Yes. Exactly. Yes. I meant really near term in terms of -- and just one of the key areas of discussion I've had with investors here post the results was just the outlook for and the incrementals in engines and components. And of course, what doesn't get asked or looked at is the fact that you did a lot better on the way down. So obviously, it creates a tougher comp coming out. But anything, Mark, that -- I mean the whole issue of JV income is -- it's always one that I found in my time covering Cummins that it always gets kind of overlooked and it's very impactful, of course, to the incremental or decremental equation. But anything else beyond that, that you think maybe didn't get enough airplay on the call or anything that you think -- that you'd want to highlight to investors internally?

First, I'd like to highlight -- I'd like to say like that the supply chain tensions are real, right? They're not just -- right? I think they're real. I don't think -- my suspicion is they're not just confined to Cummins. It's not just about chips. There is general tightness in a number of components, partly driven by absenteeism, strict working regimes around the world. And so our industry is working through them. So we talked about some costs in the first half of the year. We assume those go away about 60 basis points in Q4. Those -- I can tell you, January, we still have some of those costs now. We still have a little bit hand to mouth on some components. So on the one hand, it's great news that demand is pointing up in most markets. And even in China, in January, you can see from industry statistics, without me even discussing Cummins results, that demand has held up pretty well. We've always maintained our fear is more based in the second half of the year. We're really trying to ramp up. And so that's a better class problem to have, but we have had, yes, some extra challenges and costs and imperfections in the way that we're ramping up. Having said that, we've got a lot of revenue, shipped products delivered in the fourth quarter, like we almost have $23 billion annualized run rate. So markets are pointing up. Having said, we've got a few cost challenges. The more that the revenue goes up, we've got a pretty long established record of converting that into revenue. There's nothing changing dramatically in the prices of our business or the structure of our business that says, all things being equal, more revenue shouldn't equate to more profitability when we look through all those trends. As you said, the decremental margins last year were the lowest we've had in a downturn on the biggest revenue drop, partly because of some of the, yes, even tougher measures that we took on the cost reduction. So I think the message is, yes, we've been honest about some of the challenges, some are just assumptions about the future, but as more revenue comes, we're in the early part of the cycle, we should expect to keep improving performance going forward, all things being equal.

Yes. And maybe just to take that a step further, just the -- I think you had mentioned just on this issue of more on the commodity side, but price cost being neutral to on the plus side in '21. Maybe walk through, Mark, there's always -- there are certain areas, of course, where you have greater ability to push on price than others. And then I think on the cost side, maybe the team is -- the supply chain team historically has always found ways to wring costs out of that. So just maybe kind of walk through that in terms of what's -- what are levers out that you could potentially pull on the cost side as well as where there are opportunities for you to get price.

Yes. So generally, there's a little bit more flexibility in the aftermarket for positive pricing. So that will be the case this year. And then the inefficiencies and the material cost pressures will come primarily -- not only but primarily in the engine business and the components business. So those are factored into the guidance. But I would say, generally, just fewer -- we don't buy a lot of like raw metal, right? We're generally buying machine components. But there are obviously metal components in there. Generally, we have indices that we -- allow us to pass up or down the changes in those indices to customers over varying periods of time. The components business is more quarterly and the engine business is more annually, so there can be a period of lagging recovery from customers. But in -- over a reasonable period of time, we don't earn a return on metal market swings nor do we get excessively punched. But there can be some short-term lagging. And as you say, we usually have a pipeline of commercial cost downs from our suppliers and other innovation in costs that have helped us actually be positive on price and positive on cost. I think this is going to be a year where it all ends up to closer to neutral than it has done in the prior years. But yes, that's weighing a little bit in engines and components but not to a great degree, yes.

Yes, yes. I think you mentioned earlier on, on distribution -- we had the opportunity to host some meetings with Tracy back in the middle part of last year. And it was quite clear in terms of the runway that she saw from a -- just the benefits from some of this rationalization and consolidation efforts. But it feels like -- some of the margin improvement that she talked about feels like, at least in the numbers that's played through already, it seems to me like there's more to go. So maybe just kind of update us there in terms of that's becoming a bigger part of the earnings driver for Cummins, and it doesn't always maybe get the airplay it deserves. So...

It does. You're right. We've made a number of improvements and then we took yet some further, but modest, actions in the fourth quarter, again, continually refining and working our way through different parts of that business, not just what might be described as easier pickings on overhead and back office and all things -- they're all important pieces of work. But when you consolidate multiple businesses, there's opportunities to improve. But we really got more into the operations and consistency, even closing some branches on the margins that I think give us confidence those margins are still improving. And then we've had another look at other parts of the world. Like in Africa, we've made some adjustments to how we go to market there and the structure of how we participate in some countries where perhaps we were taking a little bit more risk -- economic risk than we need to. So I think, again, there's different pockets that we can keep adding to. There's a lot of focus on North America. North America is doing really well, and I'd expect their performance to keep improving as markets recover. It was a strange feature of the pandemic, that the drop in foot traffic at the distribution locations in North America was quite more marked than it was in prior downturns. Normally, we expect that business to be more resilient, but we saw a lot less kind of foot traffic coming in as people deferred service and just didn't want to, I guess, be around other people. And that's starting to recover now. We're getting back to pre-COVID level. So that was an unusual feature last year. But nevertheless, we still put out -- Tracy's team put out a good set of numbers last year, and we're looking forward to that continuing to improve here.

Yes. Maybe we'll shift to the truck markets in North America and China. But maybe start in North America, I don't know what there is to say, Mark, other than obviously, that you've got a good outlook, that it's pretty clear in terms of the momentum that we have in North America and what's driving that. But from an engine share perspective, historically, when you're in these -- when volumes are up globally, that has tended to give Cummins greater opportunity to be on the front foot from a share perspective. Any reason why that doesn't occur or you wouldn't expect that to occur in '21?

No, I think it's just a little -- yes, it's not quite clear who's having one or two bit more tightness, suppliers and others, in these early couple of weeks. But yes, generally, our customers rely on us as part of that flex capacity. We tend to get cut earlier on the downslope as others protect their own production and fixed costs. And then we tend to be able to offer that flex. Our ability to offer any more flex in Q1 doesn't exist. I'll just throw out that now to any customers who are listening. They'll know we can't. We've committed to all we can build. So it's a good problem to have. But hopefully, as the year unfolds and we keep working through this upcycle, then, yes, hopefully, we'll move at least in line with the market overall. Yes.

So Jamestown is running as full as it can right now or it's been...

Not as full as it can on full potential, but it's as full as it can given where it's -- where the supply chain has come from, being very low to ramped up at such an excessive rate. So yes, today, if you wanted significantly more engines from Jamestown or Rocky Mount Engine Plant, for this month, you probably would -- even dialing a friend is not going to help you right now because demand is robust. Again, I'm not trying to foretell horrible revenue. That's not what I'm saying. I'm just saying it's tight and demand keeps going up, which is a good thing. And as long as the truck fundamentals remain the same, then those trucks will continue to be sold, and we'll work our way through it.

Yes. And maybe shifting to components in the joint venture. You alluded earlier to selling transmissions in China. What -- maybe update us in terms of -- I think you're expecting now with all of the 4 major OEMs in North America, on the Endurant, at least on the 12 speed product. But just maybe bring us up to date in terms of North America, where you sit and then some international opportunities that maybe you're more optimistic on.

Yes. I think the Endurant's been pretty successful, demonstrated some clear efficiency advantages in North America, being very well received. And I think we're now on -- enthusiasm is high in China. I think we'll sell something like 10,000 units this year of AMTs in China. So there's no doubt the market reception has been strong. And working closely with our partner, Eaton, I think we're feeling increasingly optimistic about the potential in China, which is really the next leg. I mean so I think heavy-duty has been successful. We dialed back on medium-duty because that wasn't as successful. And now we feel like we're starting to get traction in China as the sophistication of those products are moving up. And best we can tell so far, the customer enthusiasm seems pretty high in China.

Yes. Mark -- and I will give you the opportunity if you wanted to take 20 seconds and you can have Jack fill in or you're good.

It's good. Sorry, it's been a little bit...

No, no. All good. Yes. All good. I just want to give you that potential out.