Cummins Inc. (CMI) Earnings Call Transcript & Summary

Thank you, everybody, for joining us. David Raso, Head of Industrial Research for Evercore ISI. Excited to have joining us Cummins. Brett, kind of become a tradition doing this with us. So I appreciate it. So thank you.

Yes, that's right. Thanks for inviting me again.

Brett Merritt, he runs the -- he is the VP for the on-highway business, obviously, Cummins' largest business. So definitely appreciate taking the time. And Jack, our first conference together. Welcome.

Yes, thanks for having us.

You've been in the scene for 4 months, 3 months?

Yes. End of the third month, so happy to be.

Well, thank you very much for all the help so far. So thank you for coming. For questions, please just send questions in via the chat room. Send them in as you think of them, they can just be sitting there waiting for me to read on your behalf later or I can just interject them as we're having a conversation.

Brett, I guess I would just start with that big picture question. I know I look very young, but I remember when I first started hearing about the Detroit Diesel Series 60 and the first electronic engine that was going to really hurt Cummins. And then from the ACERT engine to, obviously, Navistar with their EGR, I mean it's always been the case, Cummins is about to lose market share. And obviously, the last couple of weeks, you've had another -- a couple of examples of gaining share. Obviously, this time feels maybe a little more threatening. You have a more dramatic shift potentially in technology. You actually have new entrants coming in to the truck manufacturing. So just curious, just on a big picture view, Cummins has always gone through these, and there is always a lot of concern. And you look up and go, "Is their market share still 75%, 80% medium duty? Is it still 35-plus percent in heavy?" And now you're actually getting a foothold in Europe really for the first time on the engine. You always had the fuel injector business, right? And clearly, your positions in India and Brazil are still -- and China are just, especially India and Brazil, terribly strong. Just curious of your perspective. I know you're going to talk your own book a little bit. But just given all those challenges, how do you view this one next, say, 10, 15, 20 years?

That's kind of why I came back to this one, David, because you've been beating me up on vertical integration for a few years. So I had to come back and say those plans we had are coming to fruition. So that's long been the overhang for us, is, "Hey, will vertical integration win?" And we've had a strategy that 3 of our strengths are really the technology advancement and fantastic products. The second is scale, unrivaled. When you look at this industry, we make 1.5 million engines a year versus anyone else that's less than half of that. And then the third, we do particularly well are partnerships, which is really a lot of our success into China and India that we've talked so much over the years. As you looked at the future, this was 5, 7 years ago, we began the strategy that said, with automation, with connectivity, with all the new power needs for investment, new trucks in every market and all the OEMs trying to expand what regions, how would they be able to afford to do all those things? And one or two of them, they'd have to give up. And one thing that Cummins brings to many of the OEMs, besides scale and technological advancement and other things, is risk mitigation. And so when you think about they go through those investments and they say, "Wait a minute, there is part of this we could just partner with Cummins and still be able to win in the market." And then that obviously helps Cummins. And so you've seen this come to fruition with Isuzu and then our Daimler partnerships, which will just augment our other partnerships we have such as PACCAR and others. But it does, it allows us to grow that share in, say, Japan, Southeast Asia and then Europe, which is a net growth for us over the next 20 years. And in the meantime, we'll continue -- my job is to continue to expand and grow share within on-highway and bring profit to the company. So we make the right investments in the new technologies, which we believe is a path to zero and not an exact leap. So as you know, we think -- we believe in this power of choice. And so it's going to go across the spectrum of technologies, and there's no 1 silver bullet. And so we'll continue to invest in each of those spaces as they come up, but we think diesel and natural gas have a pretty long run. And being the one who wins in that long run is quite important to us. So we're starting to see those come.

If a large player like Daimler can say "better Cummins than us," what's the argument for others to say "better us than Cummins?" So what are those conversations like with VW or even a Dongfeng? I'm just curious where people's heads are that made Daimler willing to do it but they're not.

It's tough to say where everyone's heads are. What I will say is we always have those conversations. The goal of ours is always be in the room and always have a good relationship. And I think I've told you this before. A lot of times, we walk in and say, "Where can we help you? Where can we buy breadth, like technology scale, like geographic scale? And where do you want to invest?" And some will always invest in certain areas. We would think that there's some math behind the scale. So as you start to look at particular areas of medium duty, on the upper end of medium duty, in certain segments of heavy duty, we'd say some OEMs are under scale. And if so, why not do a partnership which both strengthens you and strengthens Cummins? Because we think we can bring a better cost at equal or better performance with them not needing to invest in that space at that time. And so I think that is an active question you should ask to many. But we have ongoing conversations, and I think this will be a pretty active space for the next couple of years.

Now when you think about hydrogen fuel cell versus battery, and maybe it's just my ignorance of not appreciating all that you're doing on battery, but it feels like the fuel cell side, the hydrogen fuel cell has gotten the greater attention, the greater focus. And I tend to agree with you that that's the better solution for Class 8 but it's not guaranteed. If you get enough infrastructure built out on battery, the total cost of ownership gets at least close enough to hydrogen, even if the density power -- the power density is not the same, even the charging is a little longer. But hey, I already built out my battery charging stations better than go through this all again for hydrogen.

Yes.

Am I right that there feels like there's a little risk to it? Battery is stronger than I would have thought for Class 8, that maybe Cummins isn't making as strong a push. And then on medium that you think would be a pretty good argument for battery, am I missing something that the medium feels a little -- this is down the road. I mean you just won a ton of medium so we're not talking imminent. But how do I think about battery versus hydro in especially your medium duty, right, dominance right now?

Yes. And what we think about, we would say we're making strong moves in both. I do think the Hydrogenics purchase put us in very solid footing regarding fuel cell. And so maybe it's a reaction to the strength of that move versus we've aggregated a few plays in battery. In battery, we've got a few more games to be played there. We're kind of in round 1 or now kind of version 2. We really don't think the right architecture or the win will happen until probably stages 3 or 4, and we'll be there. We already are in some school bus OEMs and transit bus OEMs, as you know. There's a variety of other applications you'll see over the coming years. But we will not concentrate on just one or the other. We just don't believe in that. We believe in the power of choice, and that is very application-driven. So there are particular applications, intercity, return to base. This is great for electric. And I would agree with you, once those electric charging infrastructure, which is a big project, happen, then electric would be very good in those markets. But we do see linehaul as more applicable for fuel cell and that that's where that long-term play is. So I think you'll see us play in a variety but don't underestimate that a diesel plus hybrid, 48 volt, where you use the power for either emissions or increased performance, will have a lot to play in the next, call it, 5 to 10 years. And so we think advancements in all 3 of those is really where our strength lies because there are some scale across each of them that you could utilize. And then one of our biggest strengths is less on the technological play but on the channel. So this is the old story that, "Who's going to be there 15 years from now when that bus gets repaired, engine and/or at the time, electric system swings out and they put a new one in?" And what we'd say is, undoubtedly, our global presence, and we're unrivaled in our ability to support and all those applications. And so it's that total package that I think it will take, and that's a long way to say you'll see continued investments by us in battery. But obviously, we've got a pretty strong start in fuel cell.

And when it comes to investments, and Jack, Mr. M&A from his prior life, how should I think about that statement in saying there's further moves in the game to be played? What are you -- I'm curious. With the balance sheet the company has, what kind of move should we be thinking about in that arena? Like what do you need, I guess, is another way to say it.

Yes. I can start, and Brett, obviously, chime in. So I think the way we're thinking about it, David, is to start with kind of organic R&D and then identify holes in our path that way, right? So I think we've been -- we've built up the electrification capabilities via a few different acquisitions but also a significant amount of organic spend. And even post Hydrogenics acquisition, we've been deploying a lot of organic spend that way too. And so when you do that, you kind of look at the whole value chain and identify which areas that you may need to supplement. So I think the way we're thinking about it right now is, especially in the new power sphere, continued R&D which allows us to get product out in the field and start to harness those technical learnings and then improve our product. And in doing so, you can canvas the competition in the market, canvas where your perhaps weak points are and then supplement as needed, which we certainly are in a position to do given our balance sheet and strong financial position. But I don't know that there's one piece that we're saying that "I wish I had that, let's go deploy it" in the medium term.

So given battery though obviously, I would say, can be adopted faster than hydrogen, right, so do we feel we're not falling behind at all on the battery side? Or is it picking your spot and sort of clamping down on "Hey, that's the right solution" and then putting the pedal down on that strategy? So it feels like it's something you -- and correct me if you think differently. It's not something we can wait 2, 3 or 4 years on if we don't feel we have maybe the perfect battery solution now. But when do we really go to market? Because the medium-duty market just does feel a little more at risk than -- I appreciate the diesel-hybrid opportunity, but you would just think you'd want a little stronger battery solution in the next 3 to 4 years in medium.

Yes. For me, I think it is a pick the spot and prioritization. So I think you'll see it. I think you've got to figure out what is that right stopping point as you're saying to say, "Yes, we're coming in and we're coming in strong." And we'll do so. We have the -- the fundamentals are there of our base platforms, our availability and then the idea that we can support it. I think you'll see us make that play, but it's picking the right time.

Sure. And when it comes to more components on the vehicle, when you think of an electrified axle or whatever it may be, I mean, your thought of where you want to be on vehicle. And then even going beyond kind of more broadly in the ecosystem from -- obviously, the electrolyzer brings you to a whole another arena, especially if it's not even on vehicle, it's industrial applications. But even from charging stations, whatever it may be, how big do you think when you go, "We can go well beyond the vehicle," but even within the vehicle, beyond the traditional engine? And of course, over the years, you now have the AMT on transmission.

Yes. I'll start a little, and Jack can chime in, specifically with his past M&A side. I'm not ready to write off the idea that we'll still get some tailwinds from the component additions as NS VI comes in fully, BS VI in a full market once India returns. And then you'll see AMT adopted quickly in China. So it will be a very, very quick transition because we can bring some advantages there that have yet to be unleashed and the market is getting more sophisticated and craves fuel economy and performance even more than before. And then I do think you'll continue to -- we'll continue to analyze what are some of the right solutions and are the applications they apply in, large enough to make that investment, and then decide, yes, we'll make the investment or not. And I would have to say it would be tough for Cummins to make up a full sail leap to somewhere that's not related. So you're going to see us in kind of the related platforms. And while some of the hydrogen investments with Hydrogenics move us off vehicle, it is definitely in a related way to bring green hydrogen and based on some of the same technology.

And the axle, that's something that would...

I think it's impossible. We -- again, this is the idea behind per application, which is the right technology to deliver in each of those applications. And is the application niche large enough to make an investment in that area. That would definitely fall in the world of things we look at.

And don't get offended if I'm saying this incorrectly, but the Weichai-Ballard relationship, was that part of the impetus? I mean Hydrogenics is working out great, so regardless of the reason that pushed over the edge to buy it, who cares at this stage. But I'm just curious, the Ballard-Weichai relationship, does that have some influence on maybe your perspective of China's adoption of hydrogen and obviously, you wanted to get it on the hydrogen fuel cell once Weichai got in with Ballard?

I don't know if it was causal or not. What I would say is, as we looked at that landscape, we believe you could either go about it as partnership or full acquisition. We had chosen acquisition, and Hydrogenics proved out to be the right partner. I do think it's going to be a large-enough market in a big enough world that there's plenty of space for a couple of players. So it doesn't -- much like our [Audio Gap] used to come here every time and everybody made it their own engines, and we've still found a way to succeed. So the fact there's another well-thought-of hydrogen group, I think that's fine. I think it will promote good competition and that we can still win with our base partnership. And so that's kind of how we look at things. We'll treat people well, and via our partnership with Hydrogenics, I think we have a full portfolio to be able to offer any of our OEM partners.

When I think about the Chinese market and the adoption of battery and then eventually, hydrogen, how do you perceive the adoption of hydrogen versus battery in that market where the units are just massive? And I'm curious wherever maybe China decides to go, it creates such scale, it almost then lowers the cost to then drive that technology in the European market. So I'm assuming China is going to drive the entire global market, but those are such huge volumes. If you wanted to get scale on fuel cell, that's the place to get it. But what do you think about China's adoption of hydrogen versus battery over the next 5, 10 years?

Yes, it's interesting. It looks like China will go towards hydrogen. That would be imminent. They already are battery-electric adopted, if you look at the transit bus market. I mean the Chinese transit bus market is as large as the entire global transit bus market, and it's been at least 57% BEV for some time. What we have not seen that do is being able to translate into larger share elsewhere around the world. There are some bits and places you can go, but it hasn't exactly been scalable. And so it'd be interesting if hydrogen translates to that or not. And what we'd say is I think the technology is developing so quickly that to build scale -- this goes back to what I said. There's a few games to be played, and maybe stage 4 is where scale can actually be built. It doesn't hurt, no doubt. But given our scale on other things, I don't think we're completely reliant on China scale alone. And so I do think there will be large success in hydrogen in China. It will be pushed by the government and the market. And then we'll likely be a player. Whether that scale of whoever starts to win early on there translates into wins in the rest of the market, I think, is a little bit of a big leap based on the precedence.

Okay. Well, I like that you have the Hydrogenics and letting Weichai run with Ballard way ahead. So I'm glad at least you have it in the arsenal. On the shorter term, the supply chain issues in North America, are you having any customers truly just say, "We have enough trucks parked waiting for a final component for assembly" that they're actually pushing back on Jamestown volumes being sent? Or is it just -- and we're just not able to ramp up the way we would have thought? And that's the impediment. It's not a true stop or really it's not very disruptive. It's just simply restraining the upside. Is that a fair way to characterize it?

Yes. I wouldn't say any -- and it's not any one OEM, and to be honest, it's not any one market. This is going to be a global issue. Definitely, the North American market, the return to a relative high is the fastest in 35 years. So we had the most drastic downturn, and we've had the most drastic upturn. And what that does in the supply chain is quite disruptive. And so it's ripped all the extra inventory that normally allows us to operate pretty efficiently. And so it's a bit of a game of whack a mole with a number of issues that the general supply base, including ours, has, and this is Tier 3, Tier 4. And so I do think it's your latter case, where there's disruptions. It's not -- as you've noted in our financials, it's not operating how we would like to nor most OEMs are operating how they would. But we haven't seen mass shutdowns where someone's saying, "Hey, we won't take any more engines." Likewise, we haven't had mass shutdowns. But it does cause a lot of work, and we've been working this for a long time. And realistically, there's a fair amount of work left to do, given the number of suppliers that are in this shape.

I know the Cummins definition historically did not include the baby 8s. But like ACT terms, if I asked you, what do you think the max build capacity for the industry is this year in North America?

It's a good question. We haven't -- you know us, we haven't exactly answered it. We would say our group 2 and then you can add on -- we could add on the group 1. But this range were given of 245,000 to 265,000 group 2, it's possible we produce that as an industry. I don't think you go much beyond that. We're going to have to have some time to get the full supply base in better shape to go beyond where we're calling it. So I don't know what ACT number you're referring to. But if it's above that type of basis, that will be difficult.

Yes. No, I'm just curious if -- that sounds like, in ACT terms, not even quite 300,000, really.

No, it wouldn't be 300,000.

And I'm just thinking if the customer -- or your customers aren't willing to open their order books for 2022, we know where the backlog is. I mean how many more orders are they going to -- can they take, right? I mean they're already starting to scrub the dealers' orders already, right? So you're going to see some cancellations move up after February, not in February as much. But -- so...

Yes. I think that's the pinch the whole industry is in right now. How will we deal with this? And then the question is does it make the cycle last longer? Or what happens? And I think that will be decided over the next probably 3 months.

Yes. The Chinese market, NS VI, NS V, what percent of your orders in China are NS VI now?

I don't know if I -- do you have an aggregated view of that, Jack?

No, not off the top of my head.

Is it a minority? I'm just trying to figure out how much is this 5 -- NS V prebuy versus the government was providing some incentives to buy the NS VI? Isn't more of your order book is NSVI? It feels more -- one's view of the second half of China is more of a macro view. If it's they're just buying a ton of NS Vs now, you know there's a sharp dropoff after July 1. And I was just curious. Are you majority or minority NS VI?

We're a minority NS VI, to be open. I do think it ramps up over the next couple of months, and then I do believe it will be a July conversion to NS VI. It's a little bit why we're calling the market where we call it, and we know we're a bit more bearish than most. But we just think the Chinese market don't support the 1.5 million units that went out last year, and so at some point, that comes a bit down. Again, we're not calling massive declines or anything. But particularly as you introduce a new emission standard, which we have fully capable, we've been selling them now for over 6 months, the products will do well. But any time a product increases in price due to content, which is additional emissions content, we have yet to see a market that has continued to boom with that introduction. And again, it may not be forever. We do think there's some months of impact. But we -- it's not emissions alone. It's just base fundamentals of the market. You would think that they have to slow down some.

And your comment earlier about the AMTs at least suggests to me it's not 1,000 going to 4,000. It's 1,000 going to 10,000, 20,000 pretty quickly. What's the average price point on an AMT in China? Is it as low as 6,000, 5,000? How low?

I don't know if we've named what, but it's in that range-ish of an addition. So you'll have to prove it out in fuel economy within the first 18 months to the end user. And why I say fast adoption is you're starting to see -- few dynamics will help it. One, you're starting to see larger and much more sophisticated fleets in China. They're pulling not only new technologies like that, but they're also pulling for particular performance of brands such as Cummins through the market. Much as you've seen in the North America and the United States. Not near to the degree -- remember in the United States, 60 fleets represent 33% of the industry. It's nowhere near that. You're talking the top 60 fleets probably represent less than 10% of the industry. But again, 10% of 1.3 million units is a pretty big part of the industry. And so you will see that group of people pull for sophistication, fuel economy and increased performance. Second, if you've seen the adoption of China of many parts of our business, it has been rapid. So when I started doing this 15 years ago in China, the average heavy-duty engine was 6.7 liter. Now the average heavy-duty engine is 13 liters. You've not seen that rapid of a conversion into higher technology anywhere else in the world. It took the United States and Europe 30 years to do that. China does it in 10. And so we would anticipate that AMTs will follow a similar curve, which is relatively steep in comparison to the U.S. or Europe.

India and Brazil, anything derailing which should be off of terribly easy comps? A big bounce back here in India. I feel like there always could be some credit issue or some political issue that arises. But does it feel like it's a pretty safe bet, it's a big double-digit growth rate?

You would think there'd be pretty strong -- there will be pretty strong growth in India. Supply chain concerns, it's global. Remember, we work off a globalized supply chain on many of our core componentry, and so that will be the only thing that holds a Brazil and India back. But India, definitely, off of what is incredibly low, will be in. We're already seeing it on a month-to-month basis now. This first quarter, our quarter not the ending quarter, is a much stronger quarter than, say, if you compare it to Q2 and Q3 of last year.

Yes. And the challenge with the Mannheim facility that you're building within the Daimler facility, serving -- I assume, serving more, out of your own factories in Brazil and India, their needs. Anything I should be concerned about a hiccup to -- I mean the German Work Council always brings unknowns, I would say. But that said, just your ability to ramp that up and do the Daimler deal, anything makes you concerned like big decisions, you have to add another facility in Brazil? Or is it not...

No. Unfortunately, in 2012, when I first kind of came into this role, we produced more than the entire industry uses in engines right now in Brazil. We have plenty of capacity in Brazil to be able to flex up. We've obviously brought that down due to meeting cost challenges over the past few years. But we can ramp up in Brazil. And then in India, as you know, we have 3 plants by which we produce our medium-duty engines, and we have the full capacity to do it. So I don't think we will be the issue, and we'll have plenty of time to do it. We feel pretty confident about what's going to go on in Mannheim as well. It's early days, lots and lots of work to do. But remember, we've done wholly new joint ventures all across the world. And this is not a joint venture. It's our own plant within a facility, but at least we have the teams, wherewithal and systems to be able to do something like that. So we feel pretty good about it, but particularly good of the 3 or 4 regions where we're just adding scale off of investment we've already put into.

Last question for me. If I thought of a VW, and you're not going to call out future partnerships right now on this call, but are we at a point where some of these next wins would actually require significant investment? Or do you still have enough capacity that you could take on another, you name the percentage, of global medium or heavy market share and then you could just fit it right into your -- generally speaking within your current footprint?

So I think there's a couple of different ways to look at it. If you looked at it as our strong markets of U.S., even taking additional Australian demand, Latin America, India, China, those can be done relatively easily off of current investment. As we expand in the new -- the markets where we have been weaker, like Europe and Japan, we'll have to look at some investment. That's an investment from a manufacturing capacity perspective, which isn't really our largest driver of investment. The largest driver of investment is our research and engineering. And that should be completely synergistic to what we're already doing. So we're already making the investments. We're just adding more volumes in the investments we're making, and that's the essence behind it. So there will have to be some scale added in certain regions, depending on the product line. But by and large, we're really leveraging this initial investment we do in the core, right?

All right. We are out of time. Thank you very much. Really appreciate it. You guys have a great rest of your day with your meetings. And anything I can help with afterwards, don't hesitate. So...

Okay. Thanks, David.

Well, thank you. And thank you, everybody, for dialing in. I appreciate it.