Cummins Inc. (CMI) Earnings Call Transcript & Summary

Okay. Good morning, everyone. Welcome to today's discussion with Cummins. I'm Jerry Revich, and I'm delighted to have with us a strong presence from Cummins. We have Jennifer Rumsey, President and Chief Operating Officer; Mark Smith, Vice President and Chief Financial Officer; and Jack Kienzler, Executive Director, Investor Relations. Thank you so much for joining us.

Thanks, Jerry. Good to be here.

Good morning, Jerry.

Mark, welcome back. Jennifer, Jack, nice to have you with us for the first time.

Jennifer, I'm wondering if you could just provide an introduction to folks who haven't had a chance to get to know you yet in this virtual environment. And if you could, just also outline how you folks are seeing the recovery progressing globally across the business.

Sure. Thanks, Jerry. Hello, everyone. As Jerry said, I'm the President and Chief Operating Officer for Cummins. This is my 22nd year with the company. I moved into the Chief Operating Officer role a couple of months ago. I've spent my career working across a variety of the Cummins businesses, a lot of time in our technical organization. I was the Chief Technical Officer for 4 years, then moved to lead the components business and then recently into the COO role. And just as an interesting side note, I started in my career working for a start-up company that was in the fuel cell space before I joined Cummins. In terms of what we're seeing in our markets, I think the headlines are we're seeing a really strong rebound and strong demand across many of our markets globally off of what was, of course, a very low point in the second quarter of last year. And that strong demand that we see globally is leading to supply constraints, which is the key thing that we're focused on right now. So when you look at the North America truck market, we see generally low inventory, strong order demand, lots of positive indicators in that market. We're forecasting the heavy-duty market to be up 45% in 2021 compared to last year, medium duty up 35%. The China market continues to be quite strong after the drop-off due to COVID at the start of 2020. We've had a record year last year in China, and it stayed quite strong into the first half of the year. We believe that we will see a drop-off as we go into the second half of the year with the emissions regulatory change that's happening in that market. And so we're seeing some growing inventory of the current NS V product that we think we'll sell off and lead to a drop as we go into the second half of the year. Pretty good recovery in India in Q1, continuing to watch the India market as well as also India from a supply chain perspective, given what's happening with the COVID pandemic right now in that market. But -- and nice recovery in construction, mining and power gen as well. So as I said, strength across a lot of our markets that led to our -- taking our revenue guidance for the year up and really focused on supply chain and working to keep up with that demand that exists for our customers. And we're seeing many of our customers are also, as you would expect, dealing with their own supply chain challenges. So that's really headlining what's going on operationally right now.

Terrific. And then can we talk about your top strategic priorities over the next 3 to 5 years? Obviously, we're not that far removed from a timing standpoint from the Analyst Day, but it's been, in reality, a pretty eventful time period. So can you just talk about how the strategy has evolved from what you folks presented at your last strategic update?

Yes. I think we do see some of the key strategies that we talked about there really starting to evolve. In particular, we've talked about this trend as our customers are facing the need to invest in all of these different technologies for the future whether it's 0 emissions technologies, vehicle autonomy, safety systems. And so increasingly, conversations around using our engine. We have a strong global presence with our engine and scale around the world. And so increasingly, there's interest and we think a big strategic opportunity for us to grow our position in the internal combustion engine market and also in our components business as a result of that. And you're seeing that play out in some of the announcements now on new and growing partnerships. So the global medium-duty partnership with Daimler, the growing business that we have in our Isuzu partnership as well as the Hino announcement. And so that growing our position in internal combustion engines and components is one key part of our strategic priorities over the next 5 years. And then the other one is really looking at this -- what we call the path to 0. So how these -- the technologies and products will evolve in our markets and investing in both those 0 carbon solutions in our new power business, which include battery electric vehicles, fuel cell as well as electrolyzers that can produce green hydrogen. And at the same time, we think there's opportunities in our core businesses for reducing the emissions impact of the internal combustion engine and as we continue to grow our position in that market to add content and reduce the emissions impact. So those are really 2 key areas that we're focused on from a product investment and partnership perspective right now.

And I'm wondering, can we talk about any white space opportunities that you folks see emerging for your business from rising technology adoption? Would you have any interest in expanding in areas like autonomous technologies or other potential emerging technology-driven profit pools?

Yes, we're continuing to look at our -- what we think are our key capabilities and how we leverage those. And largely, we're focused in the areas that we are today, but we continue to explore more broadly in the powertrain if there's components opportunities like we did with the Eaton Cummins joint venture expanding into transmissions. And then in the new power space, with fuel cells, that technology is also very closely connected to electrolyzer technology. So that is one adjacent growth opportunity for us that we're pursuing with both PEM and alkaline electrolyzers for hydrogen production. We see a lot of interest in that market, in particular, growing in the coming years.

And for EV in particular, are there any gaps in your product portfolio from a capability standpoint or product availability standpoint that you folks are considering filling inorganically?

Yes. As you are aware, we've done quite a bit over the last 5 years or so in that space, forming that business and several acquisitions to try to build out our capability in both the battery electric vehicle as well as fuel cell. We've also got a partnership on hydrogen storage. And so we continue to evaluate the -- how that business will evolve, what our customers -- the business model with our customers and the investments that we need to make, whether organically or inorganically, to provide key components as well as a full electrified powertrain solution.

And then what we're seeing, Jerry, is really different models and pace of investment across different parts of the world. And I think that's where we feel Cummins has an advantage with our global footprint. We've got -- yes, we've got credibility in the markets we already operate in, but we've got a footprint and a reputation that we can leverage into new parts of the industrial economy. And I think that's one of the advantages of being associated with a big global company today.

Yes, the -- sorry. If I can just add to that, Jerry. If you look across these different global markets, the pace of adoption is going to vary, right? So our ability to be focused on the places where we see early adoption and build our capability and then leverage that across different markets around the world over time, I think, as Mark said, a unique position that we have, coupled with the fact that we have a strong service and support network and reputation to stand behind and support our products and customers.

And then we've got a demonstrated capability to build partnerships, maybe more than the average industrial company across geographies. So I think that kind of mindset of win-win with our partners has served us well, and we hope that's something we can leverage going forward.

And Mark, I just wanted to follow up on your point. What you folks have done really well is complement the product lineups for engines for your customers, providing everyone with medium-duty engines in the U.S., as an example, 15-liter engines in the U.S. where they didn't have scale. What does that picture look like in an electric vehicle environment? So how do you view as potential lower-volume applications on an individual basis where you folks can aggregate volumes for the industry? Can you expand on whether that's, a, the framework that you would think about for your EV presence? And b, how do you think about the equivalent of these engine sizes that we would typically talk about for the core diesel business?

Yes. I'll start off, and Jen can weigh in on the technology side. But what I would say is, Jerry, even though we have a lot of scale, we also have a lot of different customer applications. And whilst people focus on the unit cost of producing something, it's really been our ability to leverage our engineering investment and capabilities across multiple markets, different regulations, different customer applications that we think sets us apart from many. And I think that's often overlooked. A bus is not a bus. The bus -- even within individual markets, the duty cycles, the operating conditions vary greatly, and we've got a lot of understanding of those applications that we think serve us well. We think that there aren't going to be big lights, which is in the near term from one technology to another. So offering this whole suite whether it's more advanced diesel, we're still advancing diesel and investing in diesel. Natural gas we think has got a bigger role to play in a number of our markets, hybridization and then more to the new power. So I think it's probably going to be a long journey if you're betting on just one windfall in one technology is our view. So we're investing across that range. And the great news is because our base business or the combustion engine business today is going to continue to grow even if the overall market for combustion engines is approaching a peak at some point, our earnings power is going up. Our cash flow generation is going up. So our ability to sustain the investment, I think it's all kind of self-reinforcing. Doesn't guarantee a success, but at least we've got the financial wherewithal to have the patience and invest in those right technologies.

Yes. I think -- as Mark said, I think we do have a unique position to create scale, whether it's in the technical investments or the manufacturing side. And then that, combined with our strength in partnership, I think both of those provide a benefit for us through this kind of adoption period. The exact solutions are not all the same. So understanding what's the unique requirement for different markets and balancing that against ability to leverage scale is what we're really trying to make sure we understand.

And somehow, any new entrants are going to have to have access to somebody's distribution network in my opinion, right? One of the beauties of Cummins is we do have an extensive distribution network that we can leverage. So that's not the only factor in new technology adoption, but I think it's an important one and will require -- it takes decades to build up a global distribution system. So it's going to be interesting to see how some of the models evolve over time. But certainly, we've got that ability to scale up in China, in Europe, leverage some of the footprint we've already got.

And presumably become vertically integrated and buying a truck maker would still be off the table for you folks the same way it has been off the table for diesel, correct?

Yes. That's not…

Yes. That's not our intention.

And Mark, in terms of your focus from a free cash flow standpoint has been lots of cash return to shareholders. And can you talk about what the M&A pipeline looks like for you today? You've been at the very high end of the range in terms of CFFO that you've allocated towards cash returns. How does that look going forward over the next couple of years based on what you see in the pipeline?

I think for the core business, that's the base case, Jerry. The exact amount can vary from year-to-year, but the simple reality and it's a good reality is that the core combustion engine business generates more cash than it needs. And we've been able to return those record levels of capital without really taking any strategic options off the table. So yet more -- we think that's important to our investor base today, and that's our base case. Again, could we engage in some inorganic activity? Absolutely, but our base case is not to become serial acquirers. And if anything, since we started talking about inorganic activities, that 2015 time frame, if anything, our confidence about organic growth has gone up. So I know we've been talking for a long time about winning more business in combustion engines. And investors have had to be patient to hear about some of those announcements, but there's clearly a lot of earnings momentum there over a period of time, not a windfall tomorrow. So between what we've got today, which is going to keep growing for the quite foreseeable future and the investments in the new that's -- there's a good combination of both being able to fund a new or keep returning that cash as the base case.

And Mark, I know you're not a proponent of high organizational complexity, but I have to ask the question. There's been a lot of capital raised for new power type assets and aggressively deployed towards building up those businesses. Is there any scenario under which you would consider essentially raising equity via the new power segment on its own? Obviously, you're able to generate more than enough cash to fund the business today, but is there any strategic case where, you know what, you would consider raising external capital to accelerate the growth?

I think some of those dynamics have been quite interesting to watch. I think our primary focus, Jerry, is what does it take to make this business successful for the long run and how do we position it. And so far, we have done some inorganic activity, and we've really been consolidating around the purchasing of other companies. But if -- I guess, if we saw a compelling need to really accelerate the future of business, we could consider that. But right now, we've been very much focused on -- it's really technology development is what we've been focused on right now, and that's all been manageable within the footprint. But again, we have to be generally open-minded about what does it take. When we thought our organic growth story was weakening, we at least said we were evaluating inorganic options. Since then, we've been able to accelerate the organic growth. So strategically, we do consider a lot of different options. But so far, we've been very able to manage the investment in both. And I think you know us pretty well, Jerry. We don't rush into decisions, and we're not -- we're in things for the long run. So very much decisions would be based on the longer run needs of the business.

That's clear, Mark. And Jennifer, can we talk about your focus for the organization from here? While you've been in charge of components, we've seen big improvement in margins and a pretty good share gain momentum. And I'm wondering, as you're, I think 3, 4 months in into your new role, how would you counsel us to think about your priorities for the organization from here? And any pivots in terms of the opportunity set that you're looking for operationally?

Yes. Thanks, Jerry. I think, yes, a couple of months in, I'd say there's kind of a couple areas I'm really focused on. I mean first and foremost, the operation today. We continue to operate within a pandemic, keeping our employees safe and healthy. We've got an amazing group of employees that have really stepped up through all the challenges of the last year, and those challenges are now behind us. And we talked a little bit about, at the beginning, the supply keeping up with demand and the supply challenges that we've had. And so just making sure we've got the right focus there and connecting and showing care for our people and keeping them motivated is one. And then second is this growth strategy that we've talked about. So coming in now with my perspective, in particular, I have a strong technical background. I know our products and customers pretty well. I feel like we're at kind of a unique time emerging from this to just look at this future strategy and really assess what does it take for Cummins to be successful for the next 5, 10 years and how do we position the company to do that. And even as we emerge from the pandemic, what have we learned? And what does that tell us around how we want to operate and work differently going forward? And so that's really where I'm focused on in kind of bringing this blend of business and technical background to the role as I approach it.

Terrific. And can we dive into a topic that you folks alluded to earlier, Mark? The patience has paid off in terms of the contract announcements from Daimler and Hino that you spoke about. So pro forma for those wins, can you folks talk about where your global medium-duty on-highway market share would track today if all of those new platforms were to transition today? And also, can you just talk about over what time frame would you expect to hear from other manufacturers about their plans for these types of products?

Yes. Again, I'm very focused on the dollars and cents, Jerry, right now. So I don't have the global market share to hand. But you're talking about, with the announcements we've got going, maybe an 8% kind of increase in our global volumes based on our current projections of what those kind of businesses could yield. And I think we're somewhat unique, right? There may be 1 or 2 with the independent engine manufacturers of scale in emerging markets. But on a global basis as a trusted supply chain partner, we're going to be unique, certainly in the engine space in terms of this kind of good situation we find ourselves and where we're really going to outgrow. And everyone tends to focus on the engine business. I know that the components will come along with that since we're going to be -- we specify those components along with the engine. So I don't know the exact share numbers, Jerry. But it's -- obviously, it's going to be going up. We have to work hard every day to meet our customers' expectations, but we're fortunate. We've worked hard over decades to be this trusted partner. And it's going to be -- it's an unusual situation where we can talk about a decade now of outgrowth. It won't land immediately. It's going to be in the second half of this decade, but it's very unique in our industry to be able to talk about that. But the exact share, I can't -- depends on a number of things, but it's going up, and it's going up in multiple regions. That's the base case now.

And in terms of when we saw this dynamic playing out on a smaller scale in the U.S. medium-duty truck market, just the increased volumes just gives you folks much greater scale, and at least in the case of the U.S., seeing the rest of the market essentially go to you because of the volume leverage that you folks have been able to create. Is that how we should be thinking about in terms of the impact on the global medium-duty market? Is it -- or are you seeing folks essentially accelerating the pace of their decisions because they're reading the -- where the tea leaves are falling and nobody wants to be on the short end of the stack from a volume standpoint in a lot of these markets, I would presume.

I think there's really -- there's 2 things driving it. So yes, as you said, this ability to maintain scale, right, and ensure security of supply over time in this area is certainly one. The other one is the reality that there's a need to continue to invest in these internal combustion engine platforms along the path to 0 because there continues to be emissions regulations and customer requirements. And so our strategy has always been the combination of, I'd say, technology, leadership and scale advantage, have the best product and have the best product in the market. And that was a key driver of our success in U.S. medium-duty as best product and then the scale advantage that we created here. And that continues to be, I think, the focus as we expand that into other markets.

And I think the other thing not to forget, Jerry, just as that decade of outgrowth or more comes, then there'll be an aftermarket annuity that keeps growing. That isn't an enormous growth number every single month, but it is an important -- and for all those who ask questions about new technologies and business models and economics, all really good questions. But safe to say the population of Cummins Engines is going up some time from -- and the aftermarket tail that comes with that is going to continue to grow. So that's -- again, it's back to this reinforcing economic case of the combustion engine, delivering those healthy cash flows that allow us to both reinvest in the future and return that cash back to shareholders. So it sounds simple. It's a bit busier behind the scenes on that to make it all happen, obviously, across our 60,000 employees. But that's where we find ourselves today. And Jen has been modest -- it's really been the technology that's won the day with the customers. Again, the OEMs have got their own capable technologies, but I think the economics now is tipping them over the edge. I think it's quite -- we've always felt it was not all capital has been rational in the investment in combustion engines for commercial vehicle applications. And I think now we're finding that window. That's proven to be true.

And there are a couple of lower-volume platforms for folks in the U.S. in the 11-liter product line. Is CARB 2024 an opportunity for you folks in that size range and broader? Can you talk about how you're thinking about the impact on your business and whether you could price for the essentially higher warranty requirements that are going to come with the new standards?

Yes. I think CARB does create a different dynamic and opportunity for us in the U.S. market. So there's unique regulatory requirements for CARB versus the rest of EPA. And so for us, we have the scale to develop and support products for that CARB unique solution. And I think that it creates even more subscale potential for others in the market. And so we do plan to have a full product line solution for those CARB regulations in '24.

And then more generally, Jerry, I would just say the opportunity set is not 0 for further OEM -- without getting into customers and predicting the future too much. It wasn't 3 conversations and done hopefully. There's still opportunity there.

Okay. Yes, good to hear. And can we shift gears and talk about your electrolyzer business? What's the size of the pipeline today? What do you expect bookings to look like over the course of this year? And if you can, touch on where you're seeing demand from a regional standpoint, too.

Yes. I mean I think in our new power business, what we see is in certain markets and regions, there is demand and growing. It's largely the same as what we talked about in our last Analyst Day we've got -- we're in production with battery electric vehicles for buses here in the U.S., where both the kind of the application and some of the incentives make that business attractive. We're seeing growing interest in the fuel cell space in the rail market. And then selectively, China is one area that's moving more quickly, I think, with the fuel cell technology, and so conversations there as well. And then the one that continues to, I think, have a lot of conversations and opportunities in the pipeline is in the electrolysis space. So with our PEM technology, that technology is also very closely coupled to electrolyzer technology that can be used to produce green hydrogen. And so we've got a lot of interesting things in the pipeline for potential electrolyzer business, whether it's firming the grids or industrial -- kind of decarbonizing industrial application or it's transportation of hydrogen. So there's growing opportunities there. Mark, you may want to add some other observations and things going on in that market.

I think you covered it pretty well there, Jen.

And is it possible just to quantify what the potential order pipeline looks like for electrolyzer specifically? How quickly are your customers moving forward for those technologies?

I think what we're seeing is, Jerry, there's a lot of interest, right? And so it's varied across geographies. I think the key is finding the right partnerships first. The incubation period is a bit longer, but I think we're optimistic that we can set up a platform for strong future growth. So I think for us, getting the right partners in the right places, that's a big focus of attention right now. And hopefully, those progress, and we'll have more to talk about on that front. But certainly, lack of interest is not the issue. So don't have an order number specifically today, but I'm optimistic we'll have plenty to talk about when we get between now and Analyst Day in terms of some more visible opportunities for us to talk about.

I'd say there's -- there continues to be growing talk in Europe and now in the U.S. with the Biden administration on regulation and policy that could increase the pace. So we're just watching to see how that plays out as well.

And in terms of the positioning of your electrolyzer technology, can you talk about what are the key points of technological differentiation or uptime that your product can deliver just from a technical element? Because the concern in the investment community is that there's a perception that electrolyzers are not differentiated forms of technology between the different folks in the market. So would you mind touching on that and commenting on your views around that point?

Yes, sure. So first, it's this shift to green hydrogen is a key driver to create growing interest in electrolyzer. So if you understand basically how fuel cell works is it takes hydrogen and air and produces electricity and water, and electrolyzer works in reverse. So you take electricity, which if it's generated from a green source like solar or wind and water and produce hydrogen. There's different type of electrolyzers in the market, and our business offers both what's called alkaline as well as PEM. And we think, in particular, in the PEM electrolyzer space as the size of these projects goes up as -- in places where footprint or efficiency matter more that we have a PEM electrolyzer solution that can be a winner. And so that's really where we think we have a unique opportunity in the market, and we do see the size of these projects is growing. So that plays to, we think, our strength.

So essentially, more power per square foot essentially, is that the idea?

And operating -- a potential operating cost advantage.

Got it. Okay. And then in terms of the fuel cell business, can you talk about how your rail fuel cells are performing in the field? How has the commercial performance played out versus what expectations had been like based on test trials? And is there a pipeline for follow-on orders?

Yes. So I think so far, the performance of our fuel cells and the rail business -- in particular, we have a business with Alstom in Europe. We have trains running commercially, building thousands of kilometers on the tracks and a growing pipeline with Alstom. So we expect to sell 82 fuel cells across 41 trains by the end of next year, and I think we're on track to continue to grow that number. So product is performing well, and we do see customers' interest growing and adoption starting to happen.

And is that a global comment in terms of customer interest? Or is that primarily Europe still?

I think a lot of the conversations today are in Europe, but we -- the rail market globally is something that we are taking a close look at. And we do think there's other opportunities globally between our Power Systems business and what we have in our traditional internal combustion engine. When we launched the new 95-liter platform, we have an opportunity for growth in the Siemens passenger market here in North America, again, fuel cell opportunity for rail as well. So we're looking globally at opportunities to continue to grow that rail business.

And can you talk about whether you see any opportunities for freight locomotives for you folks, for fuel cell in freight locomotives? Any architectural differences versus passenger that we should keep in mind?

Maybe over time. I mean, generally, we see a higher interest for fuel cell adoption in the passenger market compared to the freight. So we think opportunities there from a fuel cell perspective are probably slower.

And Jennifer, is that a different architecture in freight? Can you just expand on that point? How big of a leap would it be for you folks to get to commercial rates and freight locomotives?

Yes. One of the key drivers as you look across these different markets for fuel cells, it's the infrastructure that's required. So with a PEM fuel cell, you need a hydrogen. So you have to have hydrogen infrastructure. So how you operate that train if I'm operating across the country versus in a particular city? The infrastructure that's required looks very different, as you can imagine. So that's a key driver in how we see adoption occurring, whether it's rail or if you look at the other on-highway applications. So transit bus, kind of a similar -- like similar to passenger rail. You've got kind of these known routes that tend to be operating in a particular kind of city area.

Got it. Perfect. And last topic, I'm wondering if you could just touch on digital. Can you talk about what opportunities you see for your business as a result of all of the data that you're gathering from your field telematics, what's the opportunity for your aftermarket business and product improvement over time? And any other big data opportunities that you see emerging as a result?

Yes. Digital, I think, is another exciting area and opportunity for innovation and really transforming how our customers experience and use our product. Recently, we made a leadership change. So we now have Sherry Aaholm focused as our Chief Digital Officer. And the benefit with telematics and that data coming back, you have the ability to really help the customer optimize performance and service on their vehicle. And so we're starting to increase our focus on whether it's day-to-day fuel efficiency operation or prognostics, getting out in front of potential issues and helping them optimize the service event. We think there's big opportunities that will grow over time in the digital space. And in addition to that, we're also looking at how the tools and what we use inside the company and how we can improve efficiency and effectiveness of our work through some of these digital capabilities.

Okay. Terrific. Well, that's all the time that we have. Jennifer, Mark, Jack, thank you so much for joining us. Really appreciate you making the telecommute for our conference. And thank you, everyone, for tuning in.

Good to see you, Jerry, and thanks for everyone who's taken the time to listen today. Appreciate your time.

Yes. Thanks, Jerry. Take care, all.