Cummins Inc. (CMI) Earnings Call Transcript & Summary

Yes. I'd say we're all wrestling with supply issues. And most notably, we're all wrestling with microprocessor issues. We've not had to take broad shutdowns in our engine plants. We've kind of been hand to mouth and just keeping up and, kind of, trying to minimize any impact to our equipment customers. A place that we have not been able to keep up with demand is an aftermarket. And so that's why in the second half, that's one area where we're projecting to see some improvement because as we've been able to bring some of that supply up. We're starting to make some more progress and taking advantage of the aftermarket opportunity that's out there.

Right. So you've been prioritizing the OE channel to keep those customers happy at the expense of aftermarket. And as that unwinds, I suppose there's a little bit of a mix benefit to margin potentially?

Assuming they -- hopefully, the OEM keeps going up as well, Steve. But yes, all things being equal, more parts would be positive to the mix.

All right. Okay. And then with respect to the premium freight or the logistics costs, I think you said, Jennifer, that you expected them to come down, sort of, in the second half. But I feel like you also, kind of, expected that in the second quarter, it didn't happen. I'm not trying to throw stones. I'm just sort of trying to figure out how good you feel about your visibility?

Yes. It's a fair point that second quarter was definitely higher than we projected. We did see some improvements in engine business. I'd say other factors were COVID disruption in India and also the COVID disruption into Southeast Asia has impacted us. And that's really -- that's the part that the visibility is not so great, too. And that risk is still there. Increasingly, we and our suppliers are trying to vaccinate employees and do things to minimize that disruption. We did -- as I said, we saw improvement in engine business and a growth in premium freight and components and power systems, and we do think that we'll be able to bring that down in the second half. Mark can talk more about some of the numbers, but specifically, but I think the biggest wildcard is probably COVID. And if that creates any other disruptions or, who knows, these weather events that we're seeing, it seems like some really unprecedented things happening in the world, and we're just focused first and foremost on meeting our customer needs.

And did you see -- this is a nitpicky question. Did you see improvement month over month over month in the quarter? How did that trend?

Not really. No, it's been very volatile because just when you think you're getting some trajectory, there have been some new surprises. So we do expect to see that this quarter. Still not being perfect as we started July, that's for sure, but we would expect to see improvement, hopefully, here in August and September get some momentum. And as a reminder, we've got 50% of the level of premium costs baked into the second half and into the first half. So that's really important.

All right. Well, whatever -- however it turns out, it's temporary. Just briefly about your thinking around the other thing you announced with earnings, which was the -- looking at options potentially for the filtration business what's your thinking around that and what that would look like?

So I'll talk a little bit about kind of the strategic thinking, and then Mark can talk more about the options that we're exploring and the expected time line. Strategically, though, the filtration business is a high-quality business generating great revenue and returns. It's pretty heavily focused on the aftermarket. So in addition to continuing to have some growth opportunity in the coming years. with Cummins in our engines, there's also a nice long aftermarket tail there. That said, when we look at strategically where do we need to invest to continue to differentiate our powertrain and on the path to 0, there's less that needs to be done in the filtration area versus some of our other components, and that business really needs try to leverage its technical capability, IP and footprint to grow into some different adjacent areas that are not aligned with where Cummins is focused. And so we think by exploring the strategic options, one, we can unlock some value for our shareholders because multiples of filtration business are typically higher than where Cummins is today; and two, really bring focus and allow that business to invest on how does it grow into some new areas for the medium and longer term. So that's, kind of, the strategic rationale on what we're doing.

And really, a touch on the financials as well. And then the hard numbers benefit is, as a stand-alone company with significant tax advantages to come and pursuing that [ group ] as well. So as well as freeing that business up to set its own, kind of, cost, there are significant tax advantages versus standing as an independent company that also have some of the options so that also appeals in terms of the shareholder value to Cummins.

Right. Okay. And I think the revenue base of that business is, kind of, $1.2 billion, $1.3 billion, something in that neighborhood. How much of that is actually fitted on Cummins products, just roughly?

If you -- it's a bit of a nuanced answer to you, but if you think about first fit, it's in the probably, I don't know, 25% range that goes to Cummins either through the engine business placed on the engine or through [ distribution ] business because it uses a multichannel approach. You talk about Cummins applied, engines given our vast, sort of, installed base, there's times that is applied to more than just what goes through from a direct sale to Cummins. So first fit to the engine business is probably in the teens, another chunk that goes through distribution. And then sometimes in the aftermarket, you'll bounce around between filtration providers, so that moves a little bit.

Yes. But there's -- it's supplied on many other engines beyond just the Cummins engine. If you look at the percentages that Jack shared and its -- both first fit and aftermarket.

Okay. All right. Sounds good. And just timing, and we'll move on to the next topic.

Yes, I think a full separation on a stand-alone -- standing up a publicly traded company, Steve, could take it to something like 18 months for that separation with all the usual caveats. So yes, there's a lot of work already going on in terms of organization to prepare for that. And again, just want to close by saying, when we actually get to show the results of that company, so you'll see it's actually an improving business. It's a strong business, and it's been improving. So this is us separating, in many ways, a very highly valued asset, but with some more value creation as an independent. It is not a problem in any way, shape or form nor is it facing any dramatic changes. If anything, it's facing more benefits as Cummins sweeps up more engine market share on the combustion side.

Okay. Good. And that's actually what I wanted to talk about. Next kind of the engine strategy, obviously, is to try to convince folks to, kind of, leave the deal to you for the next few years while they -- probably the next couple of decades, while they work on the transition to whatever comes next. So you've had some wins, I think, on the medium-duty side. I assume you're having conversations on the heavy-duty side. And then I don't know, are there opportunities outside of truck where the same kind of concept could apply? Just what's your thinking big picture?

Yes. So big picture, we think there's a lot of opportunities there. If you look across the reality of all of the different markets that we're in, I think it is going to be a decade long journey and that we have a good opportunity, given our scale and technology leadership to be the engine provider through that period of time, increasingly for our customers. And you saw that in some of the deals that have been announced, and we're having a number of conversations on the on- and off-highway side around further opportunities. And really OEMs, heavy-duty engines typically are the ones that they hold most close, they really view that as a key to differentiate in their product line. And so the point in which they determine, it makes sense to ask somebody to do that, and they no longer can afford to make that investment, maybe a little bit later than medium duty, but we'll start to see that happen as well. We're going to continue to invest to have the best product in the market and give them every reason to use ours. And we're also going to continue to invest to reduce the CO2 footprint of internal combustion engines, which we think is a critical part on this path to 0 emissions as fuel cell and battery electric technology advances in the energy source, whether hydrogen electricity actually becomes cleaner for those technologies as well. So both that path to 0 strategy for our engine business as well as how we increasingly play a role for customers are key to our business.

We're expecting to pick up volumes in some of the, I don't want to say, undeveloped markets, but not the highest tier developed markets where we believe it's going to be a longer journey to even economic and practical equivalents on some of the new technologies.

Okay. Interesting. And what's your view of the opportunity on hybrid? It felt like for a while that everything was going to go hybrid for a decade before it kind of went further electric or fuel cell? And -- but most recently, just in the last couple of years, I feel like we haven't heard anything discussed around hybrids. And is that...

Yes. We talk about it a lot. We're looking at it a lot because as a way, first, we're looking at bringing some mild hybrid products to market sooner. But as you start to move to a stronger hybrid, you can get significant NOx and CO2 reduction, and you don't need -- you take away the worry of that, will I be able to recharge and have range anxiety. So I think it still could be a key part of the solution.

Okay. And obviously, it plays to your strength as well. And then I think we just have a couple of minutes left. And so my last question, I'm curious, I mean, Mark, I think you laid out a few years ago, $500 million spending on new power technologies, a combination of R&D and M&A. And I think you probably worked your way through most of that. I didn't have time to go back and look. But how should we think about sort of the investment in these businesses going forward? Is there another $500 million plan that has to happen? Or what's the right way to think about that?

Yes. we'll give a full robust update in February when we get to our Analyst Day. But needless to say, some parts of the business are going faster than we anticipated. So the electrolyzer, the clean hydrogen in the broader industrial economy, not in our core end markets, is growing faster. That isn't drawing an extraordinary amount of additional capital, but there is some extra going in there. And then I think we're just evaluating our plans always to see is there any additional investments we need to further accelerate transition and success. So today, I don't have a significant change. We've laid out, kind of, the parameters for this year. And obviously, the operating losses have stepped up as we've increased the range of things we have invested in ahead of transition. Yes, we're constantly evaluating that, and we'll give a full update at our Analyst Day in February. But probably not less than the next few years, yes.

Okay. All right. Very good. I think that takes us to our 25 minutes. It always flies by, but I really appreciate you guys chatting with me, and we look forward to, I guess, hearing more in February.

Thanks, Steve, for taking out the time.

All right. Thanks, everybody, for watching.