Cummins Inc. (CMI) Earnings Call Transcript & Summary

Good morning, everyone. I'm Matt Elkott, Cowen's transportation equipment analyst. Welcome to our 14th Annual Global Transportation and Sustainable Mobility Conference. We're very pleased to kick off the conference with Cummins. We're joined by Jack Kienzler, Executive Director of IR. Jack previously led the M&A department of Cummins. And then we also have Matt Ruch, who is a Manager in the Investor Relations department as well. For members of the audience who would like to ask questions, you can type them into your dashboard at any time, and I'll read them to Jack and Matt. Jack, Matt, thank you very much again for joining us.

Maybe can we start with a broad overview of how the different markets you operate in have trended over the last couple of months?

Yes, absolutely. Good morning, Matt, and thank you, everyone, for joining and for your interest. Maybe I'll start with our on-highway markets, and then I'll move a bit into the off-highway segment and touch on supply chain as well, which is the topic of the day, it seems. So maybe starting in North America, we continue to experience really strong demand. If you look at some of the underlying leading indicators, in our view, they all remain quite strong, really robust freight activity, strong spot rates leading to strong orders and a really healthy backlog. Used truck prices also remain quite high, which is a sign of a really healthy market and, in our view, a good catalyst for new orders as we move through the rest of the year and into next year. Production rates do remain fairly constrained by supply chain limitations. That's primarily a semiconductor issue, which is grabbing all the headlines, but it's not stretching into some other components and parts. We do expect that the supply chain constraints will continue to remain throughout the course of this year and potentially into next. But at the same time, we think that those are kind of elongating the cycle into next year and maybe even beyond, setting up a really strong production environment next year. In China, truck demand remained really strong throughout the first half of this year. It is showing signs of peaking ahead of the broad implementation of NS VI regulations here in July. And so we do, in line with our guidance, expect to slow down in the second half of this year driven by a couple of things. One, inventory levels are above normal historical levels as OEMs continue to build their NS V inventory levels. Demand has been [ a little bit high ] over the course of 2020 and 2021. And so as we talk to our OEM partners, they feel pretty well suited to fulfill demand with that NS V inventory and some of the NS VI inventory they have on hand. And so all eyes will be sort of on the end of this year to see how broader NS VI orders and production continue to pick up. Currently, we don't have any visibility to any other government policies or actions to boost production in the second half, but we'll keep a close eye on that as we continue to move forward. India truck demand was down sequentially in the second quarter as they battled the second wave of COVID cases. First quarter of this year was really strong. And as we talked to our team on the ground, I would say that all signs are pointing to a really strong second half of the year, particularly as vaccination efforts ramp and, hopefully, the situation on the ground continues to improve. So we feel like perhaps our guidance at the beginning of the year, given the second quarter slowdown, will be a little short of where we are thinking, but we do think it will be overall year-over-year '22 -- sorry, 2021 over 2020, a really strong year. From an off-highway segment, really all of those markets continue to recover and be really strong from a growth perspective, particularly in mining and power generation and construction markets really around the globe. That's driven by increased and improved commodity prices. All the leading indicators for nonresidential construction continue to be [ true ], and so we're quite optimistic that those markets will continue to be strong this year and into 2022 as well. The one exception perhaps is China construction, which is still expected to moderate from record levels we saw in the first half of this year. But again, we'll keep a close eye on that and continue to update folks as we learn more. As I mentioned at the beginning here, the supply chain constraints continue to be major industry-wide constraints. And so those are limiting how high the industry can go from a production standpoint. So we continue to keep a close eye on those trends. We do expect those to continue to improve. We're trying to improve communications with customers and suppliers and keep a close eye on the costs incurred to fulfill demand. We have kept the customers at the forefront of our mind, both in the first-fit standpoint from an OEM perspective, but also trying to be mindful of watching back orders in the aftermarket. I would say we did a -- we've done a pretty good job on the first-fit side, still some room to improve on the aftermarket side as we continue to navigate the supply chain constraints. But again, it's an industry-wide issue, and so we'll keep a close eye on that. We are optimistic that as those perhaps ease as we move into next year, again, that all of our markets should show pretty strong signs of growth in 2022, again with the exception of China.

It's a very helpful overview. Speaking of China, you guys have been, I think for the last year or so, have been very disciplined in your commentary about China, trying to kind of let people know that the extreme historic strength that we saw at some point will eventually subside significantly. And I think you -- the China strength continued beyond your own expectations or people's expectations. If we look at the last, say -- in recent weeks or the last couple of months, has the rate of moderation in China been slower, faster or in line with your expectations?

Yes, I would say broadly in line with our expectations as we move into the second half year. And I would say that the first half probably exceeded our expectations when we set those at the beginning of the year. So as we think about how the rest of the year unfolds, it does feel like Q3 will be kind of soft from our perspective, from an engine manufacturing perspective as the OEMs, again, continue to work through that inventory base and navigate kind of what the economic situation will be under NS VI emissions criteria, what the price of a truck will be, for example, and they're all trying to navigate their own market share and whatnot. So Q4 will be telling. There's kind of 2 ways it could go. One, it could recover a bit quicker and see NS VI production take off or they could kind of look in the rearview mirror and see what 2021 looks like with respect to 2020 and even 2019 and years past. If they did so, our team on the ground kind of feels like they may allow Q4 to remain somewhat low and some of the supply chain issues to recover because all things considered, 2021, even with maybe a softer second half, will still be quite a bit higher than some of the peaks we've seen before 2020. So we feel like we've called it to the best of our ability, again, first half probably stronger than we thought. But now it feels like perhaps it is in line with guidance for the first time in some time in China. And we'll keep a close eye on 2022 and how quickly perhaps it will recover both on the on-highway and the off-highway side.

Got it. I was going to say, it would be the first time that your expectations have not been exceeded. But it had to start moderating at some point. I want to begin with North America a bit. But since we're talking about China and emissions and emission regulations, this is kind of a broader-picture question. What are the areas in the world where you see the biggest opportunity from emissions reductions efforts or regulations over the next 5 years or so?

Yes. So I think a couple of things. One, we've got the upcoming next-generation emissions regulations in the U.S. with CARB leading the way here in '24 and then EPA shortly thereafter, which will be an opportunity certainly to continue to grow, share and introduce new products as we continue down that emissions reductions journey in, call it, market -- leading markets. So in North America, kind of middle of the decade. Europe, the same with Euro 7 rolling out in the middle of the decade, which was really the catalyst for some of our new market partnerships with Daimler, for example, in Europe are these new emissions regulations. So those are good opportunities again for us to continue to win new customers and gain market share in our Engine business, but also in our Components business. And then if you think about the rest of the world, you still got a fairly long runway from an emissions journey perspective. We've got China, which is just now going to NS VI and will go to some equipment to Global 7 in the next few years. Beyond that, same in India. And then in Brazil, for example, they just are going to Global 6 and probably will move to a Global 7 equivalent towards the end of this decade. So there's still plenty of room to run, in our view, both on the Engine side but also on the Components side, which are, as we've demonstrated historically, nice growth opportunities for us, more content opportunity from a Components standpoint. And we do think that those will be continued catalysts for partnership opportunities as we try to leverage our market-leading technology and scale advantage as people try to navigate where they need to make investments, right? That's really been one of the catalysts for these partnership discussions is there's a lot of investment required to hit next-generation emissions regulations. And there's also a lot of investment needs across our OEM partners, broad investment base, whether it's new power alternatives, electrification, hydrogen, fuel cell as well as things like autonomous, things like connected vehicles and whatnot. And so we feel like we are in a good position to continue down that partnership journey and capitalize over the course of the decade on the on-highway side. And then quickly on the off-highway side, there's plenty of room there as well. We'll see kind of the next-generation off-highway regulations hit in China, I believe, at the end of next year. And we expect continued emissions regulations across the world in the off-highway side, which is sometimes overlooked and should present the same opportunities from a Cummins perspective as we leverage our technology across our global footprint and leverage our global scale.

Got it. So going back to North America, you did mention that demand remains healthy, remains strong. And you talked -- you mentioned the supply chain disruptions. So my next question is kind of a 2-part question, short-term and longer-term cycle-related questions. Do you worry that even though demand remains strong, the supply chain disruptions may cause transitory hiccups in your deliveries over the next couple of quarters? And cycle-wise, if the supply chain disruptions do not ease meaningfully before freight demand subsides, I guess, so basically, freight demand starts subsiding before the supply chain disruptions ease, could that actually abrupt the cycle and cut the cycle short for Class 8?

Yes, it's a good question. I would say it's -- it seems to be the front and center question on many people's minds. Our view is that, again, the underlying sort of leading indicators from a freight standpoint remain really strong. And so, yes, ourselves and OEMs have been constrained on the production side. We do expect that to continue for some time. But I don't expect it to persist forever. It doesn't feel like it's going to go away anytime soon, perhaps, but we do think that underlying remain very strong and our -- all signs point to a continued healthy market here in 2021, although somewhat capped. And in 2022, a really strong year, frankly, and even stronger perhaps if we can see some easing on the supply chain side. And then we'll see what that means for 2023. That's pretty far out, of course, but you may get a little prebuy in the market in that period ahead of the emissions regulations, which I just talked about, which could allow that to be a strong year, too. So in some ways, it's been a bit of a slower ramp, if you will, as we move up the cycle here, and we remain pretty confident given where backlog is, given where used truck prices are again that the market is pretty -- positioned pretty well for a nice healthy run here. And we remain optimistic, but we're not going to see the cycle abruptly end any time soon. I don't see any broader macroeconomic indicators that would have you believe that things like the infrastructure bill, things like broader economic stimulus all feel like they are supporting a healthy great environment for certainly the next 18 months and perhaps even beyond.

So if we do have the strong Class 8 build cycle we're expecting next year and potentially spilling over to the year after, do you think your customers may do less vertical integration because they'll be more focused on rolling as many trucks out than they are on costs, which, I guess, traditionally, your customers do more vertical integration in down cycles and less in up cycles? And this time around, you have the added factor of some of your customers having to spread their investment dollars and R&D dollars over all these new technologies that are becoming increasingly important. So do you think we could see less vertical integration by customers in a strong up cycle?

Yes. I mean as you mentioned, historically, we do see our share improve in up cycles as OEMs use us as a source to incremental volumes to handle demand fluctuation and whatnot. Overall, our share has performed pretty well and to date, in 2021, quite well, I should say. And I would say we're optimistic that, that continues to be the case and as we move into 2022. I think in some ways, it depends on how different folks are able to navigate the supply chain dynamics. Thus far, we've been pretty successful. Obviously, we've had our own challenges, but we continue to strive to not be the one that kind of breaks the production cycle for our customers and strive to meet their demand even if it's at higher incremental costs, which we've obviously done so over the course of this year. And we look at that as sort of an investment, if you will, again, to keep our customers happy and maintain healthy share. And we feel like as supply chain constraints ease, that will benefit us as we've been here for our customers. We also think that, as you mentioned, the continued investment needs across the board, both in medium-duty and heavy-duty, will drive even more discussions between ourselves and our OEM partners on ways that we can be helpful. And we continue to invest in our product portfolio to provide really our products across a bunch of different displacement nodes to meet their needs. And so I would say that thus far, we've seen continued strong market share, and we're confident that, that continues to be the case as we continue through the up cycle.

I want to touch on -- make sure we touched on the M&A before we run out of time. How do you think about M&A in the next couple of years? Any preferred areas of business that you will prioritize? Any size, sweet spots? Anything would be helpful.

Yes, absolutely. So I mean I think you've seen in recent years, we've been focused primarily [indiscernible] areas. One would be what are some other areas along the powertrain or even drivetrain that would make sense for Cummins to expand into. That was sort of the motivation behind the Eaton-Cummins joint venture to move into transmissions. We'll continue to look at that from both an internal combustion side but also from a new power side to decide, are there any other areas that make sense to invest in. I don't know that I would guide you to anything that's large and transformational at this point. But we continue to evaluate with alongside our technical folks and strategy teams what could make sense, and we continue to monitor the market for various opportunities. The other area that we have prioritized is looking at the new power space, which is ever evolving, as you know, and trying to identify other technical areas that make sense to bring into the portfolio, alongside any strategic partnerships, joint ventures or commercial partnerships that make sense in the new power space as we look to grow our business. We've obviously been quite successful over the course of our history in forming different partnerships and joint ventures to gain access to new markets. And we've continued to do that in the new power space through the likes of commercial partnerships with Iberdrola in Europe, for example, or even joint ventures as we've announced in China with Sinopec. And so those are examples of ways that we can partner with others. We can bring technology. They can bring volume and market access, and we feel like it can be a nice win-win for both parties as we look to continue to grow our business. So we'll continue to evaluate those kind of strategic partnerships. We'll continue to evaluate our technology portfolio, the new power space, to make sure that we have technically differentiated products. And then we'll continue, of course, to monitor some other perhaps long-term opportunities as they present themselves.

Okay. At the Investor Day almost 2 years ago now, you guys identify diesel market share gains as one of the key growth drivers. How has this view evolved since then?

Yes. I mean I think as we've demonstrated with our announcements with Daimler, Isuzu and Hino, all in the medium-duty space, those are tangible examples of how that strategy is now coming to fruition. We feel like there's a really compelling win-win scenario for both Cummins and our customers as we evaluate new emissions regulations, the investments required to hit those regulations and the products that we can offer our customers across a number of regions and displacements. In the medium-duty space, you've seen it manifest itself earlier, and a lot of that has to just do with our scale advantage and some of the other inputs to the economic equation as the OEMs look at what it makes -- it doesn't make sense to outsource or continue to make themselves. We're excited about those partnership opportunities. They both represent a way to continue to build on our strength in the North American market but also to expand into regions where we are the significant of a player such as Europe. And those would represent, again, engine opportunities but also component opportunities as we offer our products to our customers. There's also -- in the medium-duty space, there's still opportunities certainly in the European market as we look and hold discussions with other OEM partners. Those players generally are quite strong in the South American market as well. And so most of these discussions are global in nature and offer us compelling growth opportunities in a lot of areas around the world. We're also excited about the Japanese and Southeast Asian market, which we'll continue to evaluate alongside our partners, Isuzu and Hino in MD and Daimler as well. So that's kind of the medium-duty landscape. There's still some opportunities there. And then in heavy-duty, we're -- we continue to feel like the same strategy makes sense in that space as well. It just will take a bit longer to navigate, one, because our scale advantage is not quite as significant there; but two, it's just a complicated market. There's a bit more economic opportunity for both ourselves and for the OEMs in that space. And so the economic equation is not quite as straightforward as it is in the medium-duty space, in our view. And I do think it will happen perhaps in subsegments as we look at the heavy-duty space. So you may not see a partnership announcement that spans all of heavy-duty, but perhaps you'll see something in the subsegment range. We kind of look at it in the kind of 15-, 16-liter range, 12-, 13-meter range and then 10-, 11-liter range. So we'll continue to have multiple discussions with multiple OEMs to find what products we can offer them that make the most sense and help them as they navigate multiple investments across our portfolio.

So as we think about this energy transition, you have a very large installed diesel engine base around the world. If you can maybe talk about that. And having that installed base, does it give you an advantage in migrating some of these customers to new power technologies when they're ready to do so?

Yes. I mean I think there's a couple of benefits, right? So having a large installed base, of course, before we even get to the new power space, offers us the ability to have a long aftermarket parts stream that's ever growing in nature. And we talked about supply chain earlier, but a lot of these units in the field are -- have been operating at significant duty cycles for some time now. And so our expectation is that as we move into next year and beyond, there's a lot of aftermarket opportunity as a result of people utilizing their assets perhaps a bit more than they did in the past, given they can't cycle through new units as readily as they could in the past. In terms of opportunities that affords us in the new power space, I think there's a couple of things I'd highlight. One is we continue to build upon our relationships with OEMs and end users, fleets around the world. And as we've demonstrated in the internal combustion space, we feel like we are -- we've shown that we can provide market-leading technology and to be there from a reliability standpoint and a durability standpoint to support the product. We have a vast distribution network, which allows us to serve our customers across really anywhere that they operate, whether it's here in North America or on a global basis. And those customer relationships, coupled with that channel, we feel like, allows us to continue to demonstrate to our customers that regardless of the technology, we will be here to support them. We're making a lot of investments on the new power space to build out our portfolio and really offer sort of a powertrain of choice, if you will, to benefit our customers. And so we feel like that certainly presents a compelling opportunity and affords us the ability to be at the table regardless of what our customers are looking for from a technology standpoint.

Got it. And I know we're pretty much out of time. But if I can get maybe just final quick thoughts on -- final update on hydrogen, electric and natural gas. And maybe you can loop in some commentary about the proposed infrastructure bill and if there's anything in it that could benefit your hydrogen business or any other businesses.

Yes. So I'll try to keep it quick, but we continue to invest across our portfolio across a range of technologies. You mentioned that both is in our core segments, on-highway, off-highway propulsion, which is primarily our fuel cell investments, which are both running in rail applications, which we're really excited about with Alstom, but also in other on-highway segments in Europe with folks like ASKO and [ Bond ], but also we announced our commercial agreement with Air Products as well. And so continue to gain traction in the fuel cell space. And while that may be a bit further out in terms of broader adoption, we feel like you're getting these units and feel it's critically important to continue to harness technical learnings and improve our products. In the battery electric space, we continue to put product in the field, primarily in school bus, transit bus and some other niche applications like yard spotters and whatnot and as well as demonstrating vehicles and the pickup in parcel delivery markets, which we're also excited about. And those would be some areas, you mentioned the infrastructure bill, where you've seen a lot of proposed dollars going into those markets, which we will continue to enhance the number of units that are put in the field and continue to benefit our business on the battery electric side. Electrolyzers are another significant opportunity to grow our business in an area of the value chain that we haven't historically operated in. We're really excited about that, not only building out our capacity in Europe and China, but also announcing significant commercial opportunities, particularly on the large PEM electrolysis space. And then finally, you mentioned natural gas, and we'll have a panel, I believe, later today with you guys to talk about some of these other call them bridge technologies, if you will. But in areas where we feel like there's a compelling opportunity to continue to lower emissions in a meaningful way, but do so with products that are for a significant amount of time and have demonstrated their ability to work and serve customers and perhaps do so in a more economical way than some of these zero-emissions products can do today. So things like natural gas, things like burning hydrogen and internal combustion engine are really compelling opportunities, we think, for the industry at large, and we feel like Cummins is really well positioned to capitalize on those.

Definitely looking forward to digging into natural gas a bit more during the panel at 4:40 p.m. Eastern today. We're 3 minutes over time. So Jack and Matt, thank you so much for a great discussion. Really appreciate it.

Thanks for having us, Matt, and thanks, everyone, for your interest, and we will talk soon.