Cummins Inc. (CMI) Earnings Call Transcript & Summary

Good afternoon. Hello, everyone. My name is Jamie Cook. I am the industrials analyst over here at Crédit Suisse. And we're very pleased to have Cummins with us for the next 30 minutes. We have Jack Kienzler, who's the Executive Director of Investor Relations for Cummins. And in terms of today's format, this will just be a fireside chat, so I'll be asking questions to Jack. [Operator Instructions]

So with that, Jack, thank you for being here today. And I guess my first question, I just wanted to talk to what extent you can talk about thinking about 2022, the end markets, which markets do you expect to be positive, neutral versus negative? And then where, I guess, well in 2022, is there potentially for Cummins to outgrow the market?

Yes, absolutely. Thank you for having me, Jamie, and thank you, everyone, for your interest. I think broadly speaking, we're quite excited about where the markets are from a trajectory standpoint heading into 2022. Maybe just going around the world quickly, in North America, clearly, there's strong demand from an end user standpoint in both heavy-duty and medium-duty truck. And really, the issue thus far has been supply chain constraints, temporary and how far the industry can go on a production standpoint. Our expectation is that, that continues to hamper on production, obviously, here in Q4 of 2021 and probably into at least the first half of '22, we'll see it. But the good thing is that, that most likely elongates the cycle from a demand standpoint. We expect '22 to improve over '21 levels. And then we'll see thereafter as we move into '23 and you then get into some prebuy dynamics perhaps along that. India, we continue to see a pretty strong recovery there. There's been a few challenges, of course, with the first and then the second wave of COVID, but Q3 saw a strong recovery and all signs point to Q4 being strong. And as we look towards next year, both in our on-highway and off-highway markets, we're optimistic that we'll continue to see recovery on the back of infrastructure spending and government policy to drive the market forward. I think in our broader off-highway markets before I get to China, really, we've seen really strong demand across power generation, mining, starting to see oil and gas pick up a little bit, albeit a pretty immaterial piece of the business. And while we've seen supply chain constraints in those spaces, it hasn't been quite as pronounced as the on-highway space. So really optimistic across the board. As China is really the one spot that I'd highlight where '22 will moderate. Really, that's a moderation off of record levels that we experienced in 2020 and in 2021. And what we saw is the first half of '21 that was incredibly strong, a lot of prebuy activity, had a broad implementation of NS VI in July and as we expected, the second half has been a bit weaker. As we look towards 2022, it's hard to call exactly where the market will be at this point, but most likely, probably more in the 2019 levels of demand versus what we saw in 2020 and 2021 from an on-highway standpoint and then also on the construction side with our excavator business, we expect a similar trend, a moderation of demand from record levels seen in 2021. So very optimistic overall about where we're at from a market standpoint. In terms of outgrowth opportunities, as we announced earlier this year, we continue to see in the second half of this year, an expansion of our medium-duty share in collaboration with Hino and Isuzu as well as a gradual sort of phasing in with Daimler in the medium-duty space. So we're optimistic, of course, that there's more to come, both in medium-duty and heavy-duty. In terms of collaborations, we're having really fruitful discussions across the board, both in on-highway as I mentioned, but also in off-highway. And we look forward to sharing more when able to do so.

Okay. And then in 2022, are there opportunities even with it -- even if it's not sustainable share -- for your share to be higher in North America heavy-duty just with you're better able to manage the supply chain? And then also on China, I don't know if there's better penetration from the automated transmission or NS VI, anything there?

Yes. So I think new partnerships aside, 2021, we've seen our market shares be pretty strong, both in medium-duty and heavy-duty. We have, of course, been doing everything we can to meet customer demand, and that's resulted in pretty strong market share throughout, albeit at incremental costs that we're not pleased with, and we aren't necessarily as sustainable. But the hope is that, that market share can remain sticky as we move into next year. We will continue to work with our customers to meet their demand. And as we often see, as the cycle is on the way up, we feel pretty good about where we're at from a market share standpoint and certainly have -- can have some room to ramp up with the OEMs already and have cleared out some of the parks, trucks that they're all trying to navigate here in Q4. From a China perspective, I think there's a few catalysts in terms of outgrowth. You mentioned the transmission business, so as we continue to see the market transition from a pretty manual-dominated landscape from a transmission standpoint to a more automated transmission landscape, we are one of the few suppliers who can provide a compelling product in that node, and we've seen a pretty steady ramp in that business. And we'll hopefully continue to see that into 2022. I think beyond that, we've seen a lot of interest in natural gas products. We've recently launched the 15-liter natural gas product in China, which ultimately will come to the U.S. as well, which we can talk about, but that should be a nice catalyst for continued share gain there, too. So ultimately, it's all a bit dependent on the pacing of the market. But again, we feel pretty well positioned to continue to grow, regardless of the cyclical nature of this space.

Okay. And I guess two follow-ups. One, just on the gas engine. We had Rusty Rush with -- the CEO of Rush Enterprises. He was on before and we were talking about the gas -- your gas engine and the JV that you have with Rush, like he was saying his expectation is could gas represent 8% or 9%, I mean, of the truck market at some point, and you're the only player. So how is that engine priced relative to ICE? And is that a crazy number to put out there?

No. I mean, I think it's a really interesting space. So you're right, we are essentially the lone player, if you will, in North America, in the natural gas space. Our product nodes today are the kind of 6-liter up to the 12-liter. And we think there's a couple of catalysts for why the market could move from what today is like a 1% to 3% market share to a closer to 10% in line with what Rusty is saying. One of those catalysts, of course, is the continued efforts to decarbonize the industry. Our natural gas products today can meet carbon, low NOx regulations, and we couple it with renewable natural gas or more or less zero emissions today. And so I think that will play an important role as we look to grow that business. I think the other piece that could help natural gas overall take share is as we recently announced, we're going to bring that 15-liter engine, which I've just mentioned for China, over to the U.S. The horsepower and performance characteristics of that engine have long been in demand from our customers, our end users. And so we feel like that could help drive some more adoption in the heavy-duty space, where the 15-liter is an important product for our end customers. So we're excited about that. From a price standpoint, there is a bit of a premium for a natural gas powertrain over a diesel, so that's a nice content expansion story for Cummins with margins more or less in line with the diesel space. And from an end-user standpoint, it's a nice economical way to, again, kind of move down that path to zero emissions, relative to some of the more expensive fully zero emissions technologies today, battery, electric, fuel cell, what have you. So we're excited about it. And yes, I do think that it can be a nice growing piece of the market.

And then I know you -- when we first started talking about the management, you were talking about supply chain and obviously, it's going to be constrained here, this being an issue until the first half of 2022 at least. But is it -- are there any signs that it's stabilizing at bad levels? You know what I mean? Or just like not getting worse? And to what degree are freight and logistic issues -- logistical issues still are like a big issue or worse?

Yes. So I think there's a few moving pieces. We are, of course, optimistic that things will improve. We haven't seen a ton of green shoots necessarily, just yet on that front. What we have seen is a pretty steady, call it, $100 million a quarter supply chain cost headwind, every quarter from supply chain as we've moved throughout this year. The difference is that the pieces making up that bucket have shifted a bit. So in the first part of the year, that was largely driven by premium freight. We were kind of bending over backwards to meet customer demand and scrambling a bit as there was just so much volatility in the production and the supply chain landscape. That has sequentially improved as we've moved through the year. And what's offsetting that now is, of course, a rise in some of the standard freight rates, which have offset some of the decrease in the premium freight activity, but more importantly, a rise in sort of supply chain inefficiencies, if you will. And so we're operating in an environment where end-user demand is quite strong. As we talk to OEMs, they show that sentiment. And so we're all gearing it up for what should be a ramp in production as we move into next year. And so we're obviously usually pretty quick to get a control -- get control on costs as the cycle goes down. We're hesitant to do that here because that's not really what's happening. It's just a short-term production constraint. And so I would say probably operating at higher inefficiency levels in the supply chain space than we generally would but hesitant to take a lot of action to correct that, knowing that demand is sort of right around the corner. So I think it will be a pervasive issue for Q4. And then from there, it feels like it's a sort of a sequential improving environment. Hopefully, those costs will begin to return back to normal levels. And then as production increases, we'll get the benefits of that volume as well.

Okay. And then one of the things I think you also commented on earlier is you -- you're talking about 2023 and you said prebuy. And so with CARB 2024 not too far away, I mean Rusty was talking about that today too. I mean I think he said he thought -- he said, no one knows what the cost is, but it's probably anywhere from [ 15 ] or -- I don't remember if he said [ 12 to 20 ] or [ 15 to 20 ], but it's a big number. And so do you have any view on -- does this create a prebuy and the incremental cost to the truckers, it's still too early to talk about it?

Yes, it's still too early, I think, to hone in exactly on what the cost premium will be. To my knowledge, the OEMs haven't come out with their fully confirmed product lines, which would kind of dictate that. But I think it's certainly fair to say to your point that there will be a decent premium. It's a pretty meaningful advancement in technology. And so with that, of course, comes a higher priced product. It feels to us like there's probably going to be multiple solutions that will be deployed to meet the regulations. I mentioned natural gas earlier, which certainly can meet them. I think, clearly, some of the zero-emissions products can meet them. But I think you'll also see some advanced diesel, maybe even some hybrid-type applications on -- that are rolled out. So we'll see what -- which shape that takes. But I think all things considered, it definitely feels like there's some prebuy likelihood for '23 and thus, you may see a bit of a longer cycle in the markets with not the wild peaks and troughs, just more of a steady-state elongation of the cycle, if you will.

Okay. And I guess shifting over and realizing we're 15 minutes in, and I haven't asked about New Power systems, which I'm sure you're getting a lot of questions on today. I mean -- but when I was with Tom last, it sort of sounded like he felt like Cummins was better positioned sort of a hydrogen fuel cell. And on the BEV side, you're still trying to figure out the right strategy there because there's a lot of players in that market. I mean, any thoughts there? Any changes there? Any reasons to be thinking about incremental M&A on that to sort of accelerate your path? Or do you think the market is too far or -- well, too far away that we don't -- you know what I mean, like we don't really need to [indiscernible] in New Power systems, Jack?

I think a couple of things. I think if Mark or Tom were here today, they would express a similar sense that it feels to us like we're being sort of discounted a bit on a couple of fronts, certainly from a valuation standpoint, right? If you think about our New Power business, there's a lot of sort of strategic things, technology advancements, all that to be had as we move forward. But if you look at our revenue stacked up against; the peer set, we feel pretty confident in our position. You then couple that with a lot of the intangibles that we can bring to the table, service network, application knowledge, long-standing customer relationships, we feel just as well positioned as anybody else. And so you look at some of the valuations in this space and feel -- you can't help but feel a little discounted on the New Power front. And then if you think about the core, similarly, we're getting discounted a bit there as well. We feel like there's still plenty of room to run, frankly, a growing market position overall and some other nice catalysts as we talked about in China from a component standpoint that we feel can offer some compelling outgrowth in addition to a really compelling cash flow stream. So all that considered, we feel, I would say, really well positioned, albeit undervalued and we'd certainly be shedding a bit more light, I think, on that as we move into February. If we think about M&A, I would put it in kind of 2 buckets, right? So we continuously look at particularly the New Power space as we think about add-ons. We -- I think you probably saw that we made a minority investment earlier this week in Zion Power in the battery space. And I think you'll see some stuff where we look to either partner with others or invest in others or even acquire others to continue to build out that technology portfolio and make sure we have the right solutions to address a wide array of end markets, both on the battery side as well as on the hydrogen side. I think the other thing in...

You might -- sorry, go ahead.

I was saying, the other piece of M&A that we always look at is some of the larger opportunities in the market. We will continue to look at those and assess whether or not those make sense. Right now, there's nothing imminent or anything like that, but we will continue to update folks. We are uniquely positioned, at least from a balance sheet standpoint, to have some capacity to make some moves, whether that's in New Power or elsewhere. And until then, we'll continue to generate a lot of cash flow back to our shareholders.

And is there a preference for new power versus core at this point? Or is it you can't say? Or...

No, not necessarily. I mean I would say that really, we feel pretty well positioned from a technology standpoint. I think that's why you've seen a lot of focus on some of these partnerships as we look to bring that technology to markets and partner with local incumbent players who have market access. That's essentially what we've done in China historically with our OEM joint ventures. It's what we now are doing with Sinopec in China to address the electrolyzer market. It's what we've done with Iberdrola in Spain to address the electrolyzer market broadly in Europe, and we'll continue to seek out those partnerships, not only in electrolyzers but also in fuel cells and maybe even in battery electric to continue to gain traction from a commercial standpoint and as well as to enhance our technology portfolio.

Okay. And then -- so it sounds like at the Investor Day, we'll get an update sort of on New Power systems and hopefully, the financials and where you think the portfolio is going. But the other thing, I think, the market underappreciates or I wonder if you'll address is if we think beyond 2023, we start to think sort of mid-decade, I mean all of these market share wins that will come into the earnings stream and how that reduces the cyclicality, I mean, on your business at least over the medium term. So I'm wondering if we'll hear more about that. And potentially, time line for more wins on the market share side, it sounds like some [indiscernible] you're saying they need to make decisions about what to do with ICE, incremental to what they've already said.

Yes, absolutely. I mean I think, as I mentioned, there's a lot of dialogue going on in this space. There's a lot of, frankly, investment needs. The most obvious being new investments needed to meet new emissions regulations. But there's a lot of investment needs for OEMs, both in the on- and off-highway space. And any time that that's the case, it feels to us like the OEMs are seeking out partnership opportunities with trusted suppliers who they know can bring an incredible solution to them. And so, we are -- have a long-standing history of partnering with many different people and a proven track record there. We have the scale and ability to continue to invest where others cannot, which kind of uniquely positions us to increase our position in many of these markets from an internal combustion engine supplier standpoint. And we expect to continue to increase our share even if long term, at some point, the internal combustion engine market starts to decline as the New Power markets take its share. So we're excited about that. That's not only a first-fit engine opportunity, it's a components opportunity. Obviously, long term, it's an ever-growing installed base, which will generate a lot of aftermarket activity as well. So we think that there's a really nice long compelling revenue and margin story there as well as a significant cash flow story.

And then just on -- I don't think we touched on the electrolyzer business. You've done a lot -- you've announced a lot of sort of nice partnerships, but sort of time line to see sort of your [ move there ].

Yes. I think there's sort of 2 broad aspects of that market that we've tried to focus in on is the smaller megawatt projects, which are a bit more steady state and sort of hum along, if you will, on a quarterly basis. So we continue to have good traction there, and we'll focus on that as sort of a recurring revenue stream. The announcements as of late have been focused a bit more on the large scale kind of electrolysis projects in the 100-, 150-, 200-megawatt range. We're obviously incredibly excited about those, and those are going to drive significant chunks of revenue in the future. And once you kind of develop a pipeline and that steady-state backlog of those, that leads to an ever-growing and rapidly expanding business. I think that from a timing perspective, it's just -- it will take a bit of time to engineer those projects and then secure government funding and whatnot. To put it in perspective, the largest facility today is the one we commissioned with Air Liquide in the second quarter, Quebec, which is a 20-megawatt facility. And so when you're talking about a 200-megawatt facility, that's a significant expansion in the amount of hydrogen you're envisioning and producing. And so it takes a bit of time, of course, to design the product. It takes a bit of time for the overall project to be spec-ed out, all the EPC work to take place and then obviously, securing government funding to help with the economic equation is a big piece of that. And so that takes a bit of time, too. So we're seeing a lot of traction and a lot of optimism in the market, and we're incredibly excited about it. I think it will just take a bit of time. Hence, our goal of $400 million, which we highlighted in Hydrogen Day for the middle of the decade, we feel well on track to outperform that. It's just a question of it will take a bit of time between where we stand now in that time period to start to see that recurring revenue stream.

And then on the filtration side of the business, I mean, I know we're going to get an update in February. But I mean, is it still sort of looks more IPO spin versus strategic buyer, that's like the sort of -- think about things and then I mean, this just adds to cash?

Yes, indeed. So yes, the plan is still -- the prime path, if you will, is still a public market separation, the form of which remains to be determined, whether it's an IPO split or a spin. But -- and the reason for that, of course, is it's a fairly low -- given it's a homegrown business. It's a fairly low tax basis. And so the valuation trade-offs between an outright sale are not insignificant from a tax leakage standpoint. That, of course, doesn't mean we're ruling anything out, and we're open for conversations on that front. But that's the prime path. And so we continue to make progress towards that. Lot of work, of course, goes into that, and so it takes a bit of time to get ready. But we'll provide an update on that in February and probably do the first step of that, call it, in the middle of next year. To your point, yes, that further increases the cash position and on top of a portfolio that's generating a lot of cash already. And so we'll continue to assess different opportunities to deploy that cash. We talked about M&A, which, of course, we're well positioned to pull the trigger to the extent opportunities arise. We'll continue to invest, not only in the New Power business fairly heavily, but also in the core base business. As you move into what we kind of call the messy middle of technologies, moving from a diesel world to a messy middle and eventually a zero-carbon world, there are going to be a lot of needs from an investment standpoint, both in the form of R&D and capital. So we'll meet those needs as well and, all the while, return a significant amount of cash flow to our shareholder base and kind of provide that steady-state return. So we feel good about where we're at, and we'll continue to update as the filtration process takes place.

So this will be an interesting Analyst Day. There will be things to be said, Jack, right?

Yes, it is a -- it will be a full agenda as everyone can probably imagine. And yes, it's a -- there's a lot to update on, quite honestly, on across the base business, which we feel still has a really compelling growth story, of course, updating a bit on the near-term margin opportunities for the base. And then diving into the New Power business, we have quite a significant portfolio of products and technologies. And so helping people understand what the addressable markets are, how our portfolio is designed to go after those markets and, of course, what the financial implications of that may be. So we're looking forward to it. Yes, there's a lot of time being spent on that, and we look forward to providing it in February and crossing our fingers that we can do so in person with yourself and everybody else.

Okay. And I think we are out of time, we'll be out of time in 30 seconds. So I appreciate your time. As usual, please say hello to everyone. Happy holidays, and I'm hoping we'll see you in person in spring. And next year, you'll be able to come to our conference in Palm Beach versus virtual.

Absolutely. Thanks so much, Jamie, for having me. Thank you.

Thanks, Jack. Take care. Bye-bye.

Yes. Bye-bye.