Cummins Inc. (CMI) Earnings Call Transcript & Summary

Greetings. Welcome to Cummins conference call and webcast. [Operator Instructions] I will now turn the conference over to Chris Clulow, Vice President of Investor Relations. Chris, you may now begin.

Great. Thank you all for joining us today to discuss the acquisition of Meritor by Cummins. Joining me today are Tom Linebarger, CEO and Chairman of Cummins; Mark Smith, CFO of Cummins; and Chris Villavarayan, CEO and President of Meritor. We'll start the call with some prepared remarks, followed by some time for Q&A with Tom and Mark. Some of our remarks will include forward-looking statements, and I'll refer you to our disclosure included within our press release and with the slides on cummins.com. First, let me remind you that the acquisition is subject to approval by Meritor shareholders and regulatory approval. Now let me turn it over to Tom.

Thank you, Chris, and good morning, everybody. We're really excited to announce and share with you that Cummins and Meritor reached definitive agreement for Cummins to acquire Meritor at $36.50 in cash per share of Meritor for a total transaction value of $3.7 billion, including net debt. Meritor is an industry leader in axles, brakes and electric powertrain capability and brings complementary strengths to Cummins that will strengthen the portfolio of our core business and help accelerate the development of zero carbon solutions within our new power business. Cummins and Meritor are a great fit, sharing common values and a strong commitment to creating value for shareholders and all stakeholders. We look forward to welcoming Meritor employees to Cummins. Before I dive further into the strategic rationale for this acquisition, let me hand it over to Chris Villavarayan to share his perspectives on why this is a very positive move for Meritor's stakeholders. Chris?

Thank you, Tom. I'm happy to be here with you and Mark to announce this transformational event. Today represents a major milestone for Meritor, our shareholders, our employees and our customers. I'm excited about what this combination offers and what can be achieved together through the expanded offerings of a best-in-class Cummins-Meritor platform. Let me highlight 3 areas of compelling value I see delivered by this transaction. First, value for our shareholders. At closing, Meritor shareholders will receive immediate value at a compelling premium to Meritor's historical trading prices and a 48% premium to Meritor's trading price as of last Friday, February 18, 2022. Second, value for our employees. Our dedicated and diverse team members have been powering Meritor forward for more than 110 years. We could not do what we do every day without the creativity, energy and tireless commitment of our 9,600 global employees. Our team members will become part of a larger enterprise with similar cultures, missions and legacies that will fuel our innovations in core powertrain products and electrification. Our employees' commitment to excellence help make this transaction possible. And I know together, we will continue to power life forward and help the commercial vehicle industry evolve and transform. Third, value to our customers. Like Meritor, Cummins, we have always put customers first through world-class product innovation, delivery and quality across our core axle and brake businesses and our mobility and electric powertrain solutions. In this combination, customers will see the powerful benefits of a broadened portfolio, enhanced technology capabilities and accelerated investment in e-Powertrain development, alongside EV adoption and best-in-class solutions. Commercial vehicles will continue to transform over the next decade with the benefit of these products, solutions and zero emissions technology. We could not be more excited about the potential of this combination to deliver compelling value to all stakeholders. Meritor has transformed from a traditional drivetrain manufacturing company into electric powertrain technology company. And this transaction is the next chapter in our journey. With that, I'll turn it back to you, Tom.

Thank you, Chris. It's great to have you with us, and I want to welcome your entire team and employees to Cummins. Climate change -- yes. And so let me just add to Chris' remarks. Climate change is the existential crisis of our time, and this acquisition accelerates our ability to address it. Our customers need economically viable zero carbon solutions for commercial vehicle and industrial applications. Our communities and our planet depend on companies like Cummins to invest in and develop these solutions. Cummins believes that eAxles are a key integration point for battery electric and fuel cell electric powertrain, and we see significant strategic advantage in accelerating investment in eAxles and integrating Meritor's significant capabilities with our new power technologies to deliver winning solutions for customers. Meritor's core axle and brake businesses bring to our components business products that are powertrain-agnostic. By leveraging Cummins sales network and global footprint, we expect to raise growth rates in both axles and brakes. The combination of Cummins and Meritor creates one of the very few global companies that can serve our customers with optimized powertrains across the full range of combustion, electric and fuel cell electric applications. In addition to the strategic benefits, there's also a very strong financial case for this acquisition, as Mark will discuss in more detail. We have built a strong relationship with Meritor over several years and in working closely with Chris and his leadership team, we have identified clear cost synergies, particularly in SG&A, supply chain and facility optimization. Just stepping back, decarbonization is a global imperative and a growth opportunity for Cummins and Meritor together. The acquisition of Meritor is a unique opportunity to build out our capabilities in the transition and to provide alternative propulsion in a scalable and financially disciplined manner. Now let me turn it over to Mark to summarize the key financial elements of this acquisition. Mark?

Thanks, Tom, and good morning, everyone. Cummins is very focused on delivering strong returns to shareholders. And at the core of our strategy is disciplined allocation of capital to support investments in the products and capabilities that will deliver future profitable growth and a commitment to return excess capital to shareholders. The acquisition of Meritor will bring clear financial benefits to Cummins that are consistent with our strategy as follows: Number one, the acquisition, when complete, will be immediately accretive to adjusted earnings per share. By year 2, we expect to deliver double-digit return on invested capital. By the end of the year 3, we expect to generate a run rate of positive pretax synergies of $130 million, which will contribute to strong returns and raise Meritor's EBITDA margins closer to Cummins' current performance levels. We expect to finance the acquisition through a combination of existing cash balances and debt. Cummins is committed to making a strong credit rate -- maintaining a strong credit rating, as this provides access to multiple forms of low-cost financing which are important in maintaining the flexibility required to operate a global company through economic cycles. We do plan to reduce debt post completion of the transaction to support our strong credit rating. And this will be achieved through the generation of strong operating cash flows and a slower pace of share repurchases than we executed in 2021. That's a quick summary of our -- of the financial benefits of this transaction and our plans. Now let me hand it back to Chris Clulow.

Thank you, Mark, and thank you, Tom and Chris. And I appreciate you joining us today, Chris. I know you have to attend some meetings with your employees. So let me turn it back to Tom for a second.

Yes. Chris, I know you're not going to stay on for the Q&A because you've got to talk to employees. I really appreciate your team's support and help, and I look forward to working with them and please welcome them to Cummins on my behalf. Thank you, Chris.

Perfect. So now we'll transition into the Q&A session. Please limit yourself to 1 question and a related follow-up. And we will take questions up until the top of the hour. Thank you. Go ahead with the first question.

First question is from Ross Gilardi with Bank of America.

Congratulations. Tom, I think this is a good one for you, naturally, but Meritor, I believe, just won a nice piece of axle business with Daimler in China. And is that a big portion of your synergy target? Or does that represent upside? And just any implications on your ability perhaps to take on Daimler's heavy-duty ICE business in addition to the medium duty, just given the synergies of this transaction.

Ross, thanks so much. And here's the way that I would talk about our synergies. We feel like there's 3 major sources of synergies. One, we think their -- Meritor's traditional core axle and brake business fits into our components business well. We have strong footprints, both of us, but Cummins is in some places that Meritor isn't in bigger ways. And we think by bringing Meritor into the places we are, that we can grow their core business. And of course, our components business becomes more powertrain-agnostic over time, providing us a more sustainable source of revenue and profit over a longer period of time. So that's kind of synergy 1. Synergy 2 is, as Chris and I both mentioned, we have a very similar culture. We have very similar operations. We believe that we can operate the 2 companies at substantially lower cost per dollar of revenue than we can operate them separately, especially because Meritor does have to supply global customers. It's a relatively small company in that terms. And so we think we can offer significant synergies, both on SG&A, supply chain footprint kind of issues. We can make significant headway and we've done a lot of work on that already. And third, we think the synergies related to investing in new power, electrification, fuel cell are substantial. We think we can be at the table now for pretty much every negotiation about what -- who's going to supply what in the commercial industrial sector. And that's a big deal. I mean this is a fast-moving sector. There's a lot of players in it, and we want to make sure that we are able to provide both systems and components that are compelling to customers in that region. So those are the 3 areas that we're thinking about the synergies. Of course, there's a lot of detail underneath each, but that's how we've been thinking through it in this transaction.

Can you comment a little bit more on just Cummins' ability now to offer a more attractive, fully integrated electrified powertrain offerings? Just kind of remind us what was Cummins offering on EX eAxle as part of that with the existing offering? And how does this help?

Absolutely. So again, it's a very fast-evolving field. But you know that in Cummins case, we've been providing batteries, overall system controls and integrating systems. In Meritor's case, they've been providing eAxles and then integrating other components into it. So what we add is in addition to the overall system, the brains of the operation and the battery, we now bring the eAxle and traction section to the electric powertrain. That allows Cummins to think again about whole systems and components much in the same way as we've been thinking about it from an engine point of view. We can provide now to OEMs a full range. You want a whole system, you want all the components, you want individual components. And the eAxle is just increasingly becoming the place where those components are centered. So it gives us a place. We -- in an electric powertrain, you kind of lose the engine as a place to hook everything to. The eAxle becomes the new engine block where you start to hook all the components to. So I think it gives us a model to bring our components and systems approach to the market. And also, it just significantly advances our technology in that area. And I think the 2 companies are largely complementary. Almost everything that Meritor has been working on, Cummins has not been working on and vice versa. And the 2 companies are going to combine investments to provide much more economically viable solutions.

Our next question is from Noah Kaye with Oppenheimer.

I just want to pick up right there. I'm just curious if you can give us a little bit of the genesis of this. Because as you said, there are a number of players in and around eAxle electrification. I know you obviously have been following the space very closely for a long time now and watching it develop. So I guess why Meritor? Why now? And did it really start with looking at the eAxle side with this part of a more holistic review process of the portfolio? Just give us a sense of how this came to be in line now, if you can.

It's a great question, Noah, and it is as you described, a more holistic look. We have done strategy work in our new power area to say what are the key systems and components that we want to invest in versus purchase outside, and eAxles and tractions kept arising as one of the places that we needed to be in a serious way, given the comments I made earlier to Ross about where we see components being hooked to and connected to in the future. And then secondly, we've been looking for ways to invest in a financially disciplined way in components that build out our entire portfolio and are more engine-agnostic. And that we can use our global footprint, our connection to significant customers, et cetera, to enhance their value. So we were doing that on our core business side. We were doing the new power -- of course, on the new power side and the 2 came together. And then there were very few candidates that fit that bill, as you'd guess. And Meritor is one we've been talking about for some time. And again, I would just credit the Board of Meritor and the leadership team for recognizing that the future depends on a more significant investment in this new power, and they decided that they were going to need to partner up to do that. And I think that's what really was the genesis of the transaction.

Great. And do you think there's a way to put into terms for us what they did in terms of or will do in terms of shortening your speed to market in some of those offerings? Because getting the software and controls, right, in some of these electrified offerings is incredibly difficult, time-intensive. So what do you think you've done in terms of shaving time off of your speed to market?

I think it's going to allow us to provide customers with more system choices. They can buy components, systems -- or systems. They can -- we can provide customers now with real hardware. Meritor has already invested in eAxles and has products running today. So they don't have to wait for some future offering, we can provide them systems today. And as you know, Cummins has done the same in batteries where Meritor hasn't. So we can offer customers now traction systems that are available today that they can start to run and we can improve upon. And then same with the battery system. So the 2 -- both companies were seeking out the other's solution, and this marriage allows us to provide both -- or hold of them together or separately which, again, just brings us to the table in most conversations in the commercial industrial space for companies that want to think about either driving electrification or fuel cell electric vehicle.

This is quite a lead in to Analyst Day, and I am looking forward to it.

Appreciate, Noah.

The next question comes from the line of David Raso with Evercore.

Great acquisition. You took a nice step function to provide a solution for 2027 emissions now with this Meritor deal, right. Great just step function in your electrification offering. If my numbers are right, and maybe Mark, correct me if I'm wrong, immediately after the deal, the pro forma net debt to trailing EBITDA is still only about 1.2x. So still plenty of firepower left. So I'm just trying to think you solved the quick issue with Jake Brake. Obviously, a great addition here of Meritor strategically. Do you still see areas, maybe not quite of this size, but areas where there's still holes to fill and opportunities that you can fill in this kind of step function way? And again, do you agree with our look at net debt to EBITDA on a pro forma basis?

David, I'll let Mark answer the financial question about do you have the ratio right? And then I could talk a little bit about holes. Go ahead, Mark.

Yes. So this -- I've got the gross debt numbers in my mind here, David. So this transaction will take us above 2x gross debt-to-EBITDA initially. And then we will plan through 2024, all things being equal, to work that metric down below 1.75 to restore that strong credit rating. That's what we see in front of us today. Those are the numbers we're aiming for from a purely financial perspective.

And then let me talk about the...

Is that growth -- is it pro forma on the EBITDA?

Yes.

Okay. Sorry, Tom.

It's okay. Don't worry, David. And so I think on the strategic side, we continue to see evolution on both sides. So in our core business, we are looking for solutions for customers that help them drive carbon footprint down and help them consolidate and to invest in the things that we want to -- that they want to invest in. So we think there are significant investments to be made given our global footprint in the core business, both powertrain-related and powertrain-agnostic. And we want to balance that portfolio. As you know, we are continuing to invest in engines because we think they have a long life ahead, especially as we reduce carbon emissions from engines, but also all these components that we think will be required irrespective of the powertrain. So we've got one leg there. And then on the new power side, the number of technologies that are coming up and how many might impact the viability -- economic viability of the solutions. There's a lot to be done there, and we are still looking at those pieces. So yes, there are still areas of investment that we are seriously considering to try to invest in. But I would say, back to your question in terms of large-scale things, I think our view is that most of the technology areas are relatively small acquisitions. And then in the core business, we think we can add incrementally in a financially disciplined way. So we are still holding to our idea that we're going to invest in the new technology spaces and then try to think how to continue to use a very disciplined model to broaden and strengthen our core business over time. That's kind of the combination. Meritor was a perfect fit for that. And we think we'll continue to look at other areas, but we're kind of thinking on kind of an incremental basis today.

And lastly, your bigger OEM customers in particular, not saying you can mention you were acquiring Meritor directly, but have you had some broader conversations with your bigger customers to get some affirmation at expanding your content, connecting with the axles and the brakes is something they would embrace to have one supplier providing that much content?

Well, broadly speaking, I think our customers -- you're right, I did not talk about this transaction directly. Of course, that would not work. But what I've tried to do, I think, is understand what their requirements are and to make sure that we're investing in the area that they need us to, to give them viable solutions. I think all the customers that I'm talking to want to invest in reduced carbon solutions. But frankly, the cost versus performance trade-off isn't quite there yet. So they need us to advance that in order to make -- to be able to sell their trucks on to end users who just find the whole thing too expensive or too challenging today. I mean not small numbers, but in big numbers. So I think that's step one. And I think customers will recognize the value of getting our joint investment together. With regard to the core business, my view is that there is increasing concern about the strength of the supply chain. And I think by Cummins investing here, what customers can count on is that we'll be there for them when they need us, that we'll be able to maintain these key components in their supply chain, invest enough to make sure that the cost continues to diminish, the quality continues to rise and the technology continues to meet the standard that they require. So I think Cummins investing in these areas provides them with more surety and more certainty that they'll have a viable product for years and years to come.

The next question is from the line of Jamie Cook with Credit Suisse.

Congrats. I guess 2 questions. One, just Tom, you're usually not one to sort of do larger deals. Just thoughts on acquisition versus, generally, you sort of go the JV route. And then my second question as it relates to investment in EV of the combined companies, is this about -- I mean, are there savings here? Is spend going to ramp before it goes down? Just trying to think about that perspective and the impact on margins longer term.

Great. Jamie, thank you. So I think in our strategy, as I answered, I think, earlier to Ross's question, our strategy here was both how to find ways to grow in our core by adding components that we think we can use with our footprint to grow. And then to -- and to do that in a financially disciplined way. You know that we've been talking about that for a long time. Meritor fit that really well. And as you said, we thought about different ways to do with JVs, different companies to do it, and Meritor -- acquisition of Meritor just seemed like the best way to do it. Even with the premium, the acquisition price allows us to do -- with the synergies, allows us to do it in a very financially disciplined way. We see returns meeting all of our targets. We see the earnings being accretive quite quickly. Again, it just looked like an acquisition was going to be the best financial -- most financially attractive way to do it. I think the new power side added significant impetus that the speed with which we need to make these investments and the fact that we need to combine these systems as quickly as possible meant that a joint venture will be complicated. By the way, we have talked with Meritor over the years about different partnership options, so you were right about that. We did definitely look at a lot of those things. We looked at a bunch of organic options, and this was by far the most attractive route. So that's why we pursued it. We will ramp up spending. I want to be clear about that. We think there are significant synergies in this transaction, as I mentioned earlier, where our cost can be reduced running these 2 companies for sure. In the new power space, we will be increasing investment, not decreasing. So to your point, we will be investing more. So it will be, indeed, that there are synergies between our 2 companies on capabilities. But one of the promises of this acquisition is that we will be investing more in Meritor's development of eAxles and traction systems because we think that's a significant area of development and that customers need us to.

And we'll put that in the context of our new power business tomorrow during our analyst day.

Yes. So that's right. So Mark was just mentioning, Jamie, that when you -- tomorrow, we'll kind of show you the overall investment, what that looks like for new power, et cetera. And so at least you can see kind of what that -- but I guess you asked, is it going to ramp up first before it gets better, and the answer is yes.

Our next question comes from Jerry Revich with Goldman Sachs.

Tom, Mark, Chris, congratulations. Tom, I'm wondering if you can talk about the opportunity for this business in China in greater detail, the eAxle and the traditional axle, how would that fit versus some of your major OEM customers in China? How significant is that opportunity, specifically relative to your priority list in terms of building up the manufacturing footprint in China for your local customer base given the strong connections you have there?

Yes. We do think there is a significant opportunity in China. I think you know, Jerry, that we have substantial partnerships in China. That doesn't mean automatically they use your components, but it sure helps. You're talking to a customer that relies on us significantly -- and the transmission example is a perfect example of one. It was that Eaton wasn't in China, they were. But with Cummins customer relationships there, we were able to get significant growth in the Eaton Cummins automated manual transmission because of all those relationships. We think the same is going to be true in axles, brakes and eAxles, so in the core business as well as the electrification side. I think also in China, what we're seeing is that the battery side is difficult to penetrate. There's a lot of investment in batteries in China. On the other hand, the eAxle and traction and other components, we think, is a better pathway into the eDrive business in China. So again, it's another way for us to penetrate the market. We think we offer significant technology advantages to our Chinese partners there. And this is just a vector, if you will, a way to get there that we think represents a bigger opportunity in the short run than just waiting for the battery market to show up.

Got it. And then Meritor had a $1.5 billion electrification revenue target for 2030. I'm wondering, based on your due diligence and cross-selling opportunities, how comfortable are you folks with that outlook? Any thoughts?

Yes. We'll talk about that in detail tomorrow. I don't want to steal Amy Davis' thunder. But suffice it to say that Amy's view is that Meritor's target plus Cummins target will equal the 2 combined, plus some. So she feels strongly that the 2 companies together offer customers more viable solutions quicker, and therefore, will offer significant revenue targets. No doubt that as soon as they -- each get into each other's numbers, they'll want to talk about exactly what each thing is. So I'll leave that to them to do. But we think this is a significant revenue growth opportunity for the new power business and really one of the biggest pieces of compelling logic of the acquisition. So let me let Amy take that through rather than jump in front of her here.

Great. Thanks very much, everyone, for joining today, and we look forward to sharing more at our Analyst Day tomorrow at 9:00 a.m. Eastern. Take care.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.