Cummins Inc. (CMI) Earnings Call Transcript & Summary

Hi. Thank you, everybody, for joining us again. We are in the stretch run of day 1 of the conference. And Cummins has given us a lot to think about in the last week, pretty active with large acquisition and in their Analyst Day, giving thoughts after 2030. So a great time to kind of get them after we digested all that information, of course, as well as some of the events we've seen around the world to pick their brain on. So very happy to have Cummins' CFO, Mark Smith, joining us to speak. I see Chris is off the screen. Oh, there is Chris. I see Chris -- everyone knows Chris now from Investor Relations. He's already an old hand at the job, given how much activity you've had with the Street in your first few months. So thank you for taking the time as well, Chris. So Mark, let me throw it to you, maybe summarize how active Cummins has been in the last couple of weeks, and then I'll fire back with some questions. So again, thank you for taking the time.

Yes. Thanks for inviting us, David, and good afternoon, everybody, wherever you are. Yes, it's been a fairly full February, I think, is the way I would describe the piece of activity culminating with our Analyst Day last week. I would simplify our message as follows that we believe we've got a very strong core business that's got an extended future in front of it, and that we are in a position to outgrow our end markets through a combination of core business growth, more OEM outsourcing to Cummins, some inorganic opportunities that are going to support our growth. That's all in areas where we have high confidence in our visibility to strong returns and strong cash flow generation. The other piece of our presentation was about our ambition and commitment into the transition to new technologies, and we tried to convey to investors a sense of the array of technologies capabilities that we've got and how we're boosting our position, particularly electrified, powertrain space with the acquisition of Meritor. I think there are clear benefits from integrating the eAxles with our battery electric technology to further strengthen our position going forward. We also made the point we don't know how fast the transition to new technologies is going to be, but certainly with infrastructure build-out, still an open question mark in many of the end markets we participate. Nevertheless, we recognize the trend. We're investing in the trend and our ambitions to be leaders and laid out our growth targets accordingly. So kind of a robust financial base coming from the core business, lots of cash flow generation, which funds that investment in our position in the new power technologies. So that was the message from the Analyst Day, just a little word on momentum, David, and then I'll turn it over to you for questions. With the exception of China and with the exception of the developments in the Ukraine and Russia here, I would say demand remains strong. Demand from our OEM customers for Cummins products remain strong in most markets. Supply chain remains the primary limiting factor, incremental easing in some areas, some remaining concerns about labor availability in the U.S. and the capability of the supply base to keep ramping up. But so far, things point to strong demand. Recent events, notwithstanding. No big shocks on the cost of the supply chains at the start of the year to comment on. And then China, yes, it feels like we're running along the bottom, not different to what we expected, but no signs of any inflection point up. So we're probably waiting until the second half of the year to see more stronger signs out of China. But otherwise, a fairly robust environment.

You mentioned Russia, Ukraine. Can you help us with your, say, percent of revenues directly into those markets? Are you still selling to those markets as we stand? I mean I think of a name like KAMAZ on the truck side or BELAZ on the mining side that maybe give you a little more than the average, but then again, it's lumpy, so I'm not sure where you stand right now as a percent of revenue from those businesses. But then the knock-on effect on the supply chain and maybe other areas where it's a positive on driving other mining customers or other oil and gas customers, whatever it may be. What are you seeing from Russia, Ukraine impact?

Yes. So to size our revenues to Russia and surrounding areas, you're talking about $675 million last year. So an important number, but in the context of $25.5 billion of revenue overall. And of course, we'll fully comply with all sanctions. I don't have the up to the minute update on all that. But needless to say, we're expecting a significant impact to those revenues. I'm not trying to undermine the overall guidance because I started out by saying demand in most of our markets remain strong, but that $675 million, it's reasonable to expect it's going to come under enormous pressure as it should in the circumstances here. So on supply chain...

Consolidated sales, Mark, right? That's not JV exposure. That's...

Correct.

That's consolidated. And it's within the engine division mostly, off-highway and on-highway?

It's a mix across how our systems would be an important contributor to that number.

Yes. So that's because the mining's inside there pretty much, is that why? Or is it truly power...

Mining and power -- it's in power generation market as well. We don't have -- we have accounts receivable and accounts payable, but we don't have significant, wholly owned assets or cash balances in country. We do -- and then as you can imagine, we're banking with recognized international banks. So that's the size of that issue. Our supply chain really relies more on China and India and less on Europe. So right now, I'm not aware of any chronic new supply chain issues arising out of this. Who knows exactly how it will unfold. But generally, we've got supply chain coming from East to West, and we rely a lot on China and India more. So I think Russia is a huge supply chain source for us. So that's what I would say about that very difficult set of circumstances over there.

When you think about the supply chain situation, basically, demand is ahead of supply in a lot of your key markets, how is that impacting how you're handling opening order books further out or willing or not willing to agree to some order lengths that you normally would because you're uncomfortable knowing your cost structure and how to price it?

Yes. So we've -- yes, I think we're being more nimble with pricing. So we -- our results suffered in the second half of last year, and we needed to work through with suppliers and customers how to make sure the market [ bore ] the real cost. Quite frankly, the inflation in the freight and logistics costs was more than we've seen at any time that I could remember. We're not a natural fit into the basket of market indices we had in our contracts, for example. So we've worked hard to get the right pricing, and that's an important part of restoring our margins here early in this year. And then as we look forward, of course, pricing and availability are having to come together, certainly, as we look at the off-highway in large engine markets where our business is more on -- it's not on long-term OE supply agreements. It's more open market transaction driven to a certain extent. So we are -- yes, lead times have lengthened out in the large engine space. There's no question about that. And if you want to go fast, probably the pricing is higher, yes.

The truck industry, now that you're a little one step removed, but I mean there is a thought out there that the evolution of the business model to where, a, now a lot of the truck OEMs are independent companies, any independent stocks under the scrutiny of whatever financial targets they set for their margins more so than being buried within a larger auto company. There's also the thought -- and I know kind of what you laid out the other day wasn't exactly massive adoption of new energy near term, but that -- maybe that business model has to be a little less razor and razor blade, make a little more money upfront on the truck because that tail end on the parts might not be what it was in the diesel world. Do you feel there's a true shift of profitability as a focus by your customers' willingness to push price on a structural basis? Or is that a thought that's a little delusional that yes, right now, it's easy to raise price, and they are being more aggressive than I've seen in my career, but it's a moment where if you're going to be courageous and push price and so forth, the dynamic scenario on supply demand. So I'm just curious how much you think it's structural or it's just kind of the heat of the moment and they're pushing price more than we've seen.

I'm not sure they're telling us that they're pushing pricing more than they've seen, but I think it's -- I'm not sure, David. I think that would be a better question for Tom, quite frankly, and Jen about what's going on at the customer level and how they're forward thinking. There's no doubt, though, the investment needs of most of the OEMs are going up, right, which is playing into their choices about where to allocate capital and resources. Going forwards -- and there is a mindfulness about how much is being plowed into these new technologies, just as there's a mindfulness about how much they want to spend on upgrading the remaining diesel engine platforms through the remaining life. And I think that's where we play an important role. We've picked up more OE outsourcing as the move away from diesel investments has picked up. And of course, we still think we've got an exciting role to play in the new technologies. And I think it's fair to say as a trusted and global supplier to the OEMs, if we've got good technology in existing new or further out, you will get a fair hearing as to what's the capability of that technology to participate. But there's no doubt, this is the big structural thing that's facing OEMs. I mean it's facing us, to some extent.

When I think about your customers that were looking to outsource, say, back to you, and then we're going to dedicate to new energy, but it seems like -- and you've really come and said this from the beginning, especially with the Hydrogenics deal, but you're always sort of advocating heavy is going to go hydrogen and won't be battery. Feel like that's becoming more of a consensus, giving you probably a further runway of diesel dominating Class 8 and heavy globally. Have you seen customers that maybe were thinking about outsourcing the heavy engines when they thought maybe it might go battery and be a -- you name the adoption a year, a little earlier than what it'll take for hydrogen. And sort of back away and say, hey, we don't want to outsource that many years of business. We were hoping to time it within 5 years of battery really taking off. Have you seen that conversation swing a little bit away from you? Or is it now just no, if anything, the broader idea of diesel is going to be a legacy entity, whatever, 15, 20 years from now, it's actually accelerated the outsourcing attitude?

I think on medium-duty, it was a clearer picture with such a scale advantage, but I think the win-wins were so compelling that any natural concerns about making that -- I won't call it a leap of faith, but that extra commitment to Cummins as a more strategic partner offered a really compelling economic solution for all involved to multiple parties. I think that certainly on heavy duty, when you start to get into the significant volume plays, then there's a bit less daylight between some of the players than there was on medium-duty. And yes, I'm sure the calculus of how quick the change -- I can't say ascribe any change in discussions to the pace of change. But certainly, I think we're not alone in this view that heavy duty has got a longer transition run. It's a little tangential to what you asked. We are seeing more momentum and enthusiasm for natural gas, certainly, from some of the large movers of packages and parcels in the U.S. here, who don't want to wait for the perfect solution for heavy-duty trucks. So we're seeing quite of enthusiasm for the new natural gas platform, which our natural gas business is all wholly owned going forward. So I think there will, yes, be a number of bridge technologies as we call them of which we're going to have our fair share of those going forward. But it is in the calculus. Has been in the calculus, I'm sure, from the start, but I haven't seen this -- heard of a significant shift just because of that factor. It's more the overall discussions, and there is a clear win-win. And of course, I can't talk about individual customers. But I will say the theme of discussing more engine outsourcing has not gone away. It's not like -- we put in our projections for the base business what we have already secured, and the only delta around those most likely is the pace of change in the overall demand for combustion engines. If there's more, that would, of course, be incremental to those targets that we put out there.

And any update on, say, Daimler medium-duty? I think the impression was even you building some of those engines in Europe even within a Daimler factory, if I remember correctly. Any updates on that, be it some negatives of any labor work council complaints about this or that or maybe some changing in the original agreements with Isuzu or Hino or Daimler on medium-duty that we should be aware of?

Nothing material. I mean when you -- we're talking about global arrangements in multiple regions, and so there's always tactical considerations that go within the vision, but not materially, no. But of course, at the working level, it's a lot of work going. But the basic premise, of course, is that we're selling Cummins' platforms going forward, not absorbing other people's legacy platforms and trying to put together a whole mishmash of different engines. That's one of the big advantages for us because we get to then put more volume down the same architectural design. By and large, most of the volumes are going to be going through existing Cummins facilities, not all or some tweaking. And yes, we'll operate some space in Germany, but not dramatic investments for them.

Post the Meritor deal, what's your answer to somebody saying, I think buying Meritor was defense, it wasn't offense. You're just simply getting more content. But is it really adding value? Is it really creating, let's say, offense to win more business in a new power world? What's your response? What are the things that you looked at, if you don't mind me asking. I mean if you think of all -- if you think that was defense, what would be viewed as offense in your mind? But I'm just curious how you...

Yes. So I would try -- the offense case would be parallels with our components business where our engine customers would say -- and again, I'm not criticizing. I'm just describing the narrative that you're quite familiar, we're vertically integrated. We've got our own transmissions. But it turns out, they didn't -- many of them didn't have turbocharges, aftertreatment systems, fuel systems. Some of them did, but our view was it was the integration of those critical components that either made our engines as good or as a bit better than the competition and influence the architecture of many other participants that made that a winning combination for Cummins. And not just in that we were selected, but another narrative that we went through is wow, all these passenger car players in the components business have come in to eat your lunch because they bring all the scale for passenger car, and it turns out we were the only ones focused on commercial vehicle. And whilst they didn't get 0 revenues, our market share and content only went up. So I think our view about the Meritor that here's an opportunity where today, at least in some cases, the e-axle and the battery almost being purchased separately through an integrated solution, we can offer something that's designed together, produces benefits together that customers will value that yes, content's interesting. But if you have a better performing set of products, that's the real win-win in that. And so we realize we have to demonstrate that to people, but that's the offense versus the defense.

Well, I generally like the deal. Is it fair, though, to say joining a transmission with an engine like you did with the Endurant, the JV with Eaton, combining an axle with the drivetrain and even our electrified model is not quite as dynamic on 1 plus 1 equals 3, is that fair?

I think we think it's going to be a significant factor. And I think when you combine it with who's participating in these markets and what's the knowledge of all these different end applications, as you know, a bus is not a bus or medium-duty truck. There's just a lot of variation in there [ on how the tail of these ] products will offer an advantage against certain players. But we'll see. And we'll -- as we get further under the hood with this, we'll come and talk about that in more detail.

On more near-term issues, it seems like China -- you feel like post-Chinese New Year, we're not really seeing any pickup, post Olympics, any pickup, but sort of a bottoming. The -- but the Chinese market, when it comes to working through the inventory of the NS Vs, is that something that should be behind us, say, come April, May? Is that sort of where that stands? Or can that bleed into the second half of still working off that old inventory?

Yes. My base case would be through the middle of the year.

Okay. And then Hydrogenics, right, you made a bet with hydrogen. When it comes to the Chinese market, how would you characterize hydrogen versus battery on where you see that market playing out? And how do you feel competitively positioned there?

Yes. The way China tends to play out is there are 1 or 2 -- typically 1 or 2 or 3 national champions, and our strategy to all our technologies, it's been to help our Chinese partners win, and we found a strong partner in Sinopec that's committed to the hydrogen market, as always, announcing a partnership versus getting all the regulatory sign-off to getting deal flow, we're now into that third stage. We've done announcements. We've done regulatory approval, so we're into deal flow. So again, I think we're positioned with the right partner. Now we need to convert that into orders. I think what's interesting is there's a potential there for more energy independence in China. Battery electric, as we know in the U.S., the way the industry is structured today isn't really an energy independence story. I think we're going to need to see more supply chain development in the -- probably in North America. But I think we're well positioned there. And I think one of the strengths we bring, Cummins over different leadership changes in decades is this ability to park our ego a little bit and say, "How can we make this a win-win to partners and build what start out as small businesses into bigger businesses?" Our joint venture with Dongfeng started out as basically a licensing agreement. Now it's a $1 billion business that's prospered and grown through technology. So yes, we're ambitious and optimistic about our position in China. And I would say with the exception of one of the major European components manufacturer, there are very few developed market companies that have really developed the partnerships and leadership in commercial vehicle markets that we did. The same is true in India. And so we're hoping to try and replicate that in these new markets. And again, it's -- this is independent of the debate about transition from old tech to new tech in the vehicles themselves and into the hydrogen [ topics ]. So we're bullish there. Obviously, we're growing our partnerships in Europe. It's lumpy, though. The enthusiasm's high. The administration is also high, project-based.

Regarding the off-highway markets right now, are you seeing any indication of anything but demand ahead of supply? Or is still simply if you had more supply chain flexibility, your off-highway business would be stronger? We know that's the case in truck on-highway domestically, but I'm asking specifically about off-highway.

I would argue it's kind of red hot with the exception of China construction.

And if I think about your supply chain and you're seeing any light at the end of the tunnel to enable that supply to loosen up, is there anything that you're pointing toward that there's some milepost to think about, some new agreement you're working on? Just anything that might -- at least in the way you're thinking of the -- how it plays out in cadence that could be a notable pop to your volumes?

I think we're making progress on the on-highway side. We have to make difficult decisions in the heat of the challenges last year with our customers about are we prioritizing first-fit or new engine builds, are we we're prioritizing parts. And by and large, the weighting went to supporting the truck customer new builds, which means there's still untapped potential in the aftermarket for us going forwards. And we're seeing some momentum there in starting to improve backlogs that we had on the parts side. So that's positive. That's on the on-highway. I would say we're in a little bit of a not on the off-highway side because the rebuilds are ramping up, which is a positive sign of equipment use at the same time as in some markets, new equipment's picking up. So I think yes, Power Systems business enjoyed some of the stresses -- enjoy is the wrong word, but start -- Q4 started to feel more of the stress that was felt on the on-highway business. I think there's a bit of lagging going on that side of the business, a lot of intense effort. So I think -- I guess in this environment, the big hope is that much of the global economy can remain stable. And therefore, this demand remains, and we can satisfy it all in a strong return. So that's, of course, the watch out what happens with interest rates, what happens with this uncertainty. But for now, demand can only be described as strong in most places except for China. And China's not horrendous, it's just -- it's come down quite [ a jump ].

Is it fair to say, though, your comment about selecting maybe a little more aftermarket with your engine part availability than last year is a relatively positive margin comment? While at the same time, I think people when you reported it, were like -- actually, was kind of encouraged by the margin comment and a little light on the revenue. But what you just said would sort of back that up that, that, hey, we're a little bit stymied on new truck production, but we're going to ship what we can to aftermarket, and there, you have better margins.

I would put it the other way that we were forced to make more choices last year as we get more flexibility. I think aftermarket will get more of its fair share. I think -- I'm hoping you will see that demand for Cummins' engines rebounds in the fourth quarter as the industry works on a lot of those red tags. So I think it's full bar on both, but I think there's a bit more flexibility for aftermarket to get more of its share.

The recent better North America truck builds we've seen, is that impacting you the way we see the industry numbers? Or does that still feel like a lot of red tag trucks going out that already had your engine, so we shouldn't equate the better industry builds to you?

You'll forgive me for having my head in other books and papers for the last couple of weeks, given the other transactions that's been going on, but I would say the general demand for Cummins' engines remains very robust. We're not hearing -- I think the -- right now, the stronger we can deliver, it's all going to be accepted with the truck OEMs.

Yes. I was just thinking we can see a little better industry builds, does that mean there's a loosening the ability of you to ship more sequentially? Or is that industry data that's reflecting more, again, trucks that were red tagged in the hospital, whatever, what term you want...

I think the OEM -- I think overall -- I think my sense is the OE build rates are going up, and therefore, that's opportunity for their engines and our engines.

Okay. So that is a little -- right, a little...

There's some lingering red tags, there's no question about that, but I think the momentum is up.

Okay. Interesting. Look, we're out of time. You're in so many interesting businesses, I could talk to you all day, but I appreciate the time you gave us. Thank you so much. And thank you, everybody, for participating. And any follow-up questions, obviously, feel free to reach out to me. Have a great day. Thank you so much.

Take care, David. Thank you.

Appreciate it.

Bye.