Cummins Inc. (CMI) Earnings Call Transcript & Summary

Okay. Great. Good morning and welcome, everyone, to the fireside chat with Cummins. I'm Jerry Revich from Goldman Sachs. And I'm delighted to have with us today from Cummins, Brett Merritt, Vice President of On-Highway Engine; Christopher Clulow, Vice President, Investor Relations. We also have joining us by phone, Matt Ruch, Manager Investor Relations; and Amber Hughes, ESG Manager of Investor Relations. Brett, Chris, Matt, Amber, thank you very much for joining us.

Thanks for having us.

So we're going to run the discussion in a fireside chat format. If anyone has any questions, please submit them using the webinar bar, and it will go straight into my inbox.

Maybe as a starting point for our conversation here. Brett, you folks at the Analyst Day essentially disclosed $2 billion in new customer wins with companies like Daimler, Hino and Isuzu, which was, frankly, twice the size of what I thought the wins to date had totaled to. I'm wondering if you could just talk about the cadence of when you expect those revenues to kick in relative to the longer time frame that you laid out at the Analyst Day and how sizable are the opportunities outside of Daimler, if you wouldn't mind commenting on that?

Sure. And I'll take a quick step back to say this is a strategy we've long worked on, Jerry, to -- and we've talked about it with you regarding the fact that everyone is investing in everything. And so there's a variety of power options that we're all investing in as well as new emission standards. And so when we go through this challenge, many OEMs are challenged by the amount of research and engineering they need to invest. So we think there's a huge opportunity that scale wins. Given we make 1.4 million engines and much, much larger, particularly in medium duty than any of the other competitors, we think there's great opportunity there. And it's come to fruition with the first announcements of Daimler, Hino and Isuzu. The revenues will begin actually this year when we think about Hino and Isuzu, medium-duty North America, and some additional share and penetration with Daimler, albeit where everyone is a little supply constrained, and we'll -- I'm sure we'll talk about that later. But it will come in other markets in Europe and around the world in the '25 time frame and the back half of the decade. From a perspective of which is larger, obviously, Daimler is much larger and represents over half of that opportunity. And you can do the math yourself. They were the second largest medium-duty player from a global perspective. And so that move to partner with Cummins is a big one, one we're proud of, and it's a great partnership so far.

Super. And I have to ask, in the U.S., we have new regulations coming on with CARB by 2024, and presumably the EPA to follow in 2027. Does the $2 billion include any additional wins that have not yet been disclosed? So for example, I don't imagine a lot of 11-liter engines will be converted to the new standards, which means the Cummins 12-liter engine picks up 20,000 incremental units. Is that in the $2 billion number already? Or is that based on the -- $2 billion based on only what's been disclosed?

Yes. Chris, do you want to talk through the $2 billion assumption? And then I'll talk through other opportunities on the 11 and others.

Yes. So Jerry, I think the $2 billion that we're -- we've talked about is really what we've already talked -- already have agreed and what we've talked about publicly between Daimler, Isuzu and some other small pieces that we've come together. And then Brett can talk about -- there is potential. I mean as Brett indicated, not a lot of potential in the medium-duty space, but heavy-duty is a little bit more open field.

And the way we look at it, Jerry, is you can start to do the -- figure out what does scale mean, how many engines would you actually need to sell on an annual basis in order to cover the R&D. The average engines, $100 million to $200 million of investment. In addition to that, you have capital. And as further regulations happen, we believe every one of them presents an opportunity, particularly in these areas that you could identify as subscale. So this is a strategy that we have -- that has not come to its culmination, and we think more will happen. And from a timing perspective, we're still waiting to hear the EPA ruling for '27. We won't get a finalization until later in the year on Euro 7 and those will have impacts on decisions from OEMs and from us. And so I think it's a stay tuned, but we think there's exciting things in the space.

Yes. Rich Freeland taught me, it's 25,000 units of minimum production that you would need, and the entire 11-liter market in the U.S. is 20,000 units. So it should be a good opportunity for you, folks. And in terms of looking globally, are there any other major product category -- I should say, product categories where we could be looking at similar sub-25,000 unit industry production numbers for any specific categories as we think about what the heavy-duty opportunity set might look like from here?

Yes. We actually think that rule would apply globally. And so as you look at challenging emission standards in each region, we see opportunities. We think we'll have some continued runway in India with a variety of partners there. We think Brazil presents a nice opportunity, particularly with some of the protectionist environment that Brazil has and the need for scale as you go through South American regulations. And then obviously, we've made pretty large investments in China. And while it's not a great market this year, it will be a good market, and it will be the largest market for a long time. And so we've made great announcements on 15-liter natural gas and a 15-liter diesel in addition to some other mid-bore diesel products in the 13-liter space that have a really good opportunity to continue our share marks that we've been committed to as the market returns.

And can we talk about natural gas? So you folks have a really strong market position. Are you seeing interest in the technology? I think a couple of years ago, natural gas engines in the U.S. were 1% of production. Can you just give us an update on where that stands and whether it's viewed as any greater than diesel?

Yes. I love that you brought it up actually. It's an exciting space for us, and I've been leading parts of this natural gas business for a long time. And I will say -- and probably we've talked about this a couple of years ago. It used to be those who moved to natural gas stayed natural gas. This is refuse. This is transit. There were a few truck operators that made some pretty large investments like UPS, and they'll continue to use it. What I'd say is that's drastically changed in the last year or so. And so we today sell a 6.7-liter, a 9-liter and a 12-liter in the North American market. We've made recent announcements that we'll extend that range and introduce a 15-liter natural gas in the 24-ish time frame. And the drive for increased natural gas is really 2 things. One, there is some regulatory NOx compliance in California, specifically come '24, that presents an opportunity. Second -- I guess there's 3 things. Second is continued infrastructure investment on natural gas and fueling and making it feasible in a variety of other areas. And then the third big one will be continued push to make a lower carbon, lower NOx emissions heavy-duty application. Natural gas becomes a really feasible durable solution. Particularly as more renewable natural gas comes into the market, as you'll see continued investments by a variety of fuel players into the '24 and '25 time frame, we think natural gas 15-liter will be a real opportunity in the linehaul segment. And so in heavy duty or battery electric is a really difficult proposition. Natural gas is a mainstay there, and we'll continue to make investments.

And Brett, what proportion of industry production are natural gas engines today in North America?

It's pretty small. We're talking 10,000, 12,000 units today. And by all means, this is not going to be the primary propulsion for some time. It will stay a niche. We think it's a much larger niche than that, but a niche nonetheless and one that we're heavily invested in, not only in engines, but you've also seen us make a fuel delivery system joint venture with Rush, which is a strategic way to make this easier, make the product better. And then hopefully, Cummins will continue to have a continued portfolio growth that makes natural gas engine a very feasible option for linehaul.

Very interesting. So you're essentially up to 4% of the industry today, which obviously absolute number is not huge, but we have seen adoption. Interesting. And in terms of your margin profile, Cummins Westport used to be a joint venture with disclosed financials. The margin profile looked really attractive despite low production quantities. So it sounds like you're able to utilize all the key components for diesel essentially is what that tells me. Is that right?

Yes. Chris will get into the margin profile, but what I'd say is we think it's a scalable business. So you've seen us introduce a fuel-agnostic strategy. And the essence of the strategy is we do believe that -- we don't believe in a silver-bullet theory. We do believe there has to be a variety of options for our end customers to serve their needs. So you'll see us introduce a gasoline engine. You'll see us introduce a diesel engine. You'll see us introduce a natural gas engine, all which takes, call it, below the head gasket a similar architecture and then some continued investment will get us the rest of the architecture, which gets each fuel an optimum output in order to serve the end customers. And so we're going to drive our scale to give that optionality for customers because, frankly, in this regulatory environment, it's uncertain which one wins, and we think that we need a variety for individual niches of the market.

Chris...

Jerry, just a little bit from the margin profile. Natural gas has operated a little bit of a premium to where we were in diesel. As the niche grows, there's -- it'll kind of come into line, we expect. But I think we -- very healthy margins. And as Brett mentioned and you indicated, we leverage our diesel portfolio. Our current production has always produced the engine in our current facility. So we already set up for it. So there's -- it's not a huge investment to get to where we need to be.

And Brett, did you say gasoline engines will be coming up?

Yes. Yes, we've made an announcement on a 6, 7 gasoline engine that will come out. It's a diesel architecture, and it's a part of the fuel-agnostic theory. So if you're going to reach low NOx in a small medium-duty truck, it can be quite an expensive proposition to move completely battery electric. And we think there's a need out there for another solution for CARB specific.

Really interesting. Can you tell me a little bit about fuel economy because that's been the issue with gasoline in those applications in the past?

Yes. There'll be more announcements on the product. And I don't want to get completely ahead of ourselves, but it will not be a traditional gasoline. So you're going to see more performance like a diesel, call it, durability and more diesel-like greenhouse gas or fuel economy performance closer to diesel and less like a current gas, but you'll have the reliability and simplification of a more gasoline-like after-treatment system. So it's a little bit of a new space. It's a very difficult one. It's difficult to explain to investors. It is to customers as well, but it'll be in the hands of some customers in the next year, which we really think generates a new option for our end customers.

Did you folks acquire anything that gave you this capability? Or it's -- I've never heard of being able to achieve diesel-type fuel efficiency with gasoline in any application.

No. It's internally developed. And we've continued to invest in this over the years. And obviously, it will be less than diesel, to be completely transparent, but it will be much more like diesel than it is the current gasoline large big bore products that play in the market.

Fascinating. Okay. We'll stay tuned. And in terms of the cross-selling capability, just to pull on that thread, you folks just announced a partnership with Daimler for hydrogen fuel cells. Daimler has invested a lot of capital in its own hydrogen fuel cell via a joint venture with Volvo. So very interesting to see the partnership. Can you talk about how their proprietary system fits in versus applying the fuel system from -- or the fuel cells, excuse me, from you folks?

Yes. It's an exciting opportunity. We talk about it with a variety of OEMs. So one thing on the new power side, whether it be electrification or fuel cell, relationships matter, presence in the market matters, the ability to be a known commodity that delivers durable high-volume product matters. And I think you'll see that with the continued announcements, whether it be Isuzu on electrification or whether it be fuel cell with Daimler. And Daimler always takes a quite practical approach. They make their own engines and buy all of ours as well. And I think their theory there is we'd like to offer what the customer would like to choose. So we do think there are some end customers who would prefer the Cummins fuel cell technology. And it helps mitigate risk for Daimler, and we think there's opportunities, particularly in the North American market. I'll let them comment on how that works in their portfolio, but I think they just make practical decisions regarding giving options to end customers.

And Jerry, I'll add to that, I think this is another illustration of what we talked a bit about in our Analyst Day, which is there's a variety of applications that our customers need, and they're not going to invest to fit every need. And this is what we've done historically as Cummins. We can fill in the gaps for them. We can provide the main body, but we can also fill in the gaps where maybe their investment level can't reach. So this is an example where we -- as we work with the OEMs, these long-standing relationships and kind of knowing where those gaps lie where we can bring the scale and the investment to meet those needs is really a huge advantage for us.

And in terms of cross-selling -- so obviously, we're waiting on Meritor. But can you talk about what level of interest you've seen in the Meritor product line from your customers? I think initially, there was optimism around Asia, specifically. What I'm hearing from you is it sounds like it actually might be in developed markets as well. Am I reading into your comments too much, Brett, or what's the feedback been like?

Yes. And we can't say much because it's in the middle of the regulatory and legal review. What I'd say is I think it -- this is a purchase that works well. Meritor, a very similar company, very similar values, provides great value to end OEMs. And these are the same relationships we generally have on the engine side as well. So I think it will not only build into the engine side truck portfolio, but also the electrification side portfolio and help augment our investments there. We're excited to be able to talk to us -- talk about it. And I'd say the industry in general is excited to talk about it. Unfortunately, none of us can until the end of the year.

Okay. Well, we'll stay tuned. And then in terms of the profile of your hydrogen fuel cell, can you just talk about where the energy density of the product stands compared to what's out there from companies like Toyota and others? Just help us understand where your technology sits from a capability standpoint.

Yes. Go ahead, Chris. Well, I was just going to say this is a difficult one because it always depends on what stage. This is our fourth stage development of fuel cell on the vehicle side. And I think we're competitive. What we'll need to determine is when we're competitive when we go into high production. And so I think we're competitive at this stage. We'll continue to invest and maintain that competitiveness. But we all, as an industry, need to prove that out in the truck application, to be quite honest. But go ahead, Chris.

Yes. I think Brett covered it well. But I think when we're looking at comparable products, we're equal or better in terms of the fuel cell density offerings. And that -- the announcements that we just had -- we just talked about the Daimler and working with Scania as well and working with others, I think kind of shows that people believe in our products and have confidence that as Brett says, as we scale up, it's going to -- people have confidence in our ability to do that, but it's certainly constantly evolving.

And 2024, is that when we'll have full production units out there? Or are those stall built-type prototypes that we're targeting?

Yes. In terms of the production, it is -- we're not in kind of the mass production mode. So it is a little bit more stall production system that we have going now. It is -- it does evolve. We have made the investments and continue to make the investments as this ramps up, but it makes sense to do it a little bit more one-off these days.

And Chris, does that apply for 2024 as well where you folks are delivering products to market with Daimler?

Yes. I think it -- we -- this is where the kind of the ramp begins, Jerry. It's a great question. With some of these announcements, as they come up, it becomes -- it is somewhat dependent on the customer uptake. I think it's still pretty early in 2024. But as we get towards the middle or late end of the decade, that's when we expect the ramp to begin on the fuel cells. We always kind of expect the fuel sales to be, in our new power portfolio, applying those is probably third in line after electrolyzers and then battery electric and then fuel cells shortly thereafter. So we -- we're kind of working in stages as these roll out to kind of mass production.

And the way I look at it, it all depends on perspective. So for us, who make 1.5 million engines, we think it's pretty low volume. If you go through our battery electric plant, just across town from me in Columbus, Indiana, we're making them in a true production facility line. I would still call that low volume, but it's really high volume for a start-up, much higher than many start-ups that are out there. And we're putting in right next to it a higher volume line as the volume ramps. And I think we'll take a similar philosophy on the fuel cell.

Super. And in terms of the relative contribution then in the 2025 plan that you folks laid out, fuel cells does sound like move the needle for you folks from there. Okay. Got it. And then where do you folks see interest for hydro fuel cells from a regional standpoint? Obviously, this agreement is in North America, but can you comment on what you're seeing in Europe and maybe touch on your approach in China where there are a range of companies making fuel cells?

Yes. I definitely do think there'll be interest in China. For sure, you'll have some interest in Europe, although Europe is really strong on BEV. We think by application, particularly a heavy-duty high torque or high-weight application, fuel cells work quite well. You're going to see interest in the United States. And interestingly, you're going to see interest in India who are making large hydrogen investments as a country. So I think part will be by application, which will be a little bit global, which I think you're going to see even a large bus or a truck. And then you're going to see it based on regional investment by the country and/or private in that region, which I'd put leaders probably U.S., China and then Europe in some areas.

And in China, specifically, obviously, you folks have experience in making low-cost systems in China with the diesel business. How does that relate to fuel cells because there is no shortage of companies making at least automotive fuel cells and starting to scale those up into truck?

Yes. I think that's being played out right now, Jerry, on, one, what level of fuel cell you need to be competitive in China and then what level of the market will actually need to be competitive in China. And so you're seeing us with a variety of partnerships there, present some opportunities, but it's pretty low volume today. And I think that's a great question we have to answer for you over the next 2 years, call it.

Okay. And can we shift gears to electrification? So we're waiting on Meritor, obviously, but how does the portfolio of products look to you folks? At this point, I think initially, you folks wanted an integrated system approach. I think that thinking has evolved. Can you just talk to us about how you're thinking about product line strategically within electrification for you?

Yes. So I can start and then Brett can chime in, of course. So I think we're feeling good about the portfolio as it exists now. We continue to make investments, particularly on the battery side, to make sure we're meeting the customers' needs in terms of, one, power, in terms of performance, energy density. So that -- those investments continue to go on. But we're building off of our current portfolio, I'd call it that. That's how I'd frame it, Jerry. And you're right with the pending, I'll call it, Meritor acquisition that we hope to complete yet this year does really kind of round it out with the eAxle, which takes the power from the battery or the fuel cell in the long run and puts it to the road. But we're feeling like we're in a very good position there, continue to work with customers in North America and elsewhere and look forward to announcing a few major milestones yet this year in terms of some growth potential in electrification.

Got it. And...

My only add -- I was just going to say, Jerry, it's a little analogous to where we are in engine. There are some customers who are going to need that full suite solution, full portfolio. They just don't have the engineering wherewithal or scale to be able to do it. And there are some others we're going to do a little bit à la carte and maybe even do some partnerships in a variety of areas. So depending on region and/or customer, I think it could be a little different answer, which is a touch different than when we talk to you, call it, 2, 3 years ago. And that's being played out right now in markets all around the world for sure.

And in terms of the eAxle product for Meritor, which is a sustainable business today, but what's your sense on what the market share looks like for their eAxle product versus conventional product based on that $1.3 billion revenue target that they've laid out and you folks have signed off on?

Yes. So I think it's -- I think it's a variable that we need to see play out in terms of adoption, Jerry, in terms of the market share. It really will depend on how quickly the infrastructure gets built, frankly. I think that's one of the big dependencies as we see this adoption and the penetration of electrification and fuel cells overall is really seeing on how that's going to progress, and I think we're going to need some investments. We're seeing some, and that's -- it's encouraging as we're seeing some localities or states build it out a bit more. But I think it's almost a little bit too early to call on that 2030, what percentage of that is. We've put a good range in there. We feel confident that -- particularly in the heavy duty, the eAxle is incredibly well positioned and making some inroads on the medium-duty space as well in terms of adoption. So we're looking for that. Feel comfortable with Meritor's assumptions there as much as we've looked at it, but that's -- it's going to play out in terms of share on some infrastructure development.

And in terms of the competitive landscape, the major products we've seen have been from Dana and from Allison. Anyone else that's notable when you're looking at the competitive landscape for that product?

Yes. I think the one I'd add there is probably [ Zeta ], out of Germany is always a very capable company and a good player in that range as well.

Okay. Okay. Can we shift gears and talk about margins? You folks, as a team, have delivered higher margins coming out of each recession. Obviously, lots of concerns about the economic outlook from here. But when we go into the next recession, whenever that will be, how are you folks thinking about the opportunities to improve the business? What are the major buckets of opportunities that you folks are -- what levers will you folks pull in the next cycle to structurally improve the business?

Yes. It's never kind of a pleasant experience to go through as we work through these cycles. It's one where Brett and I probably together have been through 7 or 8 cycles together. And it's something we know well. We know the playbook. We know the areas where we need to continue to get leaner in terms of, one, investment, we will continue. That's the big pieces. We -- where we will -- I'll answer -- we won't get [ scanaric ] as kind of some of our R&D investment, and we will continue to invest in new power and our traditional space. But areas where we think we have some opportunity is -- just recently, we did a kind of a transformation in our North American distribution. That is paying dividends now and continues to pay dividends. We'll look at that -- spreading that more globally. And as we continue to work on pushing down some of our administrative costs, our back office costs and really taking advantage of that consolidation, and that's just one good example in distribution. The other key element that I think we'll be working on it, should this downturn come in relatively short order is integration, integration of acquisitions and really pushing that hard is to make sure we take advantage of that and drive cost out where we can. So those are probably a couple of areas of focus. But like I said, Cummins has done well. We have a really good track record, peak to peak and trough to trough of raising our markets. And lastly, I will add that the one advantage is we have is the cycles oftentimes don't coincide. So where it might cycle down in North America, it may be similarly cycling up in China where it's currently down. So sometimes the timing worked out for us where it becomes a little less apparent to the outside of the cycles we're going through.

Okay. Great. Can we shift gears and talk about technology and data? So significant investment in telematics that you folks have made over the years. I'm wondering if you could talk about what business intelligence you folks are able to gather today compared to about 5 to 10 years ago? And what's that enabling you to do in terms of driving uptime or higher parts market share today versus historically?

Yes. I think data is really critical, and we'll continue to need to push the envelope there. And it's less about making money for data as a service and more as you're saying, we use it internally and get much earlier engineering data than we've ever had before, whether it be faults, issues, others, that contributes 2 ways. One is you've seen some quality improvement, particularly on the engine side. That has been -- data is definitely an enabler of that to get early ability to see where launch issues may be and how do you fix it even before the customer would see it. Second piece that helps us is it drives market share. So our core strategy is a combination of push, pull and uptime. So we push our engines through the OEMs. We have end customers pull those engines from the OEMs, which helps increase, but you can't do it without a product that's performing really well, and that's where uptime comes in. And I think our uptime measures on all our engines post the 2017 launch have continued to increase in almost every market. So we've had a phenomenal launch and introduction of our 2021 products in North America that most people talk about when we talk on these, but also in India with BS VI and in China within NS VI, just excellent launches that have really been enabled by the data. And it's tough for me to quantify all the benefits, and we'll need to continue to drive those so that it's easier for customers to download the next cow, much like we do in our cars today. So kind of think about your personal car and how you treated it 20 years ago versus today, we're on a similar journey, and I think we've been successful doing it.

And we've seen in oil and gas applications the rebuild schedules go from 15,000 hours, say, 18,000 to 25,000. As that happens across your applications, what are the implications for Cummins from monetization standpoint because you have wider service intervals on the one hand, but presumably higher market share on the other? But I'm curious if you'd agree with that characterization. And how do you think about what it means for your aftermarket business?

Yes. I'll let probably Chris talk about the overall aftermarket. But in the on-highway portion, we haven't seen those intervals change that much. What it's done is had much less pain for the customer between today and when you rebuild a heavy-duty truck in year 7 through 11. That is very much mileage-driven. And miles-driven on linehaul really haven't gone down. Medium-duty, it happens a little bit later than that. And what we've seen is great loyalty and ability to attain a good reach into the parts market. And additionally, as you kind of mentioned, because of our share growth, that rolling fleet of Cummins vehicles out there is larger than it's ever been. So I think for us, we still see parts as a good opportunity.

Yes. And I'll touch on a little bit on the Power Systems space for those large engines. You're right. They're, I guess, going longer between rebuilds, but it does drive more or the same loyalty that Brett just talked about and greater share gains, and people want us to keep rolling in the new equipment as well as rebuilding the older equipment. Now is a perfect example where demand and the aftermarket side is quite high. And one other thing that I think is also important is we just continue to put out more and more population, and that drives the aftermarket up. And many times, the aftermarket doesn't really kick in until 4 or 5 years after the product is first sold when it gets out of the warranty period and then really drives the aftermarket upwards. So the population continues to rise both in the on-highway and off-highway spaces, which will fuel continued growth there.

And question off-highway. So the rig count is up off of a really low base. What's your order book looks like compared to prior cycle levels? I guess there's concern about availability of leases for drilling applications. I'm wondering if you're seeing that in your backlog versus prior cycles.

Yes. In terms of just oil and gas, Jerry. I just want to make sure I'm answering...

That's right, Chris. Yes.

So we -- it did come a bit late. In the Power Systems business, we did see oil and gas kind of came to the overall industry as oil prices rise -- rose and with a lot of demand. Unfortunately, the industry is also at high demand with some supply chain constraints. But we're managing through well. We were able to free up some capacity, and we expect our oil and gas business to be up considerably, more than double actually now this year if you include parts. It comes off, albeit a small base, but we're growing rapidly and that -- and trying to meet as much need as possible. I would say the demand in that space is higher than the market can reach, which is not uncommon actually really across many of our markets right now.

Chris, from an absolute standpoint, doubling would get you to levels that are, what, 50%, 60% below 2014, 2015 levels?

It would still be, yes, a little bit north of that, Jerry, probably more like 80% below. Yes, yes.

80% below?

Yes. Because last year was a very low base. And now if we could produce, we would be up at those levels, Jerry, if they produce where the demand is, but that's just, unfortunately, capacity constrained really for us and same with the competitors.

Got it. Okay. Super. Well, that's all the time that we have for our session. Brett, Chris and team, thank you so much for joining us. Thank you, everybody.