Cummins Inc. (CMI) Earnings Call Transcript & Summary

1:00 with Cummins. My name is Chirag Patel. I work with Stephen Volkmann covering the machinery space here at Jefferies on the equity research side. It's our pleasure to introduce Chris Clulow with -- he is VP of Investor Relations, and I'm butchering your last name, I'm sorry about that.

It's been butchered my whole life. So it's natural, I can.

I was going to say that why don't we start out with just coming off of the second quarter here, just give us a big picture kind of an update on where things stand in the world.

Yes. So nice to see everybody here. I think -- we were very happy with our second quarter. If you take me back a few years and say China is going to be the worst since 2007. We're supply chain capped and we put up record revenues, I would not have believed you. So we're feeling really good about that. And the outlook for the future as well. So the rest, this year looks very strong. Markets are holding up quite well with obviously exception of China. But around the world, things are looking very good. We're making excellent headway and serving our customers well. So profitability as well, even in this tough environment with costs at an extremely high level for our industry are holding up quite well. And we're continuing to put up some good results on that side. So the 2022 outlook looks pretty good, and then we're looking forward to 2023 and seeing what that entails.

Sticking to 2022 for a second here. I just wanted to kind of get a better sense for how much of the growth you've seen thus far is price related? How much is a little bit more volume? I know there's a lot of end markets, a lot of different varieties here, but...

Yes. So we've been probably more successful in pricing this year than any other year in my history with Cummins, which is about 18 years. It's obviously a very unique environment. And so about half of our growth, we are expecting growth about 10%, but half of that will be in pricing. So -- and most of that sticky pricing, I'd like to call it. So it's not -- we're doing some surcharging and things like that with particular OEMs in order to just cover costs, things like elevated premium freight or elevated standard freight or other things like that. But most of the rest is really just sticky pricing. So we've been -- had some good success there and as have our customers. So they're passing those prices along to the customers as well. So we're participating in that well.

Excellent. And then I guess on the flip side of that would be the volume question. And I don't think you're agnostic in the idea that you probably have some inventory that -- were not even inventory, but finished goods that have just not been shipped. Where do we kind of stand on that sense of the equation?

Yes. So I think in terms of inventory, I think that is -- you're right, that throughout really anybody who holds inventory has a little bit too much inventory. I think we've done a good job in managing it overall, but we're looking into that over the course of the remainder of the year is how do we reduce that? How do we continue to push that down? But what you don't want to do is compromise your ability to produce. So would you have this limited production just due to supply chain issues that still remains. You don't want to compromise that. So we're putting that balance into place. But I think just to be clear, I think we've had a lot of battles over the last 2 years with our supply chain group. And so now it's kind of refocusing a bit to move on the inventory front.

I got you.

But nothing that's causing us a significant concern. I think we're in pretty good shape.

And you see volume production between second quarter, third quarter, fourth quarter, is that a natural progression of sequential improvement?

It is. And not -- we don't want to expect any huge step-ups. So all of our OEM customers are talking about ramping up production, and they have, but it's moderate. It is coming up a little bit, and we're working our way through some of the backlog in the industry, but it isn't taking a big leap forward. We still have limitations in terms of -- particularly on the electronics side, chips and other components. I guess on a macro scale, they get better, things are getting a bit better, but they're still kind of something we pay very close attention to. So that is still limiting us in terms of what we can produce and even more so for the OEMs.

I would ask you about normalization, but at some point, yes, it's one of those things where I think it's a moving target every quarter.

It is, I would say, it has seemed over the last probably a couple of months to get a little more smooth, and that's probably all the way through the second quarter, which helped us quite a bit is it was more predictable and its chaos. So we were able to -- it keeps our production more level, it keeps the OEM production more level. There's not as many shocks to the system, which really caused huge cost, but also shipments, things like that. So we're able to operate very, very cleanly, good execution. And that really helped us a bunch in the second quarter. And it seems to be evening out as we go into the third and fourth quarters. So I see a little bit of growth in North America. Aftermarket continues to be very strong. And so I think it's -- but just kind of a slow step-up from the second quarter.

Have you changed the dynamic between how you're servicing OE versus aftermarket in the near term?

Yes. It's a delicate balance because it's the aftermarket customers of today are the OE customers tomorrow. I mean in the -- whether it's the OEMs or the end users, you need to make sure that you're keeping people running. All of the end customers here, they depend their livelihood depends on uptime. So we have to balance that in terms of what goes the aftermarket versus first fit. And I will say, it's gotten a bit easier in the respect that our long list of supply chain issues has gotten shorter over the course of the years in terms of the parts, in the course of this year. And the problematic pieces, which I mentioned electronics, are less prone to being -- electronics chips and so forth. They're usually harder goods, harder materials, so you're able to shift more supply towards aftermarket, which has been nice, and we've reaped that benefit in terms of sales.

Excellent. And I guess the next stage of this is how we're looking into '23. And I guess one of the things that I kind of look at is there's been a significant change within your engine strategy and the way you've approached customers in capturing some additional medium market share that hadn't been there available previously. Where are we on that stage? What's being layered in? How much volume is really being added as we move forward here?

Yes. So '23 is the wildcard is how long will this last, and that's a question I get many times a day. Is -- will the market hold? And we're looking at right now is that market looks like it's going to be strong through this year and well into next year, if not all the way through next year with the backlog that exists, which is about 220,000 heavy-duty trucks. And the medium-duty backlog is even more robust in terms of percentage production. The demand is there, and we expect it to continue on well into next year. So it is one of the factors that we look at really closely is how many have been replaced this cycle versus last cycle. And even if we produce essentially a flat level next year, we'd still be about 100,000 units short for heavy-duty trucks, and that's a lot. So the age of the fleet keeps getting older and the efficiency with the new trucks is so much greater, particularly with high diesel prices, incentivizes people to move that way. You also mentioned share. And that is another thing that we continue to make good progress. We don't talk about share too much at the advice of our counsel repeatedly. But it is something in the medium-duty space, we continue to do quite well. We picked up the Daimler business and the Hino business and the Isuzu business last year. So the remaining competitor, which is just a few percentage is Ford. So we continue to progress and grow share over the course of the next couple of years until we get to a very high level in North America. Heavy-duty is another place where we can continue to do a little bit better, but that's an ongoing discussion with the OEMs is how can we help serve them better.

Have they been more perceptive given that there's a lot of technology changes on their end that they have to make for the next iteration?

Yes. I think that has been the shift, and that's what happened in medium-duty first, and I think that's the conversations we're having in heavy-duty now, is there's so many demands on an OEM for their investment, whether it be in the new power space, fuel cells, electrification, which we're working with them on as well. . But also autonomous vehicles or safety. And so, it's just such a high demand that they need to shift somewhere. And what seems like the many are doing is shifting the combustion engine and shifting it our way. It's the vertical integration threat that we lived with for about 100 years is kind of shifting back now in the combustion engine space.

And then I guess the next question is always what's beyond combustion engines? And while I don't think that they're going to wait tomorrow, what investments are you guys making? Where do we stand in that process?

Yes. So before I shift away from combustion, I will say that we continue to invest in that space because we think they're going to be around for a long time. And we do -- one of the most exciting announcements we've had. It was earlier this year is a fuel-agnostic engine, and that's how we're designing our platforms now, which have the same bottom end but different top ends. So you can have your big economies of scale in terms of what you're producing, how you serve aftermarkets, how you fit with OEM customers, it will be. If it's a natural gas engine, a diesel engine or a hydrogen combustion engine, which a lot of OEMs are very interested in. You can have that same kind of platform and leverage your development expenditures over time. And then, of course, we're investing quite a bit in our new Power Group. We carved that out separately several years ago, just to really focus on what's the next technology, and we want to disrupt ourselves. So our new Power Group operates quite independently from our Engine Business Group. It creates some healthy tension. And what we're investing in is fuel cells, electrification, solid oxide fuel cells. It's a number of different fronts, and we're covering most of the significant technologies as we're doing that. And it's really exciting. It's opened up some new opportunities for us in terms of just pure outgrowth. We weren't in electrolyzers a few years ago. This is a good spot to be in, particularly with the energy and security right now. That market is growing rapidly, and we're really excited about that growth potential, as well as working with the OEMs on some of this new technology, whether it's fuel cell or electrification, there is a role for us to play. I think one of the early pushbacks is like, yes, they'll give you a combustion engine and but they're going to do all of that new product themselves. And what it is, is it's not dissimilar to how we've operated in diesel engines in the past. Each OEM serves the whole world, but they can't serve every single market, every single application and we fill the gaps. And we've done that, and we've made a really good progress on that front over many years. And we see the same thing playing out in this new power space, whether fuel cells, we'll serve gas, we'll be the prime power provider in some spaces, we'll be a component provider or we'll kind of help the OEMs along.

And you said you partnered with everyone at this point. Is there any thoughts on where an EV makes more sense? Where hydrogen makes more sense?

Yes. So we -- in our view, it's really somewhat dependent on the duty cycle of the application. So a good split. It's just an easier way to think about -- it is like heavy-duty or large engine, high horsepower applications, mining, oil and gas. It probably makes more sense to be using a fuel cell. Just from the power needs, the density, the weight, all these things play into it. And then as you get in more medium-duty or delivery space, that's more electrification where you have more localized fleets where they're just operating around one hub. The fuel cells seem to be a better fit for longer haul. Now that's a North American comment. It might be different in Europe, where it might be more localized where you have some heavy-duty trucks in smaller countries that are operating on electrification because they can. It's just shorter range. But in terms of North America and in China, we see that being a split because of just the distances and the duty cycles. So that's kind of how we're progressing, but we're working really on both technologies.