Cummins Inc. (CMI) Earnings Call Transcript & Summary

Well, thank you, everybody. Excited to have Cummins, the best for last. This is our last official presentation for the 2-day conference. So very excited to have Cummins. So much to always talk about with Cummins just given all the different end markets you're in on-highway, off-highway, every aspect of technology evolution for emissions. So a lot we can discuss and who better than having Brett Merritt here, who runs the On-Highway Engine business. So you touched it all.

Thanks David.

And Chris Clulow, obviously, Investor Relations not for a few years, but spent 5 years in Cummins even before that. So you have reached veteran status. Now Cummins can challenge anybody's like longevity argument. There just some real, real, real life here in Cummins for sure. You're now a veteran.

So with that, I do want to kick off more of an emissions question. First, I'll let you if you want to comment about this morning's announcement. Is there anything we really should dive into? I would say nothing struck me as quite as dramatic as the -- we're making a major announcement yesterday. [indiscernible]

Yes, probably not as meaningful for investors. It's really meaningful that for the 2,000 people who work in that segment. We bought a series of companies. And so the identity of that group wasn't exactly one variety, whether it be Siemens, whether it be EDI and a variety of others. So this brings all that together. And kind of think of it what's called new power is now Accelera. And so yes, there was a nice buildup. But likewise, with customers, customers are, okay, this is Accelera by Cummins. Same strategy? Yes, same strategy. You're working with the same people. It's still one Cummins. But I think it will be a good brand that people can rally behind it and much better than were previously using.

Sure, sure. On that front about decarbonization, carbon neutral, in cylinder hydrogen, that combustion engine hydrogen solution -- happy to see it with Tom and Jen, I guess maybe kicking around the Germany truck show a few months ago. It got the green label in Europe. I think that's a major milestone to think could this be the long-haul solution. The U.S., where are we on the EPA deciding is combustion engine hydrogen can really be deemed green? And if you want to provide your view on what is the success the chances of success for that to get in green in the U.S.?

Yes. And a few things. So hydrogen internal combustion engine or hydrogen ICE is a really good concept in our view, for particular parts, segments and/or regions of the world, whereby hydrogen economy will happen, places like India where they could potentially have their own fuel source rather than importing. Likewise, heavy-duty truck, which line haul, battery electric is going to be a difficult application necessarily. And we've gone down our path of our fuel-agnostic engines. And therefore, this can build upon our same base diesel puts natural gas now hydrogen platform in the 15-liter segment as we've announced. And then you've seen some customer announcements where they're saying, hey, we're interested in this, and it's primarily for that. As far as the EPA is concerned, I think we've got a little bit of time to figure out. They're busy with quite a few other regulatory rule making activity that will happen. And then I think we'll learn later, whether it truly is given the ZEV status will be the important status in the U.S. That said, either way, this could be a really good option as we look towards the future, primarily for heavy-duty trucks because it fits in the same chassis. It is a little bit similar to some of the natural gas systems that are already out there. And we are already in development. There are engine sales. And I think it's something you'll hear more about in the future.

Am I overplaying it if it was deemed green for long haul in North America? Does it take the pole position as -- that might be the winner, if it's deemed green?

I think a lot of things need to prove out. Obviously, you have hydrogen ICE, you have fuel cell and you have renewable natural gas. Today, we would say diesel will be the poll sitter for some time. And then the question will be at what point do we truly have a hydrogen infrastructure by which it could be that. We would say it would start much more like natural gas did originally with those who have made investments in that type of fueling system. They'll start to use more point-to-point, and then you'll see it go more widespread once infrastructure comes. So I think that becomes a bit of an infrastructure and timing question, diesel natural gas today.

When I think of China and the recent PMI getting people a little bit interested, hey, maybe there's a real recovery, then the government puts out a 5% target, which we can debate what we're trying to message there, but obviously not on the robust side. People said it was a little bit less than they thought. Nobody has probably been in China longer than you, nobody has -- I mean the brand equity others probably pretty similar, maybe India is a little stronger, but it's a really strong brand equity. And your relationships run deep with the indigenous player, global brands. Are you seeing a 50th PMI in China? How would you describe -- because your guidance -- and I know truck, you have up 15% to 25%, but total China up 7% offered some of these comps is nothing, right? You're basically saying we're not seeing any recovery.

Slow and steady recoveries [indiscernible]

Barely even a recovery. I mean to be honest. So when you saw 53 PMI was that a surprise to you? And how would you interpret that?

So I'll talk a little bit about kind of on-highway market, and I think Chris can chime in at the overall company level. What we're seeing is definitely more build and activity on engines and systems right now than we had last year, but that's an easy comparable given it was abysmal. So we are seeing that. And then you're going to see truck inventory build in the system. This is the general, historical selling cycle of China, kind of China New Year until, call it, April, May time frame. And so I think we should all really watch that. If you truly see demand come back and trucks are selling, I think you'll see a more robust cycle, early days is what we would say. So we've seen probably part of the sentiment, but we also need to see that all the way through to the people that are actually in the end users using the truck, and then I think we'll be able to tell what the rest of the year maintains. And a lot of that is just because we're coming from such a low base. But more activity, no doubt. And we're prepared should that come.

Post Chinese New Year, you usually wouldn't know at this stage.

You would -- yes, but then it was already a robust sale cycle. So you're building up some inventory of trucks that they just frankly don't have right now. Let's see how that cell comes through and [indiscernible]

You're [indiscernible] traditional post-Chinese New Year to some degree more...

More than where we were. Yes, yes.

But the sell-through is still debatable?

That's the question. That's a question.

Okay. And off-highway?

Yes. So on the off-highway side, I'd say for our Power Systems, we have a large joint venture there, that's more flattish year-on-year, but it was also flattish from '21 to '22. It wasn't down. So that's power generation, mining, oil and gas, all very strong. And then on the excavator side, that's coming off emissions change, December 1 last year. That basically just takes the buy cycle out. So it will just be down this year. We expect it to maybe recover next year. I think the reforms they did in terms of real estate development have really taken away that speculative build, which is a healthy thing long term, but that's just not -- we don't think excavator's going to really bounce back until next year.

What do you have for excavators down this year?

About 30%. So it's another step down from what we had last year. So it stepped down last year, but obviously.

So they sold 3 excavators last year [indiscernible] I mean that was -- it's a pretty easy comp to be down another 30%.

It is. Yes. So it does continue, but we've seen that drop in the past. I mean excavators cycles in China tend to be more drastic than the on-highway cycles. We've seen it drop 86% in 1 year, I recall when I was in the engine business.

Meritor, I assume, obviously, you were deeply involved in that conversation. But what's really the value of an electrified axle and so forth? Maybe a quick little update on that. But more importantly, where do you see further needs to win in a BEV solution? Or at least I'll say, it feels like the company is -- would not mind if hydro end up being a little bit bigger part of the transition. I think BEV has been harder to -- for the whole industry, to be honest, to come up with a clear superior mouse trap. It feels a little more commodity at the moment. But when you think of what you would need if it was more BEV or are you going to finish something on the hydrogen side are there other ones that you would say, we're starting to learn that incremental component that allows that package sell to really win the drive train?

I think the Siemens acquisition was one within Meritor that helps us on the traction side. Battery management system is one we'll continue to look at.

Can you elaborate on that?

Just how you're controlling the cells and packs. And there's a lot of learning to go from where we are today. Early days, not that many electric vehicles in a commercial cycle to how do you last x number of years in the duty cycles, we all know they need to last. And so we'll use both our own and we've made acquisitions in the space. I don't think there's tons of acquisitions that we need from a talent perspective. And need to see us position of where is our space in BEV. I think there'll be more positions to come. What I would say is the early wins are not necessarily where the later wins will be. I mean these trucks are in the 10s at some point they are going to be in the thousands, and we'll be positioned when it does move for that. And so it's a long way to say, I think we can win in hydrogen and/or BEV. And our plan is that we'll be in a big way in both.

I think just to add there, I think with the acquisitions we made last year, we're certainly digesting those and really the focus as we go into this year and next year is execution. We have the portfolio. We know what we need to do, and it's now executing, integrating Meritor, moving forward with ZEV, delivering the fuel-agnostic engine in the EBU. I think those are all big tasks that we need to focus on. So that's -- we'll do some acquisitions. We'll be opportunistic in the New Power segment as maybe some of the small that don't make it through from a capital perspective or bolstering our supply chain. I think that's the other piece like we did with Jacobs last year.

And speaking on the battery side, early days, big marketer, though, Tesla. Now early days, I was at SpaceX 6 years ago, and it was supposed to be coming soon. So I'm not sure how much traction we're really going to see in volume. They're obviously talking about having not material, but share by 2030 that least debate both they're really going to have 10% share, right? What are you hearing early feedback on that business proposition of their truck?

Yes. I mean, really feedback on, not many people have them. There are a few. And I'd encourage all of you to go talk to customers who have them in hand. Typically, they'll have a variety of other BEV systems in hand. We look at it -- there's no one silver bullet. So we need to look at the correct applications and usages for BEV and then see which is the best system that we can provide. And I'm sure it's -- they've done lots of work on this. I just believe there will be -- there's more pages in this chapter than just the latest Tesla announcement.

And just want to understand -- well, let me first talk about hydrogen, but I want to get back to Bev. I mean obviously, you've looked at it for years. I mean, you're not a newcomer. But it is interesting -- and I know your balance sheet can go out and you could have bought anybody Romeo, whoever over the years, but you weren't finding a differentiated enough technology. And now some years have gone on, right, the way you're configuring the cells in that repacking, you're learning every day. It's interesting. It still feels like there is not a clear no that's winning. And I'm just curious what gets us to the point, maybe you want to answer the BEV question first. What are we trying to figure out? The initial one maybe was a little too we're trying to be the most durable people weren't willing to pay for it. Now we're trying to figure out the right value proposition. Excuse my ignorance, but is it trying to figure out truly the heat rejection issues on durability, what people are willing to pay for and how past performance? What is causing the inability to figure out we're just going to go buy that. That is the best technology versus we can do it ourselves. Is it just not known yet? What is the best mousetrap solution?

I think there's 2 different sides, and then you can chime in. One is the battery chemistry itself. And so I think you will see us come out with a specific battery chemistry, but I think the battery chemistries we were working on 3 or 4 years ago are the ones that we'll come out with now. So I do think there is a -- you can have a really good mousetrap that will come out. Particularly medium-duty truck North America. Second is there is still a lot of infrastructure and business system work that needs to be done in the market. So almost no one could go 100% BEV today that would be very, very difficult. We have Bev in school bus that Cummins makes as well as transit bus. Those are probably the best equipped to start to go there. But if you just look at it from an infrastructure, from a grid, from a who could operate and then take money from it at the end customer, I think, we're the ones that will have to be answered in addition to us coming out with the right platform. And that will take a little bit of time. The initial are just initial seeds into the market and for it to become a real business we need those businesses making money off of BEV and operating well. We've got our mousetrap to figure out and then we've got the business model for the end customer to figure out as we go.

On the hydrogen side, unique to have both electric and fuel cell. So it's a differentiating feature. As we've evolved, obviously, you're adding capacity for the electrolyzers. So you're showing that confidence in the facility in Spain, you name it. So you seem to have a big belief in the industrial, but competitively, line a little more on a highway, but I'm happy to hear industrial. Is there anything you need to win in hydrogen? Or this is simply -- let's just hope the evolution of the industry works in your favor. And is that really where we are, where it's more about regulation and adoption, but competitively, you feel pretty well set?

Yes. I mean for on-highway, we'll feel really good on the hydrogen combustion engine because it will be a part of the fuel-agnostic platform. We don't think anybody can scale that as well as we can. So the base idea is make a mass investment around the platform and then the small variants or sisters by fuel are much less than the initial, all running down the same production facility. And we've shown, with our diesel growth, whether it's many of the medium-duty announcements, that scale can help us win in that segment based on the synergies of the investment and the manufacturing side. So I feel great on that. On the fuel cell side, we also feel good. We're making money in the areas of fuel cell that you can today. So whether it's train, whether it's some of the learning off of electrolyzers, but there's a lot of learning to be done. And then for fuel cell to be -- well, for both to be viable, we need then the business model for that to work and the infrastructure of hydrogen out there. And then I think both have a real opportunity. You'll have to come down in price for fuel cell, no doubt. But we would feel well positioned given our scale and ability to use on the industrial side of hydrogen that for on-highway, I think we're well prepared.

Chris can speak on the...

Yes. I think I played out opposite from what we have in engines, where our scale in on-highway enables us to do off-highway. Our scale and electrolyzers gets you to scale because it's the same technology at its core, whether electrolyzer or a fuel cell. So we build up the electrolyzer scale as we're doing now. Four announcements last year and continue to drive that. Replacing industrial hydrogen as well as driving towards more utility hydrogen, not even getting into transport yet, building up that scale to a multibillion-dollar business by 2030. Then taking that scale and you drive it into fuel cells. And so that gets us to the cost point. That's the big puttypiece. Infrastructure is one big piece, but getting our cost down, I think, is a big element that we need to continue to work on for the fuel cells.

When you scale electrolyzers, 2030 is a bit far away. But when you scale the electrolyzer business, what kind of competitive advantage do you think you'll have on fuel cell cost base?

I don't think we've quantified it today, but you can see the direction we're going. And you've been able to see a scale engine on and apply it to off, that will be similar. But I don't think we've quantified it today, but don't underestimate the learning also on -- in all aspects of the technology just by being that much more exposed to hydrogen.

Different direction, filtration. Can you give us an update on how that's proceeding? What's the financial impact on the remaining Cummins legacy business, the thought process and everything else?

Sure. Yes. And we're in the public S-1 process. So I'll speak in generalities versus specific numbers and based on the guidance from our legal team, strong guidance. So I think at the term, when we do the first IPO, which is coming soon, we have the public out there, we'll sell off about 19.5% to 19.9% of the company, about 20%. Take those IPO proceeds as well as take out some debt on filtration. We'll still be consolidated, so there will still be on Cummins' balance sheet. That's where the bump in interest comes as we've talked about. And then in the second step, which is going to be 6 months later, it's a share exchange. So it will reduce common shares in exchange for the Atmus shares. So those are the 2 benefits really we see as -- one, certainly, the proceeds that we get from the initial public offering and giving them the gift of some debt and then reducing our share count. So most of the proceeds we expect this year is going to be into debt reduction from Meritor, given where interest rates are, we think that's the best use of the funds currently. So long term, we're still committed to our base case, 50% of cash -- operating cash back to shareholders.

And speaking of the balance sheet, which hasn't had leverage since the Dakota engine model of 2000 that was [indiscernible] myself. How is the C-suite viewing the appropriate balance sheet?

Yes. I think you've alluded to it. We have a more conservative balance sheet than most in the industry, I would say. We're -- at this point, I think we're -- have more leverage than we'd like. We're not going to get back our belief to the point before Meritor, we were kind of building up to that...

Five figure.

Somewhere in between like in the middle there.

Meritor, this is not trying to get back to because it was under levered for 20 years [indiscernible]

Yes. It was kind of -- we were building up to that Meritor acquisition over time. And of course, we're going through the pandemic. So conserving cash was the smart move. So yes, we're not going to get back to that point. It's going to be -- we'll have a happy medium that we hope to get to. And mid of next year because we're -- cash from operations, we expect $2.5 billion, $3 billion this year. So good cash from operations will help us [indiscernible]

[indiscernible] a one-off get the leverage up, but we don't have to bring it all the way back down to almost no cash necessarily. But clearly, debt reduction is the focus going forward?

Yes.

Speaking a little more near term, the second half of the year guide does imply basically negative, right? Can you take us through that thought process and what got us there? And a lot of companies admit like you start the year, you're just being prudent and things are good to start the year. We don't know where pricing will be, volume, demand. But you seem to be a little more specific on, well, North American truck builds could be down second half versus second half '22. So if you can just take us through and level set how we came to that implied second half got?

Sure. Sure. Like we talked to in our Q4 earnings call, we expect about 52% of revenue in the first half, 48% back half, really driven by the truck cycle, and Brett can talk a little bit more to this. I think it's -- expecting some moderation in Q4. I would say we're not seeing any warning signs yet. Orders in February were strong. If we continue to see that it continues to push out. This is the -- certainly the most interesting cycle we've seen in quite some time. It's all of our rules of thumb are kind of out the window. Medium-duty truck, as an example. Usually, the canary in the coal mine turns down first. We expect to hold on for quite some time because that's been underprioritized and the demand is quite strong. So I'll let Brett talk a little bit more on heavy.

Yes. On the heavy cycle, you all follow the same we do, but it's -- the backlog is high. Large fleets can't get all that they've wanted for some time, but you're not seeing any cancellation or what cancelation you are seeing is being refilled. And then the resale value of trucks have stayed relatively high. It's down from a huge peak, but probably appropriately so. And so as long as we keep seeing that, I think you'll see -- as Chris said, we keep bumping up. But we had some concerns with interest rates with a variety of others, would that start to dovetail down in the Q4? I will say our demand is robust right now. We're building a lot of engines. It's an exciting time, but a little bit of an unprecedented time from a cycle perspective.

So it was always a little more of an understandable theory than it was [indiscernible] getting build schedules. But did you actually get build schedules that really support it that it would be down and they've had to bump them up? Or was it, hey, a lot of people give us build schedules. We model what we think is really going to happen?

Yes. We model what we think will happen, and you won't get a build schedule for Q4 yet anyway. So it's a 90-day look out, a hard data look out as 90 days. You have indications. And then the other reality is the industry can't take huge steps right now. So gradual steps are possible from a supply perspective. But I couldn't say the whole industry can make another 20% right now. It's just not going to happen.

Had an interesting conversation with a large customer very large. And the conversation or the shape of the cycle, I think most investors would say '24 down prebuy '25. This OEM CEO, said, I don't know, maybe some people would like to have the better miles per gallon on the '27 model. Some might not like the incremental complexity, but there might be enough people saying, look at the fuel economy, I'm not going to prebuy it. I'm happy to get the '27 moder year. So they're almost feeling like higher for longer, not a hockey stick up on a pre-buy, but not necessarily down in '24.

Yes. [indiscernible]

And you look on, but you've been around a little bit. [indiscernible]

[indiscernible] 24 years. Yes. So it will be interesting. Two things, I think. One is I don't know if the industry can flex up enough to really give a hard pre-buy. So if you were going to have a prebuy for 24 today, it's muted by the fact that [indiscernible]

'25 is prebuys and '24 down but...

So we're at 300,000-ish. We've never built more than 367,000 You say [indiscernible]

[indiscernible], I don't think 400,000 or I don't even think 350,000?

I think 350,000 would be quite difficult for this budget. Not necessarily Cummins. I just think industry-wide to flex, it would have -- it would take some time. Second is it matters how much the stair step is on truck price. So you've seen different cycles, right? '07 and '10 were huge truck price increases. '13, '17more muted and the corresponding prebuy -- the market pretty smart, they'll figure that out. So even more than complexity, it will be that price because of the addition. But undoubtedly, people like the fuel economy. And how long are we going to underserve that market. So those are probably the 3 factors. Underserving the -- how much we can go and then what's surprising.

And you're the best person to ask this. So the '27 model year, right? The technology, not new necessarily.

No.

But having to increase your warranty is the beat debate, right, to add those incremental miles and years of all the after treatment is going to work, and we know from that the dose are clogging to the all the regeneration of the NOx, right? Can you give us some sense of what are you looking at, if you want to give us a sense of the price increase, too?

Yes, yes.

To increase the warranty, to take on the economic risk of an extended warranty. Is that a -- what do you [indiscernible] on truck nowadays, $50,000 with the after treatment, $45,000 for a 15-liter?

What are we adding on to it?

Engine to combust the aftertreatment. Your content is $45,000, $50,000?

It'd be less than that.

Even less than that? $40,000, $35,000? [indiscernible]

It's in the range of $30,000 to $40,000 depending on truck.

So when I think about the prebuy cost, I'd say, well, the technology is not that new. You're, call it, $30,000, $40,000 not even $40,000, $50,000, how much of an increase would you need on a higher warranty to make the price of the overall truck go up enough to be like, oh, I have to prebuy. That's so expensive? So that was interesting. You just said there, the price that creates the prebuy, not the complexity. How much could the price go up?

Well, it will be both. A lot of it depends on what's the answer? So I think there'll be a couple of different answers. That could be a big number. So there could be a big number out there depending on what your answer is. But second is people -- there are -- we always say heavy-duty trucks a big monolith. It's hundreds of thousands of customers. And so you've got some who just don't want to try new stuff, right? And so they'll wait for you to...

That's the complexity issue.

That's the complexity issue. There are some that are very economically driven, right? I mean it's why they're still buying a 13-liter, not a 15-liter, it's $2,000 difference. So that will tell you right there, it's $2,000 difference there. There is a different buying pattern even though on $150,000 truck, you and I say, that's not a huge difference. So I do think there is some of that. What we're doing internally is there's a lot of testing. The good news is we have a lot more data. We have a lot more connected trucks. We do a lot more predictive analytics. So essentially, not only is the duration going, but there are more parts covered in that warranty than before. And so we'll have to do that analysis over the next 2 years or so. And to be honest, unfortunately for everybody here, that pricing will not be settled until '25 probably.

And the lack of knowing the price -- it depends on the economy.

I could put unknown into where you'd want to.

But the unknown might be like I'd better prebuy.

For sure, for sure. And then the question is, can you prebuy.

Yes. I think on the other had, I'd say, well, essentially, it's going to be the same structure engine. I mean we're doing all new platforms, the tolerances of these engines to get to that low NOx level has got -- I mean we're talking millimeters, getting smaller and smaller and smaller. That takes more buying machine, it takes more work to go into it. So there is incremental cost of the engine itself, plus probably more after treatment more likely to get there. So there is some content add as well. So it's not warranty of the piece, there's some content too.

Not just warranty, there's some content. It has to be also given a longer...

For sure.

Okay. We're about out of time, but there's so much you can discuss with Cummins on off-highway technology, emerging markets. Anybody have a question or 2 for Cummins? All right. Well, we're just about out of time. So thank you so much. Always an interesting conversation with Cummins, so appreciate it.

Thanks David.