Cummins Inc. (CMI) Earnings Call Transcript & Summary

Good morning, everyone. I'm Jerry Revich from Goldman Sachs, and really delighted to have with me Chris Clulow from Cummins. Chris is Head of Investor Relations. Chris, thank you so much for joining us.

Thanks, Jerry. Appreciate it.

So Chris, maybe just to start the conversation. Cummins has really benefited from new regulations over time that have increased clean air regulations, and I wanted to start the conversation with you ahead of the EPA 2027 regulations to frame out the opportunity. First, can we just talk about your view of the technology path that we're going to see from Cummins and others for the 2027 standards. And then I would love to discuss the economics. But first, how do you see the engine evolving to hit the 2027 regulation?

Yes, yes. This is certainly the most talked about regulation I've seen in my career for sure. Everyone is nervous about the EPA '27. It's a big reduction. So it takes the NOx output from 0.2 to down to 0.035, a big reduction. To do that, it takes a lot of work on the engine system. For us, the way we're approaching is launching new engine platforms. So we'll have a 6.7-liter, a 10-liter and a 15-liter all-new engine platforms under our fuel-agnostic launch. What we mean by our fuel-agnostic launch, it's the same bottom end of the engine, and it will have a different top end, whether it's a diesel or natural gas, the hydrogen, a gasoline, perhaps a propane engine. And so this allows us to have a really finely tuned engine to meet both the emission standards, drive efficiency in the engine, but also build the platform that we can see through. What we expect is the remainder of ice, which we do expect to be long, but this new platform allows us to kind of really approach. It gives us big economies of scale and development, aftermarket, production and so forth. So it's the first time it's ever been done this fuel-agnostic platform. And that's -- so we'll meet -- we'll as we get to the '27 emissions, we'll launch the 10- and the 15-liter in 2026. We'll launch the 6.7 in 2027. So there's a lot of work building up to that. We're making some big investments now, but we know we can get a good payoff of those, given the scale we have and how we're going to be able to leverage this around the world. But it's a tough standard. We're working certainly with the OEMs to make sure they can meet it too, whether sourcing through us or selling them components to help make it on their own engine systems.

And Chris, can we talk about the engine lineup. So the 12-liter wasn't one of the 3 platforms. Can you just talk about the decision on that?

Yes. So what we're seeing is as we analyze the whole lineup, to have a bunch is difficult. So the fewer number of platforms, you can have certainly more efficient. You can be on production and development. The 10 -- between the 10- and the 15-liter, we can cover the whole range. So that's why we kind of opted for this. It really does give us this full lineup. There'll be some 12s on offer in other parts of the world that are more lagging emissions. But this -- as we look forward to the '27 EPA and really the North American market, those will be the big 3.

And Chris, gasoline engines has been a big focus for you. Which of these are going to be available in gasoline? And same question on hydrogen reciprocated.

Yes. So gasoline will be on the low end. So that will be in the 6.7-liter. It gives you diesel durability, with gasoline very efficient. And it gets you to very low emissions level. So that -- it seems like a good solution on that end. On the hydrogen side, it will be on the tail. So first is the 15-liter for heavy-duty truck. On the 6.7-liter, we're doing it. And the main focus to start is actually India. With the 6.7-liter is the most heavy-duty engine they have, it's the biggest engine they have. And -- but they are very interested in moving to more energy autonomy in India. They don't -- they have to in-source everything. So they see hydrogen, it's a good path. We just announced something with Tata recently to work with them on both the hydrogen infrastructure as well as providing the engines . So I think those are the ends on that one that we'll do, and then we'll have natural gas pretty much throughout.

Very interesting. And in terms of the content that you focus, can you talk a little bit about that?

Yes. So the content will be more. So I think that's what's making the nervousness and driving the conversations on '27 EPA is the fear that it's going to be a much more expensive truck. And it will be more expensive. We haven't quoted any numbers. But when we think about it, it's going to be much more finely tuned engine, so more finally tuned componentry. So just the base engine itself will be -- have some additional cost, more after treatment likely. And then the other addition is it goes end of useful life warranty. So this will take the warranty through. So you'll see warranty expense for us. But you'll see, we'll certainly price for that one, and it gives us more locked in part stream, which is nice to have as well. So the end of useful life warranty is -- it's intimidating for some in our business, but I think it's an opportunity when we look at it commercially. So there's a lot of good added content on there, and that's just for the diesel. When you get into the natural gas and the hydrogen, the big add is the tank system. So the fueling system and the tank system is -- brings a considerable cost even with natural gas, and those are things we can offer through a couple of different joint ventures we have for tanks.

And Chris, you mentioned aftertreatment, take us to a step up. So what I've heard from others is a second SCR aftertreatment. Is that the plan?

Yes, I think we have that under development, whether -- I think we've done that in the past is have a second one. It's better to pack it all together, then that's the optimized. So you can -- less space if you can just get the same functionality and just add more, I guess, bricks in there. I'll exhaust my engineering knowledge quickly on this. But I think the more compact package we can have, and that's what we've been doing over the course of aftertreatment. So I think that will be better, but it is essentially from a technical perspective a second.

Very interesting. And just thinking back to the content increase when we added aftertreatment at the time was something like $7,000, $8,000. I'm sure there's been inflation. But the additional complexity, it sounds like it will be a few thousand dollars on top of what we're doing now.

I think that's fair. Yes.

And Chris, can we talk about the comment you made about warranty? And so can you just step us through the process that you folks are applying to make sure that we're pricing appropriately for the warranty risk that we're taking?

Yes. Yes. So this is -- I mean we do have experience. We track our engines around the world for years and years, and some engines like a school bus engine now has a 10-year warranty. So we do -- we understand we have the modeling and so forth of what it takes over time. So it gives us a good sense for how much this will take. We also have captured whether through extended warranty or other fixes that we do for customers, what we expect in the longer term. And with that extended warranty, you'll have more maintenance parts likely. So things that they just normally will not last a full 12-year life of a heavy-duty truck, you'll have it's maintenance parts, you'll have slightly different approaches on that front. But we have all the models in place to be able to -- and all the tracking currently to know what it will take and how much it will cost. And that allows us to price well for it.

And can you expand on that point in terms of the wear parts that would be now included?

Yes, without going into specifics, there are certain parts that they may last 6 years. So they last through a normal warranty period now, and they'd be bought in the aftermarket. We just say, okay, you have to replace this after 5 or 6 years, something like that. So you'd put it into the sale agreement, They'd have to get that maintenance part, it wouldn't be a warranty part.

And Chris, can you remind me what have you folks have said in the past over the life of an engine, how much the parts stream generates compared to the cost of the engine?

Yes. So for -- it depends on the engine. As said, for a medium-duty truck now, it's 25% to 30% of the initial sale in parts. For heavy duty, it's about 100%, 1:1. And then you get into the big engines, the mining and whatnot. It can be 4x plus because you rebuild those many times.

And so if we apply your historic experience where that's the parts stream, essentially, are we looking at for 2027 double the ASP for engines?

That's good question. Yes, probably not double. But I think we would see some incremental on the parts, I think because we do have a lot of that part stream still captured through the life of the engines. For particularly the big fleets, they'll use our genuine parts for all the way through. Other times, you might get a little bit of dilution with will it fit parts like filters and things like that, people use other things. Now with the warranty, they'll use just us.

Very interesting. And how do you think about the margin on the new product because what we've seen from Cummins in the past, every new regulation, we've seen, as you folks have stepped up content, margins have stepped up as well.

Yes. That -- absolutely. And that's what we have done. And we say we raised our margin cycle-over-cycle, that comes with a mission, as you know, because the cycles are driven by the emissions. So that is how we kind of continue to drive adding more value to the OEM and to the end customer. It translates into margin for us. So that is the expectation.

And in North America, in addition to supplying yourself with aftertreatment, you also supply PACCAR and Navistar, TRATON as well. Does the opportunity expand for aftertreatment with the regulation?

Yes, that would be my expectation. I would think just from technological perspective, they're going to need similar additional aftertreatment to meet the '27 emissions.

And from a share gain standpoint, Daimler and Volvo, I believe, don't use you folks for aftertreatment in North America. Please correct me if I'm wrong. Is that an opportunity? Should we think of that?

It's an opportunity. I don't -- I think assuming they continue on with their own engine platforms, they probably would continue on with their own aftertreatment. But that's the current -- I mean, I think, that's the big question we get is, is there opportunities for share gain as we go through these emission cycles. As we have over the last several years, that's been an opportunity we've taken advantage of. So probably more on the entire engine system versus the parts side.

All right. And what's different about this regulation is your content, your pricing parts warranty, which is a bit different than pricing for a turbocharger.

Yes.

Can you talk about how does that impact? How we should think about margins over the course of the platform? Could there be a situation where, initially, because we have higher warranty accrual rates, margins might be lower upfront?

Yes, yes. You know our process pretty well, Jerry. So yes, I think it's upfront. When you initially launch an engine, you will accrue at a higher warranty rate that tends to come down over time, over the course of the first couple of years of the launch as you're working through some of the growing pains you get normally. So yes, that's a reasonable expectation.

And Chris, in terms of other engine regulations globally, so is there a similar standard coming up in Europe or other regions?

Yes, Europe is probably Euro 7, and I think the timing is quite undetermined, but it'll be very similar. I mean it's a different -- we don't have a huge presence in Europe in terms of full engine systems. We'll gain a little bit more picking up the Daimler business and medium duty there. We work with DAF. We work with some others. So there's an opportunity. It is complex to gain more share in Europe because right now, like with the business we're picking up with Daimler, both North America, Europe, Southeast Asia and South America, we can manufacture in our own plants. So that makes it much more efficient. So you can just bring it in-house and just get the margin. I guess if there's more expansion into Europe, it is an opportunity from a technology perspective that we'll be able to meet Euro 7. But it's just a little more complex model for us to gain share with it, given just the capacities.

And what we've seen also on past emissions changeovers is not all engines provide the cut to the next standard with the Volvo 60-liter, obviously, Caterpillar 30-liter before that. How are you thinking about which opportunities could arise for you folks because you're not hitting the volume thresholds on the new standards for the industry?

Sure. Sure. Yes. I think there is -- we do think there's opportunities, and that's what's playing out with the medium-duty side. We think there's opportunities on heavy-duty side from an economy scale. But we'll have conversations with each of the OEMs on what they want to keep in-house, what do they want to start moving to us. I think that's -- we've been the consolidator of scale, and we can continue to do that. I think if it's coming up on '27 EPA emissions, it's -- the decision has to happen pretty quickly in the next -- within 2023, if there's a significant migration to us. It could be just because from, one, from an engineering perspective, but also from just capacity and manufacturing perspective. You would need to know that.

And Chris, your level of optimism that we'll get incremental opportunities.

I think we'll get some. We do think the OEMs, as they've said publicly to all of you, that they'll be there to play in '27 in heavy duty. But there's other pieces of their portfolio that will move. The other gain that we expect just naturally, even if all things else being equal, would be natural gas, which we think will be a bigger player. In -- come '27 emissions, we're launching a 15-liter natural gas long last. We've been talking about it for 12 years, I think, in 2024. And this has got some really -- it's a natural gas designed engine versus a diesel engine made for converted to natural gas. It has the efficiency and the power, and it gives you a good application for heavy-duty trucking. And we do expect that to grow. It's a very good thing, particularly with renewable natural gas, very attractive for end customers, particularly those with ESG metrics. And those that are making the progression down that curve, natural gas will be a bigger player. That's -- when we have the conversations with end customers and OEMs on new technologies, the one that we're interested in most is natural gas.

That's really interesting. And with the -- per purpose diesel engine that's used for natural gas, the pricing point was fairly high based on the Westport -- financials on Cummins Westport that is now Cummins. But does that premium to diesel decline on the new platform?

Not so much. No, not so much. I think we would expect to continue to have that premium. Again, we're the only natural gas engine on offer. And with that, comes value pricing. So I think we would look to maintain those margins.

Chris, can you expand on the point on the better performance? So why is this going to drive the tipping point in adoption of natural gas?

Yes, because now it's -- you can use it in long-haul trucking. It has the power for like a 15-liter. It will maybe perform somewhere in between a 13 and a 15. It's not a 15-liter diesel from a torque and power perspective, but it's close. So this -- whereas before, I think our large was a 12-liter, which you couldn't do a long-haul trucking with that. Now it kind of starts moving the market that way. We've got a good uptake. We had an announcement last year. It was an announcement between Walmart, Chevron and us, which was interesting. First time I've ever seen an announcement without an OEM in it, where they really are looking to get into the natural gas engine, particularly renewable for their platforms. So I think now there's a couple of OEMs who definitely want to participate, of course, that are bought into it.

And in terms of -- based on the level of interest, what can adoption rates look like? Because right now, natural gas is, what, 2%?

2%, yes. Yes, we think it could go up to about 8%. It could go higher depending -- it becomes an availability perspective. It's -- diesel is available everywhere. Natural gas is not. But adding natural gas infrastructure is certainly relative to battery electric or hydrogen, very easy. There's pipeline everywhere. You can pop up a station pretty easily. So I think that's -- we do see some good momentum there. And renewable becomes more and more an offer across the country.

And lots of different ways to look at carbon intensity. How do you think about the pitch for natural gas? How do you folks make that pitch?

Yes. It's actually an interesting one because it's -- when we talk about whether it's EPA or CARB or the European regulators, they don't look at it like the full stream. Like they don't look at lower emissions like you can say negative -- arguably negative carbon footprint for renewable natural gas. And while the regulators may not look at it, the end customers do. So if you're -- I'll take Walmart again, and you're looking at your ESG metrics and your negative carbon footprint, that is a very good story for your shareholders. So it's more attractive to the customers. It may not be -- the regulators don't look at the full stream of emissions, but that's where it kind of comes into place. You get more pull from a customer perspective. And it is just natural gas on how it burns and so forth is cleaner. It's easier to get to a lower emissions level than diesel naturally.

Very interesting. And the 8% opportunity, is that across medium plus heavy duty? Or is that a...

More on the heavy side.

That's a heavy one.

More on heavy side. I think medium duty will probably be we don't expect a bigger -- a big movement in medium. Medium is probably the space where battery is starting to get a little bit more. But again, it's not cost competitive, not quite yet.

Very interesting. And in terms of the speed of uptake, so the engines available in 2026, 15-liter in gas as well. Is it as simple as, okay, we can ramp up pretty quickly to deliver to Walmart and others or should we think about...