Cummins Inc. (CMI) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm Matt Elkott, TD Cowen's machinery and transportation equipment analyst. I'm very pleased to be joined by Chris Clulow, Head of Investor Relations at Cummins. I would say if an engine manufacturer can be a household name, Cummins is as close as it gets. And I do want to get to the different parts of the business later in the discussion. And if anything has been surprising in any end markets in the last month or so.

But Chris, let's start with your self-disrupting segment, Accelera. What is it and what goes under it?

Great. Thanks, Matt, and thanks for having me today. So yes, our Accelera business, we're excited about. It's our kind of our self-disruption segment. So it is focused. It used to be called New Power. We renamed it this year to give it an actual name. And so it's exciting. I think the key pieces under that are our electrolyzer business, our fuel cell business, battery electric, and then with the eAxles we got with the Meritor acquisition as well as the inverters and motor generators from the Siemens acquisition. So really a full suite of both propulsion for transport in this newer power space as well as the electrolyzer business, which is probably the fast-growing one right now.

Yes. And then I guess there are many regulations-driven drivers in certain pockets of -- probably all of that business. How are you preparing for EPA 2027 NOx reduction requirements? I mean I think the -- it goes from 0.2 to 0.035 or something like that. And any CARB regulations as well?

Yes, yes. So I think the regulations are definitely driving a lot of change in the business, and that really was the genesis for bringing Accelera along, which will be continuing to be a bigger and bigger piece as we get to eventually zero emissions. I guess the big investment we have for meeting EPA is more within our core business, our engine business and components business. We're launching what we call a fuel-agnostic engine. It's the same bottom end of the engine with different top ends. So it has a different head and different pistons for whether it's diesel, or natural gas, or hydrogen, propane, or even gasoline, in some cases. So we're going to have these engines launching beginning actually in 2026, with one exception, which launches next year, and that's the natural gas 15-liter. So we're bringing this through to meet the regulations, all new platforms for our 6.7-liter, our 10-liter and our 15-liter. That will take us -- allow us to meet the emissions for 2027. And then what we think is beyond that, which will likely be more carbon reductions as you get to the 2030 emissions and so forth. I think taken NOx down to 0.035, there's not much more to go. I mean that's a very, very low level. It's a challenging emissions regulation. We feel really confident in meeting it. And I think these types of things present an opportunity for us. I think this is -- emissions regulations have been a friend to us from a business perspective and growing share, continuing to make a difference for our customers.

Just want to make sure I understand. I know you have a 15-liter natural gas engine coming up next year. So the fuel-agnostic engine will be either natural gas or diesel next year, and then hydrogen internal combustion engines will be added in 2026?

Yes. So the -- let me clarify, the 15-liter natural gas is kind of the first iteration of its fuel-agnostic. The diesel from that platform will come out in 2026. This 15-liter is actually in operation now in China. So we're bringing it over from there. It's done quite well. We've actually been able to go from a 0% share up to about a 15% share in that market in a pretty short time period. So it's been quite successful. And the 15-liter natural gas opens up long-haul trucking to use natural gas. And it is unlike natural gas engines of the past, it's designed for natural gas. It's not a gasified diesel engine. It allows you to be more efficient, more torque, more power, more operating, very similar to a diesel engine. So I think that's -- it's a really compelling case for many operators, particularly if you're using renewable natural gas. You get to what is, I guess, the key word, arguably a negative carbon footprint, which is really attractive for end customers.

Yes. No, you mentioned torque. That was going to be my next question because you've had a 12-liter natural gas engine in North America for a while, and I think you guys are basically, the market in natural gas. So can you talk about some of the challenges you had? I'm sure torque is one of them. And the size of that market right now? And where do you think having a 15-liter engine debut in North America? How -- what's the market potential?

Yes. So yes, right now, it is the 12-liter. And you hit it exactly right. The torque is a challenge because it's a gasified diesel engine. So it is not designed specifically for natural gas. It was kind of converted. So you're not exactly the most efficient, and it plays a very niche play right now. It's about 2% of the heavy-duty market. And just in vocational, we term it more hub and spoke distribution short-haul application. The 15 allows you to take that and get you -- on your torque up to close to where the diesel 15-liter is a bit better than, say, a 13-liter diesel, and allows you to get into the long-haul market for natural gas. And that is -- if you can do that and you can kind of get go from place to place, get really good range, comparable range to a diesel engine allows kind of help solve that question of infrastructure that's been what's holding natural gas back for now over 10 years. People have been asking about 15-liter nat gas engine. So this does answer that. In terms of potential, we see -- we've done a number of different models. It does depend on relative price of fuels, of course, and how those move. But we can see it growing to 8% even as high as 20% of the heavy-duty overall market. And as you said, we're the only provider. So the...

And that percentage right now is...

About 2.

2%. Yes. So that's a significant growth. And those are very, very meaningful numbers. Do you -- are you -- from your conversations with customers and industry stakeholders, well, not customers but the end market, I would say, and customers, do you think the adoption will be -- will come first from the larger carriers, like Knight and Werner and J.B. Hunt and Schneider? Or do you think there is room for kind of the midsize? I would imagine the small mom-and-pop carriers will be -- will lag. Is there a potential for adoption within any kind of midsized carrier in the beginning? Or it's just going to be mostly -- basically the big leaders of the trucking industry?

Yes, I think it will be the bigs that go first. And I think it's -- particularly we've got a lot of interests from those that have more public companies, ESG requirements, looking to reduce their emissions footprint. That's what we announced something last year, where it was a deal we announced it was Walmart, Chevron and us for natural gas-powered vehicles. And it didn't have an OEM in it. So that's the first time I've ever seen that it's unique. But now there's packers provided, and I think others will join as well. But it is -- the end users are really pulling this. And of all the things, this has a total cost of ownership that's viable now. So that -- I mean in the end, the industry is driven by profitability and it's narrow, in most cases. So I think that's why having a viable solution that reduces emission now with what's possible and economically viable is really important.

What's the size of -- what's the percentage of nat gas in China? Because that's a market that you've had the 15-liter engine for a while.

It's about 30% of the heavy-duty market. So it's sizable. In China -- I think the difference with China is they, I guess, made the decision to adopt and have the infrastructure in place and they can build it quite quickly. So that's why it's become a bigger part of their market, and relative fuel prices have made it more and more attractive there.

Okay. Since we crossed the pond to Asia, I just wanted a quick update on the Tata partnership and the opportunity in India as a whole.

Yes. It's -- we've been with Tata as a partner for many years. And I think the relationship is a really strong one. It continues. We've been -- it's a very large joint venture we have with them, produced 200,000-plus engines a year. So a huge -- a lot of volume from that, and Tata has a very dominant market share in the truck market. So happy with that relationship, and it continues to expand where we announced we're working with them on hydrogen. So that's becoming more and more attractive in India, where they don't have a local fuel. So they have to import all their energy. And so having hydrogen infrastructure and building that out would be really attractive. So we're working -- that's the hydrogen internal combustion engine on the 6.7 is what we're working with Tata. So that has been an exciting area for us to expand. And then I think beyond Tata, I think we continue to have a very large presence there in the Power Systems business, but we'll expand our medium-duty business as we take on the Daimler business. So that's a business we won as part of the global medium-duty deal. And it's -- we thought it would be starting to flow in the latter part of the decade, it will flow faster than that. We're moving forward on the time line to bring that in -- that business in quicker. So that's a positive development just over the last few months, where we're making progress there. And the beauty of that is we'll be able to build it in our own plants. So that's not a big capital investment, we can just bring it in and just add to absorption, a good win for us there.

Yes. Since you mentioned electrolyzer, how are you tracking on the electrolyzer revenue target? And what are some of the recent orders and deliveries?

Yes. Electrolyzer continues to be a really hot market. We're in a race now. The race is capacity in the industry. So it is -- it's a very -- it's small revenue now. It's less than $100 million last year, it would be more than that this year. But the projects keep rolling in quite quickly. IRA came faster than we expected for sure and really has spurred this. And the U.S. and I would say Canada as well, have jumped into the lead in terms of the global adoption of this in the electrolyzer market. So it is going quickly. We had a revenue target of $400 million by 2025. I feel very confident in that. And then when we put our 2030 numbers out there, this is a $3 billion to $4 billion business, and feel confident it's going to grow there. And that's before any adoption in transport. That's just replacing industrial hydrogen and having some utility hydrogen. So it's moving quite well. The projects -- it's like the race of who can get bigger. So the biggest one now is 20 megawatts in operation in Bécancour, Canada, which is ours. And then went 25 30, now we just jumped up to 90 with [ Varennes ] in Canada, a 90-megawatt project. So they keep getting bigger. And we're talking to people about 250 or even gigawatt projects, which used to be the sole domain of alkaline electrolyzers. Now PEM electrolyser are rising up there. It's just a better solution overall from a -- particularly when you have green energy. So I think that's -- it's -- it is an exciting development, all out growth for us. I think now it is, like I said, bringing up capacity, getting into more automation, taking some costs out. We're quoting at gross margin positive now in the electrolyzer business, which gives us -- given the relatively small size and fledgling stage is a really good indicator we can get to Cummins -- at least, Cummins' average margins as we get up to scale. So that's an exciting piece of the business and really the key focal area for our Accelera business right now.

Yes. Staying on hydrogen and maybe going back to the truck side. I feel like in the last -- in the recent months, recent quarters, when people think about the viability of kind of a long bridge to whatever technology the trucking industry coalesces around long term, a lot of like hydrogen, ICE engines, seem to be one of the first things that people point to. I feel like you guys are pretty excited about hydrogen ICE. Is that still your view that hydrogen ICE is the most viable bridge solution for the next, whatever, 5 to 10 years before we know what we're going to be driving?

Yes. We do think that it's -- and that's kind of gain momentum over the last several months. I think hydrogen ICE, we think it's kind of a progression more natural gas, and then you start moving to hydrogen ICE, particularly in the heavier vehicles. Battery electric will make its way in the medium duty, but its -- hydrogen ICE is attractive for a couple of reasons. One, it's a solution that people are familiar with. So it looks very similar to an internal combustion engine. The cost is at a better point right now. And one that's becoming more and more of an issue or at least in our thoughts is purity of fuel. So purity of fuel, when you have a fuel cell, it has to be very pure, or else you have issues and [ clogging ]. And hydrogen ICE, is less of a demand. So you can have -- our experience working with diesel for many years is having pure fuel is tough to come by in some places. So we do think that's a good path in that respect. And I would add that the momentum gained is really with Europe and the EPA both coming out and kind of labeling hydrogen ICE as zero-emission vehicle, and that's a bit of a game changer where there -- it's kind of more open to -- it will have a trace amount of NOx still even with an active treatment, but it's such a little trace that they're calling it [indiscernible]. So that could change the dynamics a little bit. Fuel cell long term seems to be the best move from an efficiency perspective, but I think this bridge is going to be pretty long.

Got it. And I guess the tank capacity is also fairly easily adjustable. It just creates other challenges, the bigger the tank is. But you can improve the range of a hydrogen ICE truck by the size of the tank?

Yes, absolutely. And I think that -- I mean this is also a good content story for us. We have a couple of different tank joint ventures, one with Rush and Momentum. That's more natural gas-focused. And then NPROXX in Europe for hydrogen tanks. And this is a big add. It's a big add in cost to have either of those tanks on the back half of your cab, but it gives you a very good range, comparable range to a diesel tank.

Okay. And you mentioned battery electric. Any update on that business? Can you just remind people how big it is? And anything new happening there?

Yes. So I think we're making progress in BV. I think -- it's funny, I was talking to our Accelera business. And this is a new learning for me that we have more equipment out in commercial vehicle than anybody else. I knew we had a lot, but when you just think about it, I just didn't really don on me to some extent. But we have that out. It's mostly buses now in less cost-sensitive markets, I'll say. And it continues to evolve. We have a really good full system for a powertrain. It just hasn't scaled up. And I think we continue to work through what's the best way to address the market with us. So we can -- whether it's components, full systems, it's making progress, but I think it's a ways away from, one, a cost perspective. And then two, I think the infrastructure demands are becoming more and more apparent. So the charging and the grid infrastructure is pretty massive if you have a big fleet of all-electric. And I think that's going to take some investment and some doing to get to that stage. We are operating on that side as well, working on projects to help build the infrastructure, but I think it's a ways away. We're making progress. I'd say our position because we have this wide array of all these technologies, people go, "Why are you doing so many?" Our view is for battery electric fuel cell is we want to keep pace. I guess there's no reward for being #1 technologically right now because this is a pretty market in many ways. So as this market continues to mature towards that better -- latter half of the decade, we'll probably increase investment to make sure we're in a leading position there. But it's a balance right now.

Got it. But you still -- I mean it's still looking really unviable for Class 8, I'm sure, battery electric for the foreseeable future, right?

Yes, I'd say with the current technology, unless there's a breakthrough in solid state. We'll work in some applications for more hub-and-spoke occasional type things, but not for long haul. It's -- it doesn't feel viable to us. I think hydrogen is going to be an end solution there, whether internal combustion or fuel cell.

Got it. I want to kind of power through a couple because I know we're starting to run out of time, and I want to get some of the investor questions in. Any thoughts on new power solutions and how they work in autonomous trucks, that combination?

Yes.

Or vehicles, not necessarily trucks, just the vehicles.

Right. Exactly. Yes, I think what we're doing -- our approach on both for our internal combustion and our new car, we're making sure we work with every platform. So our ECMs work with every platform so we can be integrated. And we have been with really every autonomous that's been testing, I think, has had human power. So I think we make sure that we're working with each of the providers for it to work well. And I think that's the extent where we're -- at least at this point, where we'll participate with autonomous. It's -- that's mostly within the OEMs or the specialty companies at this point, but we're working with all of them.

Okay. Got it. And then so I want to take a broader view of the business, Cummins overall. Just in the last month, I mean, have you seen anything that surprised you guys as far as the end markets are concerned in all parts of the business in the last month or so?

Yes. I think -- the two spots I'd point out is the kind of the continued resiliency of the truck market in North America. So I think we have -- in our guide, we have it moderating in the fourth quarter. And it seems less likely because it just continues to build orders are at an okay level, and the books are followed by the OEMs for the year, haven't opened up '24. So that continues to flow very well. So even with challenging spot freight rates and other things and of course, the economy, it seems to continue to move well in the heavy-duty truck market. So that's maybe slightly surprising because I think we're all waiting for some level of downturn. And when that happens, we do expect it to be a more moderate downturn or a very light downturn compared to most. I think the other piece, maybe not a surprise to us, but we're getting the feedback that is surprising is just the rate of recovery in China, which is we called it slow and steady. We had a good first quarter, but we approached it with caution. And I think it's looking like it's slow and steady. It doesn't -- it doesn't appear to be any stimulus-driven or commercial real estate build-out driven, it's going to be more consumer driven, and I think it will take some time. Fundamentals are very strong. So no concerns long term, but I think China's recovery is surprising some in terms of its rate and pace.

Yes, I feel like there are two sets of headlines coming out from China or about China. One is like the fits and starts of the recovery from the current down cycle. And the other one is more of kind of, I guess, geopolitical in nature, with some of the Western economies taking another look at China and seeing if they really want to be there. And your presence in China is nuanced because you have the consolidated -- they have some -- you have some consolidated business, but you have all of the joint ventures. So what does it mean to you? If there is kind of a -- if this tension continues and leads to some of the western economies pulling back from China, what are the implications for your business?

Yes, it's something we evaluate. This is, to no surprise, near the top of our risk management list. Making sure we understand it. I will say most of the headline stuff has not filtered down to any pressures on us. We have a very good relationship on with our partners, but also with the government and the end customers, and it hasn't -- there hasn't been an impact on us yet. It's not something we take for granted by any means, but we try to operate well, partner with them, partner with the government, and I think we've still been able to operate quite well. I think the joint venture structure is very meaningful and very helpful in this perspective. I think it will be difficult to be just being completely a wholly-owned Western company in China right now. I think it's a difficult setting. But I think with our long-term relationship, we've been there since mid-70s, I think it's helped us quite a bit. But it's something we watch and something we look for ways to mitigate the risk when possible.

Okay. So it seems like you're not -- I mean going back to the cycle stuff, the way, the China recovery, the spotty slow recovery has not unfolded in a manner different to your expectations one month or two ago?

No. No, it's about where our expectations are. I guess on the positive side, we've been able to gain share in the process, with these emission changes, 200 to 300 basis points in on-highway more than that in the off-highway space. So really making some good headway in terms of gaining share there with the more difficult emissions.

Okay. I want to pause from my only questions and get in a couple of investor questions here, Chris. First one is in terms of pricing economics, infrastructure capacity and product availability within the next 3 to 10 years, where within Cummins stationary power generation product lines from 5 kilowatts to 1 megawatt where [indiscernible] sits between the current diesel, gasoline and nat gas engines and the upcoming fuel cells?

Yes. Yes. So power generation is humming now. With the energy insecurity and the infrastructure and industrial build-out in North America, it's -- there's a lot of demand. So power generation is doing quite well. Data center is doing quite well. We have a full lineup all the way up through our 95-liter engine. And I think really, we operate with diesel and natural gas, not much gasoline. We will have some gasoline in the transport space likely in the latter half of the decade, but not in power generation. And we're looking at what's the long-term solution here, particularly in the backup space. So is it more battery packs? Is it more energy storage like that? Or is it -- are going to remain with the internal combustion generators, which are only run a very short amount of time every year ideally, unless there's an energy issue? So I think that will -- the lineup over the next 3 to 10 is not going to change too dramatically, but we're looking at what's the next beyond this and evaluating that. And we've got batteries to solid oxide fuel cells to different things like that. We are evaluating our whole lineup right now.

Got it. And then just to get in a second investor question here. No technology is perfect. Fuel cells are key to heavy transportation and small stationary power generation. There is very little information regarding NOx and SOx emissions generated through a fuel cell. What are the challenges Cummins is facing? And such emissions, possible fuel cell contamination as no hydrogen is pure nor is the air used in the chemical reaction needed to generate power from a fuel cell thus creating a possible generation of NOx and possible fuel cell contamination? It's kind of related, but any thoughts would be helpful.

Yes, I think I touched a bit on the purity of hydrogen. I think that is an issue that we will continue to face. Filtration certainly helps and helps address many of that, but I think that's a piece. On the air issue, that's one -- in terms of emissions, we have not seen significant emissions from the fuel cells we're running. We have fuel cells in operation in trains in China -- sorry, in Europe with Alstom and one in Canada. And so we're seeing that, and we obviously have some testing as well. But air handling, this is good to get in early on fuel cells. We found is a very key issue for fuel cells. So like the design of our -- for our heavy-duty truck fuel cell has changed quite a bit, has two e-turbos on it. So leveraging our knowledge in internal combustion with turbos has really helped us in terms of air movement and so forth, and you begin to address some of that air flow issues, but it hasn't had an emissions output from that -- from the fuel cell itself.

Okay. And then literally 2 minutes we have left here, I want to go back to the maybe Class 8 cycle. April was -- orders were weak, and then we had a slight recovery in May. It seems like some of the OEMs' commentary has been a lot more positive than what the Class 8 order number says. What are you hearing from the OEMs? And what are your views of the cycle? I mean are we going to have a production down cycle in 2024? Is that almost inevitable? And how steep could it be? And how then does EPA 2027 -- when does it start to factor in to the kind of next cycle? Or is there a pre-buy prospect that could start earlier than normal?

Yes, I think it's -- I would say on the cycle, it continues to take on -- the order levels are not surprising because '24 order books are not open yet. Just it was similar -- actually last summer, we were seeing mediocre numbers in terms of orders because the books shouldn't open and then they boomed. We don't expect that level, but we do think there's a downturn, but I think it's probably because that's all we have, always has been. With all the factors involved, we think it would be maybe a more subtle down to more slight downturn and then bouncing back pretty quickly, as you got into the key topic, Matt, and it's prebuy. So people are thinking '27 emissions and given the last couple of years where they may not have got a truck for 2 years, there's nervousness with expected cost increases on the trucks that they want to get started in maybe '25 versus waiting for '26 to prebuy. So I think it will be a little bit more drawn out and we'll see how it evolves. But I think what we thought was going to be moderating towards the end of this year, it seems like it's pushing into '24 and we'll see. It's squeezing. It's squeezing in terms of time you have to turn down before spot rate starts bouncing back and the economy starts moving forward, and then it changes things.

Yes, you're right. And even though the trucking industry is in a down cycle, it really is off of a very record levels. So it's a down cycle, but a lot of the truck carrier base is really not hurting as they would in a typical down cycle. I mean having been an associate on the truck and rail and logistics team for 10 years, and my -- the first portion of my transportation career. I know that a lot of the trucking carriers buy trucks when they can, not necessarily based on supply/demand when their financials allow them. And even though it looks like a down cycle now, the number of exits has not been as dramatic as we would have thought, and their financials are fairly solid. So it does create a very interesting dynamic for 2024 of kind of a more smoother downturn than usual?

For sure.

Yes. All right. Well, we just went 1 minute over. Chris, thank you so much for this insightful conversation. Really appreciate it, and I hope you -- the rest of your day goes very well.

Thanks. Appreciate it, Matt. Take care.

Take care.

Thanks, everybody.