Cummins Inc. (CMI) Earnings Call Transcript & Summary

Thanks for joining us for the Cummins session. I'm Steve Volkmann. I cover Cummins for Jefferies. And very pleased to welcome Cummins to this session. And we're joined by Mahesh Narang, who is President of the Components business, and Chris Clulow, probably most people know looks after Investor Relations. So we'll do this as a fireside chat kind of a situation. I would love to have your participation. If you're interested, we'll have time, I'll pull in a few minutes and see if anybody has any questions.

But with that, welcome, guys. Thank you so much for joining us. Cummins was kind enough to put out a fairly meaningful price release this morning for this conference. I think it was just for this conference. So maybe we can start by -- if anybody hasn't seen it, perhaps you could just kind of hit the highlights and specifically sort of the timing and the amount of investment, I think, is of interest to people.

Sure. Yes. So I'll cover that one. So we announced this morning that we are forming a joint venture with Daimler, PACCAR and EVE Energy for battery cell manufacturer here in the United States. So we're really excited about this. It's a key step forward as we look to decarbonize the industry. And one of the big hurdles is battery supply, the battery cell supply and making sure we qualify for USMCA and meet the needs of the IRA in order to get some funding and are also key elements in this decision where it allows us to get scale, manufacture battery cells. We'll do the packaging and all the other supporting componentry outside of the joint venture. And working with not only just PACCAR and Daimler, but our other customers as well. So we'll be able to sell outside of the joint venture, really excited about this, get us to a place where we can get a secure supply for the future and at a cost that is much more manageable and more controllable. And so really excited about it and it will launch in 2027, start of production, a significant investment as these battery plants are. So it's $2 billion to $3 billion for the construction that will split between the 3 of us. So this is a good way for us to get the scale and the capacity while kind of managing the cost for each of our companies.

And what sort of capacity will this give you?

Yes. So initial capacity will be to support about 80,000 medium-duty trucks or about 40,000 buses. So it's scalable from there. We can continue to expand that as it becomes more and more a part of the market as we proceed through the next decade or so.

And presumably, you'll get 1/3 of the output from that factory and you can sell that as you wish.

Yes. Yes, and we're still working with both PACCAR and Daimler on how we approach the packaging of the batteries as well as all the other componentry on it. It really opens the door for a very collaborative conversation as we approach this electrification side.

And in terms of the investment, I guess, as a trained analyst, I can conclude that the difference between $2 billion and $3 billion is significant.

It's $1 billion, yes.

Is a whole $1 billion. So what would make that be high or low?

I think it's -- as we're going through the process, we're working through what are the IRA qualifications, where we're going to locate it within the U.S. and what incentives there are around that and then just kind of the cost to complete. So it just put a pretty wide range around it to start.

Okay. Fair enough. All right. Let's pivot and talk a little bit about the rest of the business. So maybe leading off, just curious if there's been any sort of interesting development since the second quarter in any of the end markets that you might want to call out?

I can go for that. So end markets have been pretty high over the last few years. And going into '24, we announced in our call that we do see some softening, not a big dip, but some softening because the market has held so high. And for Cummins, we expect some inventory corrections or red tag trucks being cleared by OEM. So a little bit of less sales in Q4. So we expect the heavy-duty market will be about 10% down. The medium-duty market is holding fairly steady, and we are increasing our capacity. So that market should hold for us next year. As we move around the world, India and Brazil would be similar to slightly up compared to this year. And then China, which has been down for a few years. We are hopeful that there's some recovery that happens in the China market next year. I would say I'll let Chris talk about the Power Systems market, which is another big market for us.

Yes. Thanks, Mahesh. I think Power Systems market, which is the large engine market, we see really strong markets continuing through this year and in next year with mining being very strong around the world, both with energy and security for coal and other minerals being mined, that will hold for a while. And the other one is power generation, particularly data centers is really strong. So we're seeing orders well into -- towards the end of '24 and into 25 even for some of the data center demand. So with the AI boom data center construction continues to be very, very strong.

And I think you've talked about it, if I'm not mistaken, it was at 7,000 to 8,000 of these red tags that you've talked about that need to ship. And -- so presumably, those already have our engines in them. And so that's why...

Yes. So that's one of the pieces. And as we look at the fourth quarter, because we've seen some flattening out of the heavy-duty aftermarket demand. That's usually a good foreshadowing as people manage inventory. And when this usually occurs and next year is looking a little bit softer, the OEMs manage through that, they clear out the red tags. And at times, it will take a day or 2 or even a week of extra shutdown around the holiday. So we're just -- we're banking that all into our guidance this year. It could be -- we'll see how September orders come through in the order books for 24 open up, and maybe we're on the conservative side, but we'll see.

So are you -- I'm just picking up on the last thing you said, are you expecting the OEMs to take normal shutdown weeks in the fourth quarter?

Normally, yes. So I think that, that's -- when they're going through this process of managing inventory, and we're getting ready for what we think will be a softer market next year, that would be our expectation. I guess if it's looking like the market will remain strong next year, it could hold up and continue production all the way through the end of the year.

So I guess where the rubber hits the road a little, Cummins is kind of known, I think, for being pretty proactive with the cost side of the equation when you're worried about end market demand. So are you pulling back on any specific costs as we speak?

Yes, I can start on that, Mahesh, and then you can jump in. I think what we're looking at is trying to manage a lot of our discretionary spend now, controlling headcount, drawing that back. There's not -- given what we expect in this later downturn next year, just in the heavy-duty space, there's not much you're going to make leverage you're going to pull in manufacturing. One, manufacturing labor is very hard to come by still. And two, you just don't get the payback in just a short downturn. So I think what we'll look at is just areas where we can cut back on SG&A. We'll continue to work on development. That's where we will power through whatever cycle there is because this is our future. But I think we'll look at other areas where we'll kind of draw back on the costs.

The only other thing I would add is we think through scenario planning if things go bad, but don't act on it. So we just finish our thinking through it. So right now, it's all about controlling discretionary spend and travel.

All right. But it sounds like what I'm hearing is you haven't really pulled the levers that you would pull if you thought next year was going to be a tough year.

Correct.

Okay. Can we talk a little bit about the supply chain and sort of what you're seeing, but also your ability to kind of produce and whether there is needs to be more capacity or something?

So overall, the supply chain has eased a bit this year, but there are still constraints more so for our OEMs than for us. We do get supplies, sometimes it's intermittent, sometimes it comes with extra cost, but the supply chain situation is a lot better, including electronics. I would say for OEMs, there are a few components that are an issue, a lot of them on the truck side like frame rails, and then on the medium-duty side, if we could give them more engines, we could sell more. So we are increasing our capacity for medium duty. And generally, what we find is if OEMs could get more supplies, we could sell more. And we are not necessarily the bottleneck for them except for in some cases for medium duty. Chris, I don't know if there's anything else you have.

No. I think generally, like Mahesh mentioned, the throughput is getting better and continues to -- I think cost continues to rise, though. I think the supply -- our suppliers continue to be impacted by inflationary pressures, whether it's interest rates, as many of these have our finance companies or labor rates. So there is still some upward pressure. It's waning, but there's still some upward pressure on cost.

And talk about the other side of this, which is, theoretically, if you're having supply chain volatility, that drives inefficiencies into your production process, which is probably some sort of a margin penalty.

Yes, it has been. I think that's -- we've -- it's continued to improve. With this through -- the throughput is the key thing. On-time delivery to our plants is a key metric we look at, and it normally runs north of 80%. It's in the mid-70s now. It was down in the 50s when we were in the midst of the pandemic. So it's not quite back to where it was. So we're getting back to the efficiency levels, I would say our plans and our supply chain has been quite resilient.

And are we kind of done with that now? Or is there more margin opportunity as supply chains normalize?

I think there's still some throughput opportunities because when we still have some efficiencies to gain and we still have some work to do to lower our inventories back to more normalized level.

The offsetting dynamic to getting more efficient is supplier costs continue to increase as you would have seen in our Q2 results. So that's the offsetting and that's going to be the bigger challenge going ahead.

Do you feel like those offsets are fairly similar in size? So we end up kind of neutral here.

We hope so for the rest of the year. And then for '24, we are planning now for how to offset any incremental increases.

All right. Okay. All right. Well, Mahesh, since we have you here, maybe we'll start on components then. There's been a lot of activity in components with axles and brakes and expanding the product line fairly significantly. Just give us your lay of the land in terms of how are you doing with those integrations and how are you going to market now with sort of that full package?

Yes. So we've been very pleased with the Meritor acquisition. And we are on plan or slightly ahead to the goals we had as of this time for the integration synergies that we announced. We said we would save about $130 million over 3 years, and I think we are on track for that. The team is great. I think they have a great position, and it really sets us up in a fuel agnostic way because you sell an axle on diesel and then you sell a eAxle on a BEV truck. So the acquisition for us has been great. We also see opportunities for growth around adjacent markets because Cummins is stronger in markets where Meritor was not as strong. As an example, in Asia, we are quite strong. We have really strong relations in some other markets like off-highway. So I feel really optimistic and we continue to feel confident that we will hit the goals we had set for the acquisition.

Okay. Great. And then it feels like components is kind of the tip of the spear when we have these various types of regulatory changes. And so -- as we go through the next several years, there's a few that are coming at us, I guess, globally. So how should we think about the potential for additional content on engines from your components?

Yes. The most significant content increase has been -- in the past has been on Emission Solutions, and it will continue to be that going ahead. Especially with the EPA 27 regulations when they merged with COP 2024 regulations. And in North America, that will drive a big content increase. And that just helps us because you don't increase cost, but as you increase content, you get leverage. And hopefully, you get more value pricing, right? So I would say CES will continue to grow. The content increase, depending on the application could be anywhere between 30% to 50% for some of those U.S. applications. It won't be as high in other parts of the world, but U.S. it's a big part of our business. So I feel again optimistic about the regulatory changes coming up.

So am I reading this right that your U.S. sales could be up 20% to 30%?

For the Emission Solutions.

Yes. Right, for the Emission Solutions. Okay. And then presumably, there's margin opportunity in there as well?

Yes. That business has continued to perform. And as things get stricter, it becomes more difficult to make, so you get better value pricing. And you could see our margins for components have kept expanding just as regulations have tried them across the world. But when you look at components, the big margin driver for us is going to be improving Meritor profitability from the 10.8% we've said to making it similar to where other components businesses are, and that will take more time.

When do you think you start to see the benefits of the '27 emission changes? Do we wait for '27? Or does it come a little bit ahead of '27?

For the most part, you'll have to wait for the '27 changes. And if -- we may see some prebuy in '26. But generally, you have to wait for the regulatory changes.

We will be launching -- some of our products will launch in '26, the 15-liter and the 10-liter will launch in '26 with some pricing. So we get some benefit then in kind of continue to pull forward. In addition, I think as Mahesh mentioned, with CARB '24 coming in, that will add some content even as we go into next year.

Okay. Maybe shift to engines then a little bit. What does the trajectory look like over the next few years? I know you've won some business with Daimler, Isuzu, but how does that ramp look over the next few years?

Yes. So we've done well on that ramp in terms of -- in North America, that's where we continue to take on the business, as Mahesh mentioned, we're kind of capped out in capacity and continuing to look to expand capacity in medium duty, probably some more 5,000 or 6,000 more to gain in North America. But then you have a ramp elsewhere around the world it's a 10,000 or 20,000 units in Europe, which will come with Euro 7, which will be determined, I guess, towards the end of this year. But the bigger pieces are in South America, which is 30,000 to 40,000 and Southeast Asia, another 30,000 to 40,000 engines, and those were starting pilot production yet this year. So we've pulled forward those trying to bring those in earlier. And I guess the beauty of this part of the business is we're manufacturing in our own plants. So it's just no need for significant capacity expansion. We're just bringing them in and manufacturing where we already have capacity.

So I can't do all that math, that fast in my head, but it sounds like there's an underlying growth rate of sort of 8% to 10% or something?

Yes, and the medium globally. Yes, that's about right.

Let's just touch on China and then I want to see if there's questions in the room here, but China always comes up in my discussions for you guys. So give us your read of the land in China.

China is always unpredictable. It always surprises us, and we are waiting for the positive surprise to come. So far, it's been low, government has not spurred the economy, but we do hope that they will do something in 2024. I don't know, Chris, if you want to add anything?

Yes, I think this is one where the market is up from last year. We came out this year and said we expected slow and steady improvement, and we have seen that. The second half will be down just seasonally, but we have seen kind of continued progress, but it has been slow going. I guess, on the positive side for us is we've gained share in the process. So both in on-highway and in the off-highway markets, we've got greater penetration with our existing customers, new customers and then big presence in exports that it continues. So we've bumped up share over 200 basis points and on and over 300 in off-highway. So this is a place as it continues to gain momentum and the market is at its low point. And we expect it to continue to move up from here. It's just how quickly it goes. And we don't expect any big stimulus for the rest of this year, though.

It feels like it's been bumping along at this low point for a while. Is there actually a story at some point where the fleet gets old?

Not -- there's not so much of a fleet getting old and the reason being back in 2021, they took out all the old trucks. They basically have renewed the fleet unnaturally. So the fleet is not too old right at this point, and I think it's a pretty durable fleet at this point. I think at some point, maybe in a few years, it starts getting old. But at this point, it's still more just kind of moving it up and it's relying on the economy because construction is not driving it. With the real estate reforms and some other forms in the economy, construction is not going to pull it through unless there's some big stimulus.

Okay. So we wait. All right. Anyone here have a question? Great, in the back row.

As clients are trying to decarbonize and more interested in their footprint, are you kind of seeing with the 15-liter engine, any new interest coming to the market? Or existing clients? Can you just kind of speak to how that's unfolding?

For the 15-liter fuel agnostic? I just want to make sure. So yes, we launched the 15-liter natural gas to be the first launch of our fuel agnostic that comes next year, and there's been a lot of interest in the market. This is one where customers, large customers, large fleet customers or large public customers like Amazon or Walmart or whatnot, this is very attractive because you can get close to diesel performance, you can get diesel range on a 15-liter long haul. With natural gas, which is something that people had been looking for many years. I think it's finally turned now where the market is swarming and you can use the existing infrastructure and ship across the country with long haul for natural gas. So we're making really good progress there, and people are excited about this one on what's on offer, particularly with renewable natural gas. It's a very exciting proposition from an environmental standpoint, but it's also a cost-effective way to meet your ESG goal. So that's where kind of the interest has come. We launched this engine in China in 2021, late '21 and already had really strong reception. It's performing very well. That market has migrated much more significantly to natural gas in the heavy-duty space, but we don't expect that level of movement, but we do expect some increased movement for natural gas and heavy.

When should we expect that you'd start to get orders for that?

Yes. We're talking to customers now. We've -- even last year, we announced a collaboration with Walmart and Chevron on this, and we've talked to Werner as well and had some announcements there. So we're -- actual orders will come in when we launch the product because we can deliver it pretty quickly.

Okay. Anyone else? No? Maybe let's focus a little bit on power gen then, you mentioned you're seeing, obviously, good activity in data centers, but it feels like there's more than that going on. And certainly, there seems to be more sort of power uncertainty on the grid these days. And I'm thinking I'm going to date myself, but I remember a cycle in power gen when the last time the grid was capacity constrained. Is there a chance that we get that kind of a cycle in power gen?

Yes. I was actually in our business at the time, there was one time to be in the business because we were powering, I remember the picture of us powering a large portion of Africa with our gen sets. But I don't -- we don't expect a super cycle like that. However, there is a big -- beyond data centers, the industrial expansion in North America is driving a lot of demand. I mean case in point building a backup gen sets for a battery plant that we will be doing. Things like that. I think as people onshore more and more, there's a lot of nonresidential construction going on, which is driving a little lot of demand. And this is long lead time demand. So we have a pretty good visibility for the next at least year plus to see this as strong markets.

And where are we on the journey relative to margins in that business because that was sort of the laggard for a while, but it seems like you kind of got it moving in the right direction.

Yes. The Power Systems business, we're really pleased with the kind of -- they turned the corner in Q3 last year, brought it up and bumped their margin up a couple of hundred basis points, continue to improve that. Plus, we're -- even with having record profitability currently, we're doing some transformation efforts to continue to improve that margin, make it more stable for the long term. So we have this -- we launched that earlier this year to make some big improvements there, really very bullish about the prospects for the business.

And have you talked about sort of what the opportunity still is to come?

No, we haven't gone into detail, but that's -- it's kind of a continued improvement along for -- with some of the progress we've made and more. Yes.

Okay. All right. Anyone else, final opportunity. Yes, in the front here.

Your hydrogen and basic strategy, and it was a small part, but fuel cell and the electricity, I think you probably said $500 million by 2025 in terms of revenues. Are you still on track for that? And then PEM has really had a hard time getting off the ground. It's alkaline, especially pressurized alkaline, it just sort of seems to be winning the race. So maybe talk about how you think now about technology?

Sure. Yes, we feel very confident that reaching that $500 million revenue in that 2025 time frame. We just talked about our backlogs up to $550 million currently. So that kind of really fills that pipeline pretty easily. So we're working our way towards that. We have 4 different capacity expansions going on now around the world to make sure we're meeting the demand. And that's where we're really focused to making sure the product is right for more wide-scale launch as well as having the capacity to do so. The demand is definitely there. And alkaline does play a big role in this. I mean it's a proven technology, has been around for 20-plus years. But PEM has some advantages over it in terms of green energy supply and some other advantages in terms of footprint that we think it will carve out a meaningful niche. We don't think it's going to replace alkaline. We never was under that thinking, but we do think it will carve out a meaningful piece of the market. And in our projections for 2030, which we shared at our Analyst Day last year, we had $6 billion for our Accelera business, which electrolyzers will be $3 billion to $4 billion of that. So it's a sizable growth opportunity for us, all complete outgrowth for us and the market is forming up well. So we're feeling still confident with it.

[indiscernible] Alkaline and PEM and/or maybe their valves feels like and that's controversial because basically all the sell side have been rooting for PEM and PEM is really, you look at ITM, it's really soft. So the problem is the iridium. I mean there is not enough iridium for PEM, so.

Yes. So there are some alternatives there as well. So we think it is like a 60-40, 70-30 split. So it's not -- and so we don't expect it to take over completely. And we're -- the advantage we have in this space is and within the Mahesh's business is our emission solutions business, we've been using precious metals for many years, looking for ways to reduce them, and we can use some of those learnings to address some of the iridium needs in the electrolyzers.

And with that, I'm afraid we're out of time. But really thank you, guys, and thank you, everybody, for coming, Mahesh and Chris, thank you so much.

Thank you.

Thank you.