Cummins Inc. (CMI) Earnings Call Transcript & Summary

Perfect. Well, good morning, everyone, and thanks for joining us. Why don't we get started. So my name is Angel Castillo, and I'm the Machinery Analyst here at Morgan Stanley. And it's my pleasure today to welcome Cummins. And we have Brett Merritt, VP of On-Highway and Engine. And Christopher Clulow VP of IR. So why don't we dive right in? So gentleman, thank you for joining us. First question, I wanted to start maybe a little bit more high level or longer term, I guess, in nature. So a lot of discussion around the EPA 2027. I wanted to get your thoughts on how is Cummins approaching this? And not just from kind of, I guess, broader strategy perspective of product offering and just kind of thinking about it strategically heading into that time line.

Okay. Sure. And apologies, my voice is a little raspy over the -- all the travel. But, so we generally look at regulations where we want them stable and we want them achievable. But we're okay with having them tough. And this was a little bit controversial as EPA and CARB came to be for '27. But we would say, hey, it's good we know it now, because it is a 4-year investment cycle for sure. And the second thing is, it is achievable with a wide range of our fuel agnostic engine. And I'll go into that a little bit more. There are always areas we think that, that could be better, but the third benefit is now we don't have kind of disparate states with all sorts of different rules, which is very, very difficult to manage both investment and enforcement. You know our position in North America is quite strong across medium-duty and heavy-duty, and our belief is, for the future, you're going to need a wide variety of power offerings because it's very application-specific. So at a macro level on the product side, we will come out with a fuel-agnostic set of engines. Everything from a gasoline in, but in a diesel -- with diesel durability in the medium-duty, all the way up through heavy-duty offerings that will include hydrogen and of course, our natural gas line which we'll even launch next year. So what you'll see is a full suite of new engines for this investment. Given our scale in North America, we think that we could uniquely solve that, and we'll have both our 7-liter, a new 10-liter and a 15-liter engine, launching in '26 and '27 because if you look at the regulation, there are some nuances in it we're bringing some of the engines in early will be both beneficial but also will bridge out the implementation challenges we have. So that's how we see it as a macro level. And we think during this cycle, we'll do just as well as we have in the various other emission cycles as we come through. I don't know, Chris, do you have anything to add?

And maybe that's a good kind of segue there to the cycle, right? And what you're seeing more broadly. We look to get your thoughts. Just kind of both near term and longer term, right? I think there's been a lot of discussion about some of the near-term potential for fears of a recession, whether it's soft landing or something. But just as you think about what you're seeing in the market and what you're seeing from estimates from consultants like, what, how do you view the market both in the short term and as we get closer to that '26, '27 evolving in terms of the typical cycle?

Yes. In the short term, what we'd say is we have not seen medium duty change at all. The medium-duty truck still has very robust demand, both across the vocational platform, which should theoretically strengthen given some of the investment in North America but also just based medium duty. Many of those users just haven't been able to get as many as they want. And there's a relatively old fleet. So we see that quite steady. We also see heavy duty right now, quite steady. Although based on consultants and others, we would say that if there's a potential to soften heavy duty, there is a potential for the softening as we head into next year, we watch that as much as anyone. As you look a little longer term though, you have underserved -- we've underserved this general customer base over the past couple of years, given the COVID supply challenges and others, and they're going to have a new emissions regulation, which generally promotes some prebuy. So we would say this is a little softer cycle than what we've seen in many other times. And I don't know. I don't know, how else you want to describe that, Chris.

Yes. I think it's, the one positive on what we think this cycle will be is we see heavy-duty North America maybe coming down 10%, 15%. That still gets get you though about replacement level, so it's still at a pretty high level. And unlike the past few cycles, it's not, everything is not in sync. I mean, the past view has been every part of our business: China, Power Systems, all our markets kind of in sync. And so this allows us to navigate a little bit easier through this cycle.

And just to clarify, I guess, is that more kind of a 2024 comment and then, as we evolve closer to 2027, you mentioned potentially kind of offerings coming in 2026. So as you think about maybe the prebuy or people preparing for that time frame, no need to kind of give a specific number. But I guess as you think about like that '25, '26, do you expect that kind of a typical or a ramp-up in that time frame? And just -- just how are you seeing that kind of play out?

I do anticipate a ramp up. If you see just broad numbers, Chris mentioned back to replacement demand, but we've never reached our previous peaks. Not sure actually we can as a supply chain in general. So I believe that keeps the standard deviation down a little bit as we go. But I would anticipate, as you go towards the '26, '27, you'll see an increase in orders. We always have almost every market as you look at an emission cycle.

I want to, I guess, understand that a little bit better, too, just you mentioned the supply chain issues, right? I think we've, there's been a lot of discussion about that over the last couple of years in terms of -- it's impacted every industry. But as you think about that ramp-up of '25, '26, I think there are some expectations that you could see a bigger ramp up. What do you see from a capacity standpoint, production supply chain challenges. How does that play into it? And do you see that, it sounds like you kind of expected to kind of put a cap on the ultimate production?

Well, I think theoretically it could. Right now, the truck market is constrained, not on the engine side, but on the truck side, by some supply challenges as we speak and sit here today. So otherwise, we would be building more in the North American market, I think, right now. We've had our challenges as we went through the various chip shortages to electronic shortages to various -- lots of supply disruptions that a myriad of issues. But also, we had some potential capacity challenges, and you've seen Cummins investor during the cycle. I think we'll be ready. We're not going to be a bottleneck in the remaining cycle, but it's a pretty complex supply chain. And so let's see how everybody responds to that. And while I say it's quite easy if you talk to our plants today, there are spot shortages all the time, which historically, that may have happened, it just seems to happen a little bit more now. But I think we're prepared for to support the full cycle. I just don't think you'll see a heavy-duty cycle of 380,000 trucks. It will be more muted than that.

And what would be the bottleneck then ultimately? So if Cummins kind of prepared for that? What, is it more kind of upstream, downstream, like where do the bottlenecks kind of come in?

Yes, go ahead.

Yes. I think they're in, within kind of the whole industry supply chain. And I think what I mean is like there's big suppliers, of course, like us. There's also a lot of smalls. And if you're a small company and you want to ramp up supply and you're already financing at rates that they are now, it's a big bet. You're betting basically, your livelihood there. So you've seen less of that like more the smaller suppliers that are part of this overall truck supply chain that aren't just going to make that big ramp up. It's just not as feasible right now.

Yes. And I want to remind the audience, if you at any point, if you have any questions, to raise your hand, and we'll get a mic to you. So I wanted to kind of maybe take all of this and go back to something you said earlier, right, in terms of your, the strong position that Cummins has in the market. As you see all of this evolving between now and 2027, One, how do you kind of see your market share evolving? In particular, I'm curious as your thoughts, you've seen, I think, some degree of integration or at least more dual kind of sourcing or OEs introducing some of their own kind of product lines. How does that impact? Again, the strategy and the market share as we head into 2027.

Yes. So we've had a strategy for quite some time. And the base of the strategy is we want to, we have push pull and then we maintain uptime. And the base idea is, we want our product available and as many chassis as possible across the OEM landscape. You've seen us do a lot of partnering in that space. And today, I think we would be offered in an unrivaled number of chassis across. And then those end users, we want them to be able to pull that product through those OEMs because every OEM will want to sell their own engine. But at the end of the day, they're choosing those because of a higher TCO model. So it's either a better performance on fuel economy, it's better durability or it's better around the maintenance. So if you think a heavy-duty truck. So we give those end customers a couple of advantages. We can meet their TCO model, but we can also allow them to have the OEMs compete against each other, all offering Cummins engines. And then finally, we do have a residual value advantage based on our durability, our reputation and number of service locations and flexibility of the base heavy-duty engine specifically. And so you've seen us employ that model on the medium-duty side where we were in the teens in the late 2000s in market share. And now we're at a number which is quite good. And we've done that in a market that everyone had their own engine. And so we believe that base product plus support plus this general partnership model and frankly, we have to have the better engine, we can exist. In heavy duty, that's brought us to the 30, high 30s in percentage of share, which is something we're also proud of. So we are no stranger to the introduction of new engines, and we'll continue to employ that again, with a brand-new 10 liter -- a 10-liter natural gas, a 15-liter natural gas and a brand-new 15-liter product. which we think will take this industry to the decades to come. And I think we've shown during these complex cycles, we can actually win out of them. I think it will happen again.

And I do want to go back in a second to the partnership dynamic because you had a very good announcement that came out this past week. So, but before moving to that, maybe just to tie it all up, in the more near term, I think at the last quarter, you talked about some aftermarket weak -- softness that you were signs of softness that you were starting to see, but more importantly, what you're hearing from your customer? So we'd love to kind of hear what's -- how has that evolved? What's kind of the latest that you're hearing from the ultimate end user in terms of maybe tying into that 10% to 15% that we talked about?

So end user, I mean they're really happy with our product. We have some big customers who buy over 20,000 Cummins engines a year. And that is, that's a huge customer who we meet with frequently. Multiple customers who are quite happy with the performance of the product itself. So there's many of them as just don't keep it going. And that feels good. They also say they have some latent need of just replacement trucks. So they're still ordering, we're still partnering, but they definitely want us to be someone who helps educate them for this uncertainty as we think of regulation and what we call kind of the messy middle of technologies in between. But we've become very much a trusted partner in that space. I do think there is some softness in the parts market, by the way, off of a very, very high peak, and that high peak was driven by trust, frankly, in the supply chain. So if you don't know you can get the truck. And remember, one day 1% fuel economy advantage in the North American market is probably $2,000 to $3,000. One day down is also $2,000 to $3,000. So there is an absolute need for the market to have a lot of Cummins parts to be prepared so that nothing could be down ever. What you're seeing is a correction in some of that inventory. Because their Cummins and parts are available at over 3,000 locations. As those 3,000 locations start to realize, oh, I can trust that the supply chain is going to provide it again. You're going to see a little bit of an inventory tightening. But the base need of those trucks is still good. Our rolling population of Cummins trucks is higher than it's ever been. So we still feel good long term on the parts market, but there is an inventory correction. Is that a safe way to say.

And is there any, do you have, I guess, a way of kind of quantifying or do you sense for how long that will persist, that kind of correction?

Yes. I think it's, overall, the industry has built up inventory over time. I don't think this is a long term, I think as we come out, if the market softens next year come up aftermarket comes up with it an aftermarket because of the population we have out there, it doesn't, it just kind of flattens out. And that's what we're seeing. So I think we still have the big population that pulls it through even when the -- first the demand goes down.

Yes. Got it. No, that's great. Any questions from the audience before I switch. Okay. Now let's dive into the partnership. I think Accelera had a great announcement here, JV with Daimler and EV Energy and PACCAR as well. So just give us a little bit more details as to how this kind of advances the 0 emissions transition? And just anything else you can share on that partnership?

Yes, we're really excited about it. It's something as we're moving. We do expect migration of battery electric over time in some of our markets. Bus is the first one to move because that's subsidized and funded by taxpayers. We're seeing that already. We think medium-duty truck is a good use case as well. One of the big uncertainties was battery cell supply. We are relying on a very limited set of suppliers where you, the supply was not -- we're not comfortable with getting to supply, one, and at a reasonable cost. This joint venture answers that question. It's a U.S. manufacturer of battery cells with LFP technology, which we think is the right technology for the commercial trucks in terms of durability, safety, cost and so forth. I think this is the right recipe as this PACCAR and Daimler. And so bringing this together gets us cell supply. Cells are not the big differentiator in the market, but not having them is a big differentiation. So I think this allows us to have that, the security of supply, getting them at a reasonable cost and the economics for battery electric become much clearer. So I think this is, we're really excited about this. It brings it up partnering with Daimler PACCAR gets us to a scale level. It equates to about 80,000 medium-duty trucks or 40,000 buses, this first step in this investment, and it's scalable up as the market moves. So this gets us -- it will launch in 2027 production, and we'll already, we'll pick it up for buses. We'll still work with certainly PACCAR and Daimler and every other OEM space.

And help us understand, I guess, the time line or the ramp-up of this. I'm assuming it's not going to be kind of maybe the full 21 gigawatts right away. So just 2027 is kind of when it comes to market. What should we expect in terms of that $2 billion to $3 billion spend. Is it all between now and 2027, or is there a ramp up beyond that to kind of grow for the capacity more?

Sure. Yes. It is between now and 2027. It will, I think the capital spend we still have to get regulatory approval of course, and then site selection, and then you start probably mid next year, we'll start spending capital. And then it goes through 2017, and we will launch with that capacity. We were already selling quite a bit in the bus space. This will provide that supply and then we think medium-duty will start moving that way.

Yes. And you talked about maybe the sale not being kind of a key differentiator between , but what other lessons can we kind of draw from this JV, right? Because you have competitors, you have supply chain, everybody working together in a way, I guess, it seems like a different step change. So just what implications does that have for the kind of industry dynamic?

Yes, I can start and then you can jump. Yes. So I think, I can quote somebody who said it last week on one of you, one of the investors. It shows where you are in the space. It shows what Cummins place in the space where a few years ago, people were like, why haven't you announced you're partnering with X, Y and Z, all the OEMs. We were working with them, of course, in the background, it's been a couple of years in the making. But it shows that we are a key part of the industry. And the dynamics and competitively, we expect that are in ICE now, we expect to be in this new power space.

And I mean we're proud to announce it with our two largest customers. I think what we need is the technology and make sure it's the right one. So I think everybody knows we're a prudent participate in this market. We're long term. We're always that way. And so we wanted to make sure we get the right thing. Second is, I think this validates the fact when the three of us as technological leaders say we believe this is the step to make. I think that's quite a move. And I think it will provide a leadership position for us for here. Now the challenge will still be the market has three things they need for battery electric. They need it available in a truck, we're going to help that. They then needed to meet a TCO model. In some applications, it already does in other applications, it will definitely need to be subsidized or we need the scale to bring that cost down to make that TCO model work. And then third, you're going to need electric infrastructure. So the charging infrastructure realistically will be the bottleneck. But yet, we've made what we think is a really good kind of beachhead investment that will bring a scale that's unrivaled by anybody else. And so I think that's a very good move to do it at the right timing. If you'd have done this 3 or 4 years ago, you probably had the wrong technology, then you definitely wouldn't get near to scale.

That's very helpful. Maybe sticking with Accelera, just in terms of the backlog that you reported, so $550 million, very strong within electrolyzers. So just I recognize the profits can be lumpy, but can you help us understand the process of kind of turning that backlog to revenue over time?

Yes, the electrolyzer market, particularly for PEM electrolyzers, continues, demand-wise continues to be incredibly strong. Europe was leading for a while with the IRA, the U.S. jumped into the lead. And Canada is doing, is playing a big piece in this as well. So the demand is definitely there, and it's a race of scale. Now we have 4 different plants we're scaling up currently to meet the demand. But to your point, it's going to be lumpy. I mean the backlog keeps building you have to want to make sure the products right, make sure that we've invested correctly and that we can scale up and do this in a good profitable way. And so that we're getting ready to launch. The one thing, we used to say it would be 12 to 18 months between backlog and revenue. That's more like 18 to 24 now. And it's not because of delays. It's because the size of the plant keeps getting bigger. So the largest one in operation now 20 megawatts that's in Bécancour, Canada, that's ours. There'll be one for 25 and then went 35, and then it went 90, and now we have one coming for 150. So it just keeps getting bigger and those take longer to launch. We think over, as you get to the latter part of the decade, that will even out. The lumpiness will even out, and we'll see good growth in this space.

Got it. No, that's very helpful. And, maybe just as you think about how much capacity you need, you were talking about expansions and continuing to kind of build that. Where are you in that process of investing into this business? And how does that look for the next couple of years?

Yes. So I think it's, we are in the midst of the big capacity investments and that it's taken up. We've bumped up our losses in Accelera as a result. We do expect this to be the peak year of losses for Accelera. As we progress towards breakeven in 2027. I should mention on the capital side in this New Power, Accelera space for us, it is a little bit lower lift on capital than a machining and engine plant. I mean it's assembly other than the battery plant, which we announced, we're sharing the investment in. It's a little bit lower lift on capital. So we'll scale this up. But it's, I mean, overall, for Accelera this year, we're spending about $150 million in capital, which compares to about $1 billion in our Engine business plants.

Yes. Yes. And beyond 2027, how do you think about the longer term? Just remind us for Accelera in terms of margins and growth?

Yes. So I think we see a path to bring it up to kind of the Cummins average margins. I think it's going to take getting to scale there. The first one to scale be electrolyzers. Battery will follow after that. Fuel cell is going to be longer term. We think Fuel Cell is not really going to come in probably a hugely meaningful way until mid-next decade. So we're going to keep working that. And we're adjusting our investments in those accordingly. So we're make a big investment in Fuel Cell now to be #1 with a market that's not there. So I think it's, I think we're kind of staging that out, but we see that kind of rising up and getting up to Cummins average margins in next decade.

I want to make sure if there are any questions. We got one up here.

With regards to electrolyzers, can you talk about how the order book could change based on the IRS guidance around additionality? Plus the matching hourly versus matching annually in terms of how they -- I'm talking about the production there to qualify for the $3 tax credit?

Yes. I think I unfortunately don't know at that level of detail. I do think just in terms of momentum we don't see anything slowing. But we can take that down and try to get an answer for you on that specifically, but I don't have that right now.

All right. I guess I wanted to also ask about maybe taking a step back and asking just more broadly geographically what you're seeing in some of the more challenged areas in particular, China. Would just love to get your thoughts as to what you're seeing in terms of underlying demand kind of year-to-date or quarter-to-date rather? And how are you seeing that plan in terms of share, content, pricing dynamics?

So we've been a long-term player in China since the '70s. Very proud of the partnerships we've made largely through a variety of joint ventures in China. So you see that show up really in the JV income side of things, but also some core sales across some customers. What you see is a really tough market in China. I mean it's down 40-plus percent from peaks. We are not seeing that return right now. still quite sluggish. There is a fair amount of investment coming from the government, but that has not moved completely through the truck market. By the way, still the largest truck market in the world. So way down, but still much larger than any other truck market. We still see our share in the high teens. We play in a definitely a premier segment of the market, and we have very, very high penetration with some of our core customers. So we think the product is doing very well. We do have additional content as it's in NS6, but we don't see the next stage, which is NS7 until later in the decade. But it's moved well for our Components business as well as Engine. We anticipate, we have picked up a few points of share, both on Off-highway and On-highway and we'll continue to do so. And we've said we'll will continue to increase in China, much like we do in a variety of other spaces based on partnership and having a better technology there, albeit right now, it's a very difficult environment. Probably the other benefit is there's a fair amount of export now of vehicles out of China, of which many times they choose Cummins because of that network of support we have around the world that doesn't exist for some of the some of the Chinese engine suppliers themselves.

Okay. No, that's helpful. And maybe to the technology dynamic, I would just love to get your thoughts on maybe more from inorganic investments, right, in terms of what particular maybe is there any white space or gaps that you think could still be areas of opportunity to kind of target or continue to both the offering, particularly as we think about the different fuel alternatives as we head in the next few years?

For the base On-highway business, I mean, I think we have all of the technology covered. Our move into Meritor was a really key one. It showed up two areas. One, it continues to allow us to do some advanced powertrain features that you'll see will unleash as you see it as fuel economy, particularly in North America and later in Europe. But it also gave us the opportunity for an eAxle which was a hole in our offering. You've seen us make advancements in Battery Electric just recently. That would have been the one I had mentioned that we make a large play there. But we have the ability to do Hydrogen Engines. We'll have the ability to Fuel Cell electric our suite of Fuel-agnostic Engines. Probably the only other spaces, there will be continued electronic and software investments. But other than that, I don't think we have a huge hole to plug. I don't know if you have any others that you were thinking of.

Yes. I think from an acquisition perspective, certainly working on digesting Meritor, biggest acquisition in our history. I think there's a, we'll look at continuing to secure the supply chain, as Brett mentioned, I think that's something we'll look at if there's key technologies that are a part of our current offering, but, and we can acquire in that like Jacobs Brake and so forth. The other piece is in Accelera. No holes in the offering necessarily, but it is the buyer's environment. So I think we'll assess right now. We get calls every day because some of the pure play and the start-ups can't raise the capital. So we'll get calls to acquire people often. And I think we will look at it. I think it's just whether there's something unique and different there that could help us, but it's nothing major. I wouldn't expect big acquisitions in that space.

And then maybe just how would you view just general capital allocation though, with all that in mind. It sounds like some of this will be peaking particularly in the organic investment side. So as we think about the next few years?

Yes. So we are committed long term to the 50% operating cash back to shareholders. And if you go historically, it's been higher than that, more like 70%, 75% on average over the past decade up until the Meritor acquisition. Right now, we're concentrating on paying down that debt. So some of it's floating rate and so forth, we want to get that off the balance sheet. We want to make sure that we get while we get pushed sometimes for having conservative balance sheet, it has served us well. So I think we want to pay down debt some, and then we'll kind of go back to paying back. We're in an investment cycle. Brett mentioned, we're making big investments in the field agnostic now this year next as well as in Accelera and so we want to make sure we're securing our future. But we'll, we have a history of if we don't have a good use for the cash, we'll give it back to shareholders.

And we have a minute or two left for any questions anybody in the audience? I guess maybe one last one for me then. Just we talked a lot about On-highway, and we kind of briefly noted off a little bit, just maybe there. What are you seeing there in terms of those end markets?

Yes. So I can start with like the Power Systems business, which is our big, the big engines where we compete with mostly CAT and MTU. So really strong markets right now. Power generation continues to be quite strong for both for industrial, for people on-shoring business into the U.S. and other industrial build-out around the world. So that's very strong as well as data center build out with AI blossoming. It seems like everybody is building a data center. And most of those have our engines as backups. So that's a really good revenue stream over the past several years been averaging about $1 billion for just backup generators for data centers. So those are going quite strong and mining is very strong. And mining -- in maintaining this level of strength with one, no business in Russia and China being down is saying something. So it continues to operate at quite a high level. The only one we're seeing on the big engine space that softening a bit is oil and gas, but that's a relatively small market for us that's, it just kind of tends to go in cycles. On the construction side, we're seeing North America flattening a little bit. I think we're seeing flattish volumes. I think we adjusted it down a bit, but it was just within the margins. think we're seeing that relatively flat but still at a high level. And around the globe, construction is quite strong.

Perfect. Well, I think that brings us to the end of time. So gentlemen, thank you so much for your time.

Appreciate it. Thank you.