Cummins Inc. (CMI) Earnings Call Transcript & Summary

All right. Perfect. We'll get started here. So thanks, everyone, for joining us. My name is Adam Seiden. I lead the U.S. machinery and construction franchise for Barclays. This session here, we're very thankful to have the folks from Cummins joining us. So immediately to my right, we have Jeff Wiltrout from Corporate Strategy. And then also everyone in the room probably knows, Chris from the IR side. So the format of this session is going to be a fireside chat between myself and the folks to my right. We would invite your participation, though. Certainly, if you have a question, please raise a hand. We'll get a mic to you. And then at the very minimum, though, one of the great things about a Barclays conference is we have -- we do an audience response question, which we'll do towards the middle to the end. In order to participate in that, there's a remote on your desk there or table, let's call it. So please feel free to participate, and we'll love to share answers with you. So with that, team Cummins. Thanks so much for being here.

Thanks, Adam.

Awesome. So maybe to start, I just wanted to start actually on headlines. So over this past weekend, there were some headlines out of -- I guess, out of DC per se, that the Biden administration is looking at some of their EV rules into 2030 and beyond and talking about potentially pushing them back. Now a lot of those headlines were concentrated more on the -- it seemed like for the passenger vehicle side as opposed to necessarily your world. But I'm just curious, your guys' thoughts around that? Does that reinforce Cummins' view that this will be a decades-long transition here? And then what does it also say about some of the complexities that you can see as the broader on-highway world adapts to a new alternative propulsion world?

Yes, I'll start. You can add, Chris. Yes. I think it is a market, as you said, of what I think we've been pretty consistent in saying, certainly in our commercial and industrial space is that the transition towards decarbonization will be a long one and will likely be a little messy and bumpy along the way. And that's informed our strategic direction, where we really wanted to set up our business to be able to win, grow, deliver cash flow generation in our traditional core business as well as to be able to invest in some of those technologies that we think will be part of the recipe in the future going forward in our Accelera business, but to be able to do both and fund both at the same time to prepare ourselves to win and grow profitability in the near, medium and long term through all of the phases of that long messy transition. And so what we've seen with that headline in the general tenure over the last 6 to 12 months is we think reinforcing that strategic posture, enabling us to manage that pretty effectively and we think that's starting to show itself, the challenge for us is, of course, then managing the investment cadence, the investment timing to make sure we do have the right technology at the right time as we go through that, like I said, that long transition. And that will vary by region, by end use market. And so that's a complex answer, but one we spend a lot of time evaluating and analyzing and making decisions on an ongoing basis.

Yes. The only thing I'd add is, in some ways, it's encouraging for regulators to -- or the government to acknowledge that. That is like because we have adoption trends and we have like what the economics say and what the regulations say, and they're not real close at this point when you look at a decade. And so it's good to see some movement there for us.

Yes, sure. Definitely, the more the government is thinking with an economics [ head ], the better for all of us. So then maybe taking a step into -- from the -- trying to read into that headline and see if there's any like parallels from the truck side. So you guys, as an industry, the heavy truck folks, they signed on so what the clean truck partnership in Cali. So I think part of that was to align essentially CARB with the EPA. Now if we're in a situation here where the EPA is moving the bar, at least on passenger side, we'll see what they're talking about there. How, if at all, like what sort of implications is there? If you think about trucks, like if the EPA were to move some things around there too, does the agreement give you guys flexibility to also see some of those CARB initiatives push out through?

Yes. That's been -- I mean that's gotten really complicated. Since CARB and EPA deviated, you're like trying to meet both. And so when it came back together for '27, that is very helpful on the NOx emission. So you're shooting at one target, now looking at multiple products and multiple pieces to meet 2 markets. So we're encouraged by that. We're hopeful that, that kind of stays in sync. There's other pieces in there that part of that [ CTP ] was CARB kind of acknowledging that we need some time before they put in regulation. So there's like they'll work collaboratively to make sure that they are realistic, they're achievable, and you get like a 3 or 4 years lead time versus 3 or 4 months. And so I think in having that level of clarity will help us. Our perspective is, at this point, a big change in EPA is not our expectation. But I think it is something we would closely monitor. It seems like the industry is moving full speed ahead to meet that, as are we.

Got it. And we'll talk a bit about the truck cycle here in a second, but connecting some of lower talking about around headlines and regulations and so forth. One of the things that I think a lot of folks that are sitting out there in that seat and also myself in my seat, we look at 2027, and we do see how there could be some increased demand and prebuy potential. So when you think about that prebuy, like how impactful, how meaningful of a delay would there have to be in anything on the EPA side in order to push back some of that expectation? I mean how far in advance, I guess, are customers going to get ahead in order is maybe another way to look at that?

Yes. I would say our expectation is -- it's kind of driven from the experience people went through the pandemic, where they might not have a truck for a couple of years. And the supply chain for the whole industry is not kind of like we don't want to ramp up for 1 year, which used to be the whole behavior where everybody like sprint the year before and ramp it up, and it was very costly and not very healthy. I think that there may be a little bit of a sanity has been introduced, there were suppliers are pushing back, not just on us, but on the OEMs themselves to say, "Hey, we're not going to sprint up to $400,000 for a year and spend a bunch of money to do it." So I think it does balance out that does just prolong it. It just draws it out. And that's why we think there'll be -- so probably some level of activity in '25. The other piece of it is for our heavy-duty engines, on our fuel agnostic platform, but the diesel side will be launching, we expect in '26. And so we're going to stage our launch out over the course of a little bit of time just to make sure that we're not launching everything new at the same time.

Yes. And maybe on that, we'll touch on that. Maybe now just when you think about the fuel agnostic platform and so forth, you just mentioned as far as that phase in, let's call it, of those platforms. So over the last year or 2, you certainly -- it feels like you're extending the range of that. And -- so I guess the question is, what are some of the inefficiencies that you've seen in the past during like prior rollouts around emission cycles? And how can you best get ahead of that today?

Do you want to...

Yes. So I would say in this one, I think it's a different rollout. One is because of the investment needed to get down to this NOx level. Going from 0.2 to 0.035 NOx is a big investment. Couple that with having 3 platform-level investments. Platform-level investments are the ones you do every 20 to 25 years. We're doing those. Now it's fortuitous time because it can extend the useful life of internal combustion for many years to come. So I think it is -- as we manage these kind of efficiencies of the rollout, if we can stretch this out, if like the prebuy stretches out, it kind of takes out the ebb and flow of the big swings in the market, and that drives efficiency through the whole industry. OEMs have gotten used to more steady builds, suppliers have, we have, and it's just better for the industry. It's just healthier for margins. It's also healthier for just kind of overall performance.

Got it. So maybe let's shift gears just for a second. So if you think about from the strategy side, clearly Cummins has been pretty active. In prepping for this, I was looking through just your news releases and it's at least 3 pages worth of things that have gone on in the last year. And -- so I guess maybe to start, just on Meritor, right? So we're at around the 2-year anniversary of the announcement there. So generally, I guess, how has performance been? Certainly, you guys do get some disclosure on that, but how's performance been versus maybe Cummins on expectations internally?

Sure. Yes, we're really pleased with the progress since we closed on the acquisition later in 2022. So we're coming up on 1.5 years of owning it. and we're quite pleased both financially and strategically with the outcomes that we've seen so far. So on the financial front, we're very much on track to deliver our 3-year synergy targets to have $130 million of run rate synergies. So we left 2023 at about 60% towards meeting that target, which I think is very solid. And it's showing up in the P&L. Meritor had the highest EBITDA dollars in 2023 has in the last 15 years as a company. So I think proves that we've been able to manage that business quite effectively and is representative of the strategic posture I articulated, which is strong core business that can generate cash flow. And then additive to that is obviously what we got to the EX side of that business as part of what we think is going to be an important technological piece of increasing value as the integration point for electrified powertrains in the medium to long term. And so we've been pleased on both fronts. Like I said, the performance of the core business and the ability to grow it and ability to improve profitability and the long-term optionality associated with the eAxles platforms we acquired. So we're very pleased.

And from a margin standpoint, so 14% to 15% margins within Meritor. Is that still the goal there?

We're certainly looking to drive once we layer in all those synergies and obviously digest some of the cyclical implications to the extent we have those in some of those core markets, we'll kind of see where exactly where that lands. But yes, I think that's a fair point that we want to aim to try and drive towards.

Got it. Maybe dovetail off of that, too, just on M&A. So Meritor was a fairly sizable acquisition for you guys historically. Just does having taken on Meritor seems like things are going well. Does that give the organization confidence to maybe as you're thinking about your pipeline and the funnel that I'm sure the organization builds to look at other things out there that are similar size or bear?

Sure. I mean we think it has been important. We've been able to demonstrate over the last few years that when we feel like it's strategically critical that we can grow inorganically and we can deliver on the promise of that activity. In the current state, we're at a position where we do kind of want to. Like you said, we've had a lot going on. We want to digest that. We want to execute we want to deliver on the promise of the engine platforms Chris was alluding to. And so we're not necessarily in a big hurry to kind of add another big multibillion dollar acquisition here in the near term. We do want to reduce leverage. We want to pay down the debt we got associated with that Meritor acquisition and go execute and drive some profitability improvement. As we think out medium, longer term, and we start playing for the growth trajectory over the next decade, a decent chance that inorganic growth partnership will be part of that equation. But that's something we'll continue to pursue and evaluate in a disciplined way. So yes, looking to take a bit of a breath but we do think that helps us be confident in our ability to execute on future inorganic growth to the extent it's required for us to deliver profitable growth.

So keeping with the theme of keeping busy. When you think about the -- some of the partnerships that you guys have announced or some of the different arrangements that you have with some customers. I think last year, when we were here, we talked a little bit about he knows us and so forth. I want to focus on one particularly this year just on Daimler and see ultimately, where -- if we can start seeing some acceleration in some of the volumes coming off of Daimler in '24 and '25 and how that varies by region?

Sure. Yes. I can -- so I think we still have a little ways to go in North America. So given some of our constraints last year, we weren't able to pick up all of that. Now that medium duty is maybe more flattening out. We've added capacity. We feel we can continue that journey to pick up the remaining 6,000, 8,000 units in North America. And then I think the next step would likely be in India or Southeast Asia. That can be in the neighborhood of 30,000 to 40,000. We will start in some production this year, but more like a few thousand, and that will ramp up over the next couple of years. [indiscernible][indiscernible] The last 2 pieces would be Europe, which comes in EPA 27, that's more like 10,000, not EPA 27, Euro 7 comes towards the end of the decade. And then Brazil would be probably also the latter part of the decade. In addition to that, it's kind of been kind of developing over time is Japan has kind of opened up as well for us. And that actually is through Fuso, but it's also through, you mentioned, Isuzu and Hino, where we haven't had much of a presence in the on-highway market, and now we're with the top 3 players. So there's -- that's starting to open up towards the latter part of the decade as well.

Got it. So when you guys think of the guide -- or if we go back to the guide that you guys put out, I assume that North America volumes are a little more left in North America is that in that number that you have?

It is. I mean say, when we look at -- we give a medium-duty market guide of maybe down 5% to flat. And I would say we'll be flat to a little bit up, given we can take on a little more volume. So yes, I'd say we've got to built in, taking on more volume.

Got it. So now everyone's favorite topic, the heavy-duty truck cycle. So if you -- when I think about the heavy-duty truck cycle, in a lot of ways, it reminds me of what's been a lot of like broader calls, is that we've all been waiting for slowdowns, whether it was a broader economy and recession. I see in some other industries and now in trucks, it's like just kind of waiting for it to slow. And here we are, in the beginning of 2024, and things are still relatively good. And I think your guide even calls for the first half of the year to not to see any material deceleration until the back half. So let's just play devil's advocate because I know what the narrative has been. Why -- do why does things need -- why do things need to slow in the second half of the year?

It's a great comment because we had the same exact conversation last year at this time. Yes, really, we were looking at second half kind of slowing down, and I think we've all been expecting. When you operate in a cyclical market, you expect cycles. And I think this is one where we think where freight rates are and where the feedback we're getting from end customers. That we do think it will be a gentle downturn in the second half. But even sequentially, it's been about the same coming off the back half of last year, which is down from the first half of last year. So it is down a little bit, maybe 5% or so. And a further step down in the second half would not be unheard of as people are kind of taking a breath before maybe launching in the prebuy as we talked about. So I can't point with any certainty by any stretch of the imagination that it is coming down, but it is -- I think you made the comment to me in a call the other day like, is going to replacement level really a downturn? And it's a really good comment because -- and that is the one market where one, a little bit weaker in construction in China, but that's the one market in our industries that we're seeing is maybe facing those headwinds.

Yes. No, that's there. I mean look, if all downturns are going to replacement, then that's a good thing. We'll take that for sure. Yes. I bet we would. So if we're thinking on -- into that prebuy, prior emission cycles have certainly been strong value -- let's call it value creation points for Cummins. Should this time be any different? You guys are investing a whole lot. Certainly, it's fair that you get paid for some of that. So just curious if this time could be any different? And then if there's any way to quantify it at these early stages, which I know is up?

Yes, I'll start and you can add probably predictably a little disappointingly, it's going to be hard to quantify right now. But there's a couple of things we're certainly looking forward to that we think are going to be important pieces as we introduce these new engines in a staged way over the coming years. A couple of things. One, as we've seen in previous cycles is we will be adding content, right? So it will need different aftertreatment solutions -- we will need different, obviously, engine designs that drive content associated with meeting those regulations, which is good for our business, right? In addition to that, given our -- what we think is strong performance, deep customer relationships and the finer tuning of these engines, we will kind of expect to be able to price for the value add that we deliver through the channel and to our customers. And so both of those elements, we expect to offer an opportunity for us to take advantage of the significant development we've done that we think have industry-leading products and to improve margins and add content. So we're pretty excited about the opportunity that presents as we get deeper into the decade. Exactly how much is hard to pin down quite yet, and we'll have to have those conversations as we move forward.

Yes. And I think I would say just the cycles where we're delivering these new products are opportunities to take bigger bites of price and expand our margins. We have been reminded many times that our pricing is lagging behind what the OEMs are doing. It's a different market you're facing, of course. And so I think this is our opportunity to kind of work on expanding our margins is the theme that we're kind of driving through the company is how do we continue to drive profitability growth and cash flow generation.

Got it. And I guess we were talking about price quite a bit. Certainly, that was the nexus of the question and margins. Now how about from the share side? Like is there -- you don't need to do these obviously, very good share already, to begin with. But generally, is there a share opportunity? As I'd assume some of your customers, some who may produce their own engines are probably looking at themselves saying, like, do we need to -- how much do we want to spend right now?

Yes. I think what we expect is a couple of drivers. So the OEMs will be delivering their own engine platforms as well, right? And so in terms of fundamental shifts in the share profile in North America, we wouldn't expect that to drive fundamental shifts. What we do hope and expect us to be able to continue to drive incremental share gains, part of that will be a function of using these investments to drive some of the benefits of the fuel agnostic platform, a specific example, being introducing the 15-liter natural gas at which if we think that can generate some improved uptake in the market, will serve to our advantage from a market share perspective. So there's going to be some pieces like that where we want to drive incremental market share wins. But significant leapfrog type changes we wouldn't expect in the near term.

Got it. So at this point, I wanted to pivot to the audience response questions, if we can get those on the screen. [Operator Instructions] So first question, do you currently own the stock? Yes, overweight, market weight, underweight or no?

I was trying to remember what the answers were last year. Maybe better that I forgot.

Here you go. So 60% of the room says no. Next question, please. So what is your general bias towards the stock right now; positive, negative or neutral? The real-time feedback category I suppose... Neutral. So about 50%, say, neutral, 33% say positive. I was thinking about doing a live audience poll here, but we're not going to do that. Next question, please. In your opinion, through-cycle EPS growth for Cummins will be above peers, in line with peers or below peers? And the context of that is, I think some of these questions are also marked by thoughts around cycles as opposed to necessarily the company. So in this question, we've got about 65% above peers, all right, for EPS growth. Next question, please. So in your opinion, what should Cummins do with excess cash; bolt-on M&A, larger M&A, repos, dividends, debt paydown or internal investment?

I think I can predict this one. Jeff needs a break, so don't vote 1 and 2.

Yes, this is the strategy guys. We need to keep him busy. All right. So a lot of voters in the room says repos and debt pay down. So can hang tight for a little bit here. All right. Moving to the next question, second last question. In your opinion, on what multiple of '24 earnings should Cummins trade? There's bands from less than 10x to higher than 21x. And again, a reminder for folks who have probably seen this today. These are standardized ranges for every company at this conference call. I know what you're hoping for. All right. So about 40% of the room. It's 4, so it's about 16 to 18x. I will say one thing. Multiples are multiples across the board so far, so there's been a good enough sample sets today that I've seen. And most of them are to the mid to the right of that screen, which thinking about last year, we were more on the left of that screen. Yes. So quite a bit different. All right. Moving to the last one here. So what do you see as the most significant share price headwind facing Cummins? Is it core growth? Is it margin performance, capital deployment or execution strategy?

I kind of mastered it.

All right. So about half the room says core growth, probably reflecting some of that cycle and about 1/3 room is in the margin performance camp. So that is a good segue actually to move into some of the margin side. So the most generic question first, how do you guys think about price cost this year about the background? And then more so, where do you guys see price in aftermarket and really power systems where the company has been able to get some incremental gains over the last couple of years?

Yes, I can take that one to start. And so right now, price costs were 200 basis points above, higher than our normal average, which is probably more like 100 across the company. I think we continue to drive more and more pricing. We have long-term prices versus big bites. So I think we will continue to drive that. And it varies across the business. Power Systems, as an example, is higher than that. That's been a very strategic pricing. We've taken pointed efforts in the last couple of years to improve that margin, drive pricing, particularly in the power gen segment. So it's eased to be a negative mix on first-fit sales, much more comparable to the industrial margins now. And it's 60% of the volume. So that's very helpful. So we've been kind of making this march towards improved pricing. On the cost side, I would say it's relatively stable. A little bit is still a headwind on materials -- and that is historically speaking, when you have a lower downturn that materials would start coming off, but that's been stickier than normal. It's not a surprise, but it's -- we have that as -- it's still a minor headwind this year for the company.

Got it. And I'd be remiss if we didn't talk Accelera. Just in general, though -- and this relates to margins, so we'll connect the 2. Clearly, the business is investing a lot in itself. So if you like think -- if you look at like cycle on cycle, how much more, if any, is the company investing in this cycle versus the prior? And what I'm trying to get to is to try and get a sense of where -- like where margins could have -- where margins could be without some of that investment? I don't know if there's a way to level set that.

Absolutely. I will start and then you talked on the Accelera side. On the core business, it's certainly more because it's what I talked about those platform-level investments, just looking at the raw numbers, our R&D and engine business, as an example, is about $200 million higher than it was in 2021. So that's like -- it is a considerable piece we're in this bubble that once you get towards the latter part of next year and beyond, that starts to drop in back to more normalized levels. So that's -- we knew we had to make this investment, and then it will kind of come back down. That's helped us on the margin expansion. Maybe you can talk to Accelera?

Yes, the Accelera one is a little harder to put in a cycle over cycle perspective, just because, I mean, those are very much as you'd expect, multiyear, decade-long type foundational investments we want to build. So as I alluded to at the beginning, the art in Accelera is to make sure we're getting those foundations built, credible, sufficiently operational, but we could start to see the adoption as we head into the back end of the decade that will drive gross margin positivity drag towards breakeven, really drive that business to develop into a scale such that we can start to show some of the cycle-over-cycle demand. It's a little premature to say that because those are certainly longer term, more strategic investments we're making.

No, for sure, on Accelera side it makes sense. On the core that [indiscernible]. And then maybe just to wrap up, just could you talk a little bit about the Daimler-PACCAR JV that you guys have on the battery cell production? Just maybe some of the economics behind it, I'd be curious.

Yes, sure. So that's a 21-gigawatt-hour battery cell manufacturing plant. Daimler-PACCAR as our other volume partners, we each own 30%, and then EVE is a 10% owner there. That joint venture will be set up to be a profit-making entity, right? So -- and of course, in alignment with that ownership percentage and then we, as the volume partners, will use the offtake of that plant, the cells to use in our own applications. That's making the battery packs and then sell going forward. The overall capital investment of that plan is roughly $2 billion. So we'll be splitting the price tag along those lines that we just talked about and we expect to start production there in 2027 as our plan, right? So we still have not yet gotten that closed, but hope to quite quickly. At which time, we'll obviously begin to break ground in Northern Mississippi and move towards that 2027 production date.

It sounds like you'd get investor event at some point.

Exactly. I think it's important. I just on that one. I know we're wrapping up time, but that only represents a small, slower than market. So like this is a step along the way, it doesn't presume we own battery electric in 2027 by any stretch.

Completely fair. All right. Great. So like you said, we're about out of time. So I wanted to thank the Cummins guys. And certainly, please give them a round of applause. Thanks, gentlemen.

Thanks, Adam. Thank you all.