Cummins Inc. (CMI) Earnings Call Transcript & Summary

Good morning, everyone. Starting off day 3 here on the conference on a strong note here with the guys from Cummins. Chris Clulow to my left, has continued the long-standing history of having excellent IR folks at running the department at Cummins. And so I think just to start for those that are newer to the story. Maybe just -- Chris, it would help just kind of give an overview. Cummins today is a lot different than it would have been 10, 20 years ago. So kind of just walk through the story and then we'll go into Q&A. And if anyone has any questions as we go along, just raise your hand, and I'll get to you.

Yes, you're absolutely right, Tim. This is a very different company. I joined about 21 years ago. 2004, and it's -- now we're about the 5x size of revenue and in a much better place. I think Cummins is a global provider of power is how I'd say, starting with diesel engines is our history, our 100-plus year history. But we also have natural gas. We go into the big engine space, which gets into mining, data centers, which I'm sure everybody is interested in, backup power generation. And then we have battery electric. We have hydrogen, we have a multitude of fuels. Kind of -- our strategy is Destination Zero, which is taking all of our products in decarbonizing over time, and it is a business opportunity for us because harder emission standards and difficult technical challenges is kind of our bread and butter. That's where we shine. And so we have continued to grow -- or really globally over the course of the last 20 years really and expand out into different spaces, different avenues. We're certainly North America is a big piece of our business, but we have a presence in nearly every country in the world, including our global distribution network. So if you have a product anywhere in the world, we can service it which is a huge advantage for us. And it's been a really nice growth story. This year is a really remarkable year for us where in the -- our North America heavy-duty and medium-duty truck market we expect a bit of a downturn, which I'm sure we'll get into. And we're raising our profitability guidance. That's historic for the company, where that's been usually -- that's the cycles that we've gone through, but we have other pieces of the business that have compensated and we've driven a lot of efficiency and improvement in the business to enable that improvement in profitability, and we're not done. I think we're still early in the journey on improving our margins and really looking forward to the next 100-plus years of the company.

That's great. Maybe to your point on the globality of Cummins, maybe just spend a minute or 2 kind of taking us around the world in terms of the key geographies in a year overall from a Cummins top line perspective, that's flattish. You obviously got some markets that are moving up and down.

Yes. So I'd say the big markets for us, North America, that's the truck markets, the construction markets and then the big engine markets, mining and power generation being the big ones. When I go around the world, probably the next biggest market for us is China, biggest truck market in the world by far. It's a down market this year and still including exports is about 1 million trucks, which is bigger than probably the next 3 markets combined. So it's still a very significant market. And we've been playing there. This is our 50th year. So this is not a new market for us. We're well established. We have some joint venture relationships that go back several decades that really give us a good foothold in that what is a very big market for us. And that market is starting to -- we're starting to see some recovery signs. It's been stable and at the low end for a couple of years, at least in the truck space. The big engine side, the big industrial side has been strong for 4 or 5 years still with like power generation, with mining and so forth. India is probably our next biggest market. Again, it's another market where we've been in 60-plus years, have a publicly traded entity there that's in -- for our large engine space as well. And that's been -- that's the market I think that has probably got the least of barriers for growth. It is starting to hum. We're seeing a lot of infrastructure build-out. That is kind of starting to see the signs where they're getting through many of the bureaucratic barriers that were there in the past. And now it's really starting to grow. We see a really good growth scenario in both power generation. Currently, the truck market and all the industrial markets. So that's an exciting market for us. Europe would play a bit. I'd say we have a good presence there, lots of manufacturing there. We don't play as much in the truck market there, but in the big engine side, the global -- that's more of a global market where we play. And then everywhere else around the world, I think, is the other pieces that still are important for us so we have a large presence in Africa and Australia and really pretty much everywhere.

Just on China, obviously, a key driver for Cummins. If you look at the profitability of the joint ventures over time, maybe better than if someone were to look at industrial PPI in China down 2.5%, you think, well, it's probably a difficult market to get price, probably one that is a little harder to improve margins, but Cummins has been able -- it seems to do that. Maybe spend a minute on that.

Very much so. Yes, I think this has been a market where we've taken different approaches to improving our profitability there. And it's a big profit driver. It's not as big a revenue driver given some of our joint venture structures. It's 10% or so of our revenue. It's -- but it can be in the high teens in terms of our profitability overall or EBITDA overall. And what drives it is we have our joint venture structures, and we've moved those over time where we get good profitability out of those joint ventures, but we also have license fees and tech fees in different ways to extract value. And then we set up our Components business as emissions have changed in China. They're a Euro 6 equivalent right now. They have taken more after treatments, different turbos, different things. And those are our wholly owned businesses for us, and we sell into our joint venture. So that's been a very good growth mode for us and quite a profitable one because we're -- it's become more and more difficult for the local players to hit those emission standards, and this has open up business opportunities for us and pricing opportunities. So I think we've navigated through it pretty well. And I would say that we've also done well in terms of moving cash. So like it's good when you have profits, but if you don't have cash, it doesn't make as much of a difference but we've done well in terms of getting cash from the country as well over the past several decades.

Switching to North America on the truck market that monthly orders don't probably tell us as much as they used to. But still, we have seen some deceleration here in the past month or 2 as we saw some numbers last night. Does that change the view of -- obviously, 1 month isn't, but just the trends, does it change the outlook in terms of the expectation for the year as we start slow and then we build as we get into the back half of the year. Maybe just how you're thinking about that.

Yes, I don't think it changes our outlook in terms of the base market. It is -- we expected Q1 to be the lowest point, Q4 was down, production remains at a relatively low level currently and we expect it to ramp through the year. So that's not too surprising. The orders were stronger than people thought in the back -- including us in the back half of last year. And so we look at it kind of average over time, and it's still strong. Medium duty, it was nice to see medium-duty strengthen a little bit because that had been down for a couple of months. But it's -- we don't read too much into the orders. I think our long-term view is -- what we've seen from the orders, I'll take heavy duty is it's not prebuy behavior ahead of the EPA27 emissions. It's more of indicating that the base market is strengthening. The base market is at about replacement level, which is I guess you could -- it's a downturn, but getting to replacement levels is hardly a downturn. So I think we're still at a pretty stable level. The demand is strong with freight showing some signs of improvement. I think that will certainly help. This is very unique cycle. We've drawn out the cycle long time. Usually, when freight trends down, our markets trend down, but it's been just different because of a long backlog coming out of the pandemic from years ago. And then the OEMs probably realizing the benefit of building stable as have we. So I think overall, I think we're feeling pretty bullish about the market in terms of how it will improve for the rest of the year. I will put the proviso on there, that's a nontariff-related comment. So that can put a wrinkle into our markets for sure.

Yes. And just the uniqueness of this cycle as we look forward, you have the prospects of what may be the biggest ever year in '26 as we look ahead to a potential prebuy. But at the same time, it wasn't too long ago that supply chain challenges were with us in a big way. So -- and again, that's hard to forecast, but in terms of the supply chain's ability to ramp up and then with the view that maybe '27 is a really soft year. So how do you manage that and your suppliers manage that?

For sure. I think it used to be the case where you get the year ahead of an emissions change even if it was not even a big price change, that this customer base -- end customer base doesn't like change. So they like the tried and true product. So you would get -- the industry would ramp up to near 400,000 truck production for heavy duty. It does -- it won't do that anymore. There's a cap on the supply chain now. People will not ramp up for 1 year. I think it could get up in the 350,000 range. I think that's what we're feeling from our OEM partners is the art of the possible but to ramp up and then come back down is unhealthy for most of the business, most of the supply base as well. And so I think you'll see a little bit more muted. And from our perspective, the prebuy is not helpful for us. I mean we'd rather have a steady build that of course, would help us. So we'll see how this works out. We think it's -- if it -- we do expect some level of pre-buy even pushing back into '25 because of that dynamic. It's not going to -- you're not going to be able to get it '26 ahead of '27.

On the market share in North America, medium-duty has been a big a tailwind for you. Maybe speak to heavy and medium duty in terms of where Cummins is as we look ahead to '26.

Yes. I think from a market share perceive, we have continued to grow, and this is in North America and really around the world, we expect that to continue for the most part. I tell you in the medium-duty space don't have much more. The competitor in that space now is really Ford, they're mid-single digits. And so we provide for the rest of the market. And I think...

I'd say that's a gasoline product.

Yes, primarily gasoline products and some diesel. But it's -- I think we are -- our position there is really very strong. And that's -- it's been a journey from when I think, started, it was around 17% and now up in the 90-plus is nice to be. And now I'd say in the heavy-duty space, probably over the last decade, we've seen a journey from a little below 30% to now or just slightly under 40% in market share, really good reception of our product, a lot of end customer pull. And that's what it is though when the end customer or a fleet customer as an example, goes to buy a truck. They buy for the engine oftentimes. And so they will -- we provide to all the OEMs. And so we can have a good pull through that. And so I think we think there is still some potential for us to continue to grow share. We don't see big chunks moving in the next few years, but our steady growth in shares is what we expect.

Yes. One of the larger for higher trucking companies presented here yesterday and asked about the prebuy and their thought was, hey, EPA27, this administration likely takes a hard look at that. I think the timing is we're getting closer. So is got to be...

2 years ago, it's closer, yes.

But again, in terms of the hard-to-answer questions, what's the latest view on that in terms of...

Yes, our view is we do think the most desired thing for the industry really is to have some level of certainty. This is not the case, of course, right now and really clarity in terms of regulation. Normally, you have 4, 5, 6 years ahead of regulation. So we would have a decent idea of what 2030 regs would be. We have no idea what 2030 regs. We think the greenhouse gas regs are -- those are not going to go into place. We thought they were aspirational to begin with, but I think those seem less likely. The '27 emissions, we do expect some changes in those. We'll see what they are. We do -- from a technical standpoint, most of the industry is there or just about there in terms of development and ready to go. And it is -- it's -- what is delivered with this product is not just lower emissions. It's for us, it's a 5% to 7% more efficient product. That's a big economic value for when they're sometimes #1 cost is diesel, having 5% to 7% more efficiency is a big gain for them. So we do see this continuing to move. So from a technical standpoint, we're kind of continuing forward that this is going to go into place, and we'll be ready for it. There is some question marks and rumors about there's an additional warranty piece, which takes the warranty to the end of useful life. It does add a considerable amount of cost. We think that is probably more under debate, and we -- I will say there's not a lot of visual advocates for that versus detractors. So that probably is more likely to be adjusted and we're taking away. And that would take away about half the cost increase.

Let's shift gear to some of the off-highway markets within Power Systems, specifically, couple of years ago, no one would have probably associated Cummins with the data center. So maybe just talk to the -- where Cummins plays and the role of distribution and how that presumably, as you think about more of those builds moving outside North America, how the role of the Cummins distributor facilitates that?

Yes. So I'll hold a few. Our Power Systems business, large engine business up to 95-liter engine, which for a power gen set, that's about 3.5 megawatts. It's the right in the sweet spot for backup power generation for data centers, but it also was sold into mining markets, rail and other industrial markets that we utilize. It's been a really nice growth story. I would say the Power Systems business going back 4, 5 years, I was traveling with our leader there, Jennie Bush yesterday. No one asked about it. No one talks about it because it was like okay margins, 12% every year EBITDA. Now we're up near 20%. And the improvement in that has been -- data center has been kind of icing on the cake, but it's been a lot of internal work, taking out extra costs, thinning the product line, driving strategic pricing and then data centers on top of that has really helped drive that margin forward. But the data center play is we do backup power for a data center. So if you have a 100-megawatt data center, it has at least 100 megawatts of backup power. And think of that as for our large engine -- our 95-liter gen set is about the size of this room length-wise. It's -- they're very large, very hard to do. There's only a few players in the world. The key thing you need for a gen set is an engine. There's only really 3 providers, and that's ourselves, Caterpillar, MTU, and so it is a boisterous market, and I think we're seeing a lot of growth potential there. As you mentioned, Tim, distribution is a key differentiator for us. Not only do we make the gen set, we make -- it's the engine, the alternator and the radiator. We make all 3 of those pieces. We're the only ones to do that. And then we have our distribution network, which will take that, install it, do the wiring, do the commissioning. It's one-stop shopping for the hyperscalers, for the colos, whoever is building out those data centers, they can come to us and we can provide it wherever in the world. So I think we're -- and we're seeing over the last couple of years, of course, massive growth in the U.S. We do expect that to continue, maybe not at the same clip, but it is growing elsewhere in the world as well. I would say we're the #1 player in the China data center market, they use slightly smaller engines, but there's still 2 to 2.5 megawatt gen sets. So hard to compete in. And so we see that growth profile there in India, in Europe as well, and we're serving all of those markets around the world. It's exciting. There's been -- people often ask us about like the DeepSeek. Did that change anything? The only thing it did was increase demand in China. It didn't really disrupt any of the other demand. Everybody expected certain changes in this industry over time. So it didn't cause much of a disruption as we work with all the big hyperscalers it's kind of full steam ahead. We don't think it's infinite. We are currently building out, doubling our capacity, investing a couple of hundred million around the world, U.K., U.S. and in India to raise our capacity, but it's -- the way we're approaching it is just cautiously, making sure we're in our current plants. We have the assembly capability already. It's adding machining, it's working with our suppliers. It's not building whole new plants because this is-- we're cautious because of this, it seems like every boom is -- comes with the trough right after it. There's always been an overbuild in this industrial space. And so we -- investing a couple of hundred million dollars in this space is a very quick payback and we see we have line of sight for that demand probably for at least the next 3 to 5 years.

And in terms of how you can protect yourself from a pricing standpoint as you think about you're probably quoting into at this point what, '27, '28?

Yes, we're in '27 now. Yes. We haven't open up '28. That's why we're not in '28. So we do protect ourselves on pricing. We have long-term contracts with many of the big hyperscalers with price protections in there, some cancellation clauses, things like that. But yes, we have -- given the movements on pricing and other disruptions, we always make sure we protect ourselves on price. It's been a good pricing market, as you might expect, over the last few years with a very, very high demand and only a few people able to supply it. It's not -- it's -- these are tough customers when you're dealing with Microsoft, Amazon and others like that. It is tough negotiations, but we've been able to price pretty well.

I think 1 of the things you mentioned from a distribution standpoint, it's worth highlighting is that servicing, that the rents turning, the difference between your big competitor and Cat, those revenues would be going to distributor or a Cat dealer rather.

Some have a greater value capture of the whole thing, and it's easier for the customer.

Yes. Is the -- as you think about the Power Systems business and the margins there, going back to Cat, obviously, they've got a very profitable oil and gas business in there, but they're going to do 20-ish percent operating margins this year. Is that -- as you think about -- is that -- historically, you would lagged them in a big way. Is that a reasonable target to think that margins can be closer to Cat's E&T business?

Yes, because I mean the top end of our guide this year is about 20%. And then -- and we're adding capacity. And as you add capacity in existing plants, you get really good incremental margins. So we do think we still have some good runway to go here in terms of expanding margin. We did a lot of the efficiency and all that structural work within the business that gained us a few hundred basis points. But most of that is largely done, but there's still a lot of room with this capacity expansion to drive margins up.

One of the things you talked about earlier was as emission standards increase, it's kind of a content opportunity for Cummins. The components business is really where you see a lot of that leverage. If you look back over recent years, the margins have kind of moved around a bit. But it seems like this year, as you look in flattish revenues, you're seeing now some steps to take the margins up. Can you just take us through what's leading that?

Yes. So it's been up and down a couple of years for the Components business with the acquisition of Meritor, which had slightly lower margins, we're driving those upward and then the disposition of the Atmus filtration business in first quarter last year. So that's been -- now that we're getting apples for apples, we see a much clearer sight of how do we improve margins, how do we drive them forward and it's -- a lot of it's -- there's some a little bit of pricing in there. A lot of it's cost out, driving costs out and making sure that we're being as efficient as possible manufacturing in the right locations where in the markets that we serve in the most efficient way possible. And I think that's really been the key. Meritor has been a big piece of this, the former Meritor business driving that margin upward, but now it's taken hold, and we're expanding in the Emission Solutions business, which are the after treatments for every engine. Those are -- that continues to grow and be a really good profit center.

And within -- talk about corporate margins in a second. But Accelera maybe just talk about -- and this is 1 of the advantages of having a kind of a hedge portfolio between the legacy, the base business versus the playing as you -- as we move towards this energy transition, that's kind of the play of Accelera. That's clearly not been a moving at a pace anyone thought. So how does the company think about just kind of tapering the investments there while also keeping obviously a longer-term view?

Yes, we definitely take the long-term view. And within Accelera, we have battery electric, and we have e-mobility, which includes fuel cells, which is likely decade-plus away. And then we have hydrogen generation. All of these markets are going slower -- even slower. We thought they were going to go slower than most people thought, but they're growing slower still with adoption. There's some places in the world where they're maintaining a pretty swift pace. China is a great example. But I think we are pacing our investments for this. We are targeting to get breakeven in that business in 2027. We don't think that's likely under the current scenario because of just the slow adoption rate. In balance, it's probably better for the company. I mean from a profitability standpoint, more internal combustion will continue to grow our base business. And our overall targets are probably running at or above those overall targets. But we just need to be really judicious about how we invest. And you have to take the long-term view, but be very critical. So as we look at it and someone who've been asked like over the next few years, are you going to trim losses? Yes, we do expect to significantly trim losses as we go to '27. We just don't think we'll get all the way to breakeven. And if adoption continues to slow, that maybe further reducing investments or -- and some of it will be volume tick up. But we still see the really good long-term potential in the business. It allows us to serve all the needs of the customers around the world. And the slow pace I'll take battery as a great example. The slow pace of adoption has been an opportunity for us to gain share what is a smaller market but that is going to be meaningful in the long run. So the pure plays are largely gone from the market and the OEMs aren't rushing to make big investments here. So we're gaining a bigger share in probably the battery electric space than we expected going back a couple of years, and I think that's going to help us more.

And Air Products recently canceled a couple of big hydrogen products. So that clearly electrolyzer business today versus what 2, 3 years ago it's...

Yes. And we took a pretty big charge in the first -- at the end of the year because of slower pace and writing some assets and so forth. And then it's interesting we had a couple of our biggest orders right after that. There's still some movement in different parts of the world on electrolyzers and some of the hydrogen production, but it is -- the challenges are very real in terms of infrastructure.

Yes. Maybe a question that you fielded once or twice yesterday in New York, just on tariffs. Obviously, Mexico historically has been a solid footprint for Cummins, who knows what this looks like, what happens with the peso and there's a lot of moving pieces. But how do you kind of frame the risk and where can kind of potential mitigation strategy?

Sure. Yes. Largely, we source and manufacture where we sell. So China for China, North America for North America because historically, it's -- for industrial companies, it's been an industrial supply chain is all of NAFTA or all of USMCA. So we don't source for a lot of external suppliers in Mexico, probably very little in Canada and -- but we have some intercompany stuff that moves across the board, and we have things that sell down and some trucks are assembled. So from an industry perspective, we're probably median to probably less exposed than the industry. But I guess the concern really is what does it do to the industry. So if these remain for the long term, then it is -- we clearly signaled and everybody in the industry knows this will come through in pricing. So we've had the conversations with our customers, we have it in our -- most of our long-term agreements already is clauses for this. So we will be having those conversations this week and we'll continue to move forward with that. But what does that do to demand? That's -- so it's okay if we can get the pricing for it and it kind of flows through, but if it will dampen demand. That's probably the bigger worry. Yes. So we'll see how we'll navigate through. I think they're making huge changes in your supply chain. We've changed over time and so forth, it takes years. So I don't think -- I wouldn't expect any big shifts in supply chain.

See if there's any -- anyone has questions from the audience. Okay. Maybe talk a bit about distribution. I think going back, I guess it was actually over 15 years now at this point when you bought in -- bought out the stakes in North America. So just kind of talk to the evolution of that business obviously, a business that doesn't cycle up and down like your engine or Power Systems business. Maybe spend a minute on that.

Yes. So we're pretty unique in that we owned most of our distribution network globally. We did acquire -- we have joint ventures in North America structure for many years and we brought those out in the last decade. So now it's wholly owned. It's a huge advantage for us for one, maintaining the relationship with the end customer. So we have a close relationship with every fleet, every end user because they're getting service done and buying parts from our distribution network. It's also the path to market for the primary path to market for our Power Systems business, not just data centers where they're doing the up fit, but passing through all the other power generation equipment, passing through some of the rail equipment and others, servicing the mining equipment. So it does -- it has a really key piece there. And aftermarket is a big driver of that business, as you might expect. Overall, aftermarket is about 30% of our revenue, and a good -- very good profit driver, we don't carve it out separately, and that flows through our distribution network. So having that owned is a really big asset. It has progressed. When we changed the accounting structure and took away the joint ventures, the profitability -- EBITDA percentage went down. But now it's on its way back up and probably up in plus 12% right now. I mean it is finite because you're distributing our own products. So we have driven a lot of efficiencies in that operation, and it's proved to be a really, really big asset for us.

Despite the mix tied to parts has been coming down as you've seen this growth in power gen. So actually that would be something that you would think would dampen profitability.

A little bit, but I think our -- I think like the data center work, that's about on par profitability for us in the distribution network. And demand for parts is -- it can ebb and flow with some economic cycles, but the really biggest driver is population. And population, because we've gained share so significantly over the last couple of decades, that it usually comes into the parts sweet spot about 5 to 7 years after initial purchase. And so a lot of things that we've gained in the past, our population just keeps growing. Our parts consuming population keeps growing and that offsets any dampness of downturn. So we expect a little bit of parts growth even this year with the market down.

Got it. So wrap it all up. So you outlined a target at the last Investor Day, 2030, get to 17% to 18% EBITDA margin this year, you're closing in, in the lower end of that. What's driving that? What -- is that a market dynamic? Is it some of the pricing coming in faster? How would you...

Yes. It's a nice embarrassment to have is when we get to the lower end, 5 years in advance. I think it is a couple of things. We don't expect a linear line. It's not going to be all roses for end markets for the next 5 years. We don't expect that. But it is -- we've driven -- the improvements we've driven in engine business and Components that are playing through better-than-expected profitability in Power Systems and Distribution, all are contributing. It's like all the businesses are moving in the same direction other than the Accelera as I mentioned. But it's -- I think we're seeing bigger steps early on. And it hasn't taken away from our runway going forward either. So I think we're feeling very bullish about achieving that. And we've got a lot of questions at the time like we haven't seen you do that in many years. And just a couple of years on or actually what 6 to 8 months on, we're already kind of there. So I think it's -- I think we're feeling -- we're happy at our Analyst Day to raise our guide. And then just a couple of months later, people are asking, are you going to raise it again? That's a nice question to get. It really is. So I think we're feeling, we're very positive about the outlook.

Got it. Last one, and then we'll move on. But as you've delevered post Meritor, what are the priorities here from an allocation of capital?

Yes. So continuing investment in the business is really important to us. That will start to wane off after '26 in terms of both capital and R&D investment. We do expect that to step down a bit after we launched these new platforms. So that's key. Dividend is absolutely key. We've grown it for 15 years plus, and we expect to continue to do that and then we don't see a lot of M&A priorities. We're very comfortable with our portfolio. We don't see a lot of opportunities or needs to go externally. And so that opens up us to do more share buybacks and things like that. We have a long-term target at 50% of operating cash back to shareholders. In many years, we've done well more than that. I think we've peaked at 98% one year. So we -- if we don't have a use, we have the same philosophy. It's always been our philosophy. We'll give it back to shareholders if we do not have a good internal use.

Excellent. We'll wrap there, and then we'll head downstairs for a breakout.

Perfect.

Thank you, Chris.

Thank you.