Cummins Inc. (CMI) Management Presents at Credit Suisse 9th Annual Global Industrials Conference Call Transcript

Cummins Inc. (NYSE:CMI) Credit Suisse 9th Annual Global Industrials Conference Call December 2, 2021 3:30 PM ET

Company Participants

Jack Kienzler - Executive Director, Investor Relations

Conference Call Participants

Jamie Cook - Credit Suisse

Jamie Cook

Good afternoon. Hello, everyone. My name is Jamie Cook. I am the Industrials Analyst over here at Credit Suisse. And we're very pleased to have Cummins with us for the next 30 minutes. We have Jack Kienzler, Executive Director of Investor Relations for Cummins. And in terms of today's format, this will just be a fireside chat. So, I'll be asking questions to Jack. If anyone in the audience does have a question that they want to ask, the way to get that done is to email me at [e-mail] and I'll make sure we get the question asked to Jack.

Question-and-Answer Session

Q - Jamie Cook

So with that Jack, thank you for being here today. And I guess my first question, I just wanted to talk to what extent you can talk about thinking about 2022 the end markets, which markets do you expect to be positive, neutral versus negative. And then, where -- I guess, well in 2022, is there potentially for Cummins to outgrow the market?

Jack Kienzler

Yeah. Absolutely. Thank you for having me Jamie and thank you everyone for your interest. I think, broadly speaking, we're quite excited where the markets are from a trajectory standpoint heading into 2022. Maybe just going around the world quickly, in North America, clearly there's strong demand from an end user standpoint, in both heavy-duty and medium-duty truck. And really the issue thus far has been supply chain constraints temporary and how far the industry can go on, on a production standpoint. Our expectation is that that, continues to hamper on production obviously here in Q4 of 2021 and probably into at least the first half of 2022. We'll see.

But the good thing is that most likely elongates the cycle from a demand standpoint, we expect 2022 to improve over 2021 levels, and then we'll see thereafter. As we move into 2023 and you then get into some pre-buy dynamics perhaps and whatnot.

India, we continue to see a pretty strong recovery there. There's been a few challenges, of course, with the first and then the second wave of COVID. But Q3 saw a strong recovery and all signs pointed to Q4 being strong. As we look towards next year, both in our on-highway and off-highway markets, we're optimistic that we'll continue to see recovery on the back of infrastructure spending and government policy to drive the market forward.

I think in our broader off-highway markets before I get to China, really -- we've seen really strong demand cross power generation, mining, starting to see oil and gas pickup a little bit, albeit at a pretty immaterial piece of the business. And while we've seen supply chain constraints in those spaces, it hasn't been quite as pronounced as the on-highway space. So, really optimistic across the board.

China's really the one spot that I highlight where 2022 will moderate, really that's a moderation of record levels that we experienced in 2020 and 2021. And what we saw is the first half of 2021 that was incredibly strong, a lot of pre-buy activity had a broad implementation in July. And as we expected the second half spent a bit weaker. As we look towards 2022, it's hard to call exactly where the market will be at this point, but most likely, probably more in the 2019 levels of demand versus what we saw in 2020 and 2021.

From an on-highway standpoint and then also on the construction side with our excavator business, we expect a similar trend, a moderation of demand from record levels seen in 2021. So, very optimistic overall about where we're at from a markets standpoint. In terms of outgrowth opportunities, as we announced earlier this year, we continue to see in the second half of this year expansion of our medium-duty share in collaboration with Isuzu, as well as a gradual sort of phasing in with Daimler in medium-duty space. So, we're optimistic. Of course, if there's more to come both in medium-duty and heavy-duty, in terms of collaborations, we're having really fruitful discussions across the board, both in on-highway, as I mentioned, but also an off-highway, look forward to sharing more when able to do so.

Jamie Cook

Okay. And then in 2022, are there opportunities, even with it -- even if it's not sustainable share for your share to be higher in North America heavy-duty, just with you're better able to manage this supply chain. And then also on China, I don't know if there's better penetration from the automated transmission or anything there.

Jack Kienzler

Yeah. So, I think, new partnerships aside, 2021 we've seen our market share to be pretty strong, both in medium-duty and heavy-duty. We have, of course, been doing everything we can to meet customer demand. And that's resulted in pretty strong market share throughout, albeit at incremental costs that we're not pleased with. And we aren't necessarily sustainable, but the hope is that market share can remain sticky as we move into the next year. We will continue to work with our customers to meet their demand. And as we often see as the cycles on the way up, we feel pretty good about where we're at from a market share standpoint, and certainly have -- can have some room to ramp up when the OEMs are ready and have cleared out some of the parks trucks that they're all trying to navigate here in Q4.

From a China perspective, I think there's a few catalysts in terms of outgrowth. You mentioned the transmission business. So, as we continue to see the market transition from pretty manual dominated landscape from a transmission standpoint to a more automated transmission landscape, we are one of the few suppliers who can provide a component product in that node and we've seen a pretty steady ramp in that business. And we'll hopefully continue to see that into 2022. I think beyond that, we've seen a lot of interest in natural gas products. We've recently launched the 15 liter natural gas product in China, which ultimately will come to the U.S. as well, which we can talk about, but that should be a nice catalyst for continued share gain there too. So, ultimately, it's all dependent on the pacing of the market, but again, we feel pretty well positioned to continue to grow regardless of the cyclical nature of the space.

Jamie Cook

Okay. And I guess two follow-ups, one just on the gas engine. We had Rusty Rush, CEO of Rush Enterprises -- we were talking about the gas, your gas engine and the JV that you have with Rush, but he was saying his expectation is could gas represent 8% or 9% mean of the truck market at some point, you're the only player. So, how has that engine priced relative to ICE? And is that a crazy number to put out there?

Jack Kienzler

No, I mean, I think it's a really interesting space. So, you're right. We are essentially the lone player, if you will, in North America in the natural gas space. Our product nodes today are kind of six liter up to the 12 liter. And we think there's a couple of catalysts for why the market could move from what today is like 1% to 3% market share to closer to 10% in line with what Rusty's saying. One of those catalysts, of course, is the continued efforts to decarbonize the industry. Our natural gas products today can -- low NOx regulations. And when coupled with renewable natural gas, are more or less zero emissions today. And so, I think that will play an important role as we look to grow that business.

I think the other piece that could help natural gas overall take shares. We recently announced we're going to bring that 15 liter engine, which I just mentioned for the China over to the U.S. the horsepower and performance characteristics of that engine have long been in demand for our customers, our end users. And so we feel like that could help drive some more adoption in the heavy-duty space where the 15 liter an important product for our end customers. So, we're excited about that.

From a price standpoint, there is a bit of a premium for a natural gas powertrain over a diesel. So that's a nice content expansion story for Cummins with margins, more or less in line with the diesel space. And from an end user standpoint, it's a nice economical way to, again, kind of move down that path to zero emissions, relative to some of the more expensive fully zero emissions technologies today, battery electric fuel cell having. So, we're excited about it and do you think that it can be a nice growing piece of the market.

Jamie Cook

And then I know you -- when we first started talking about demand -- you were talking about supply chain and obviously it's going to be a constraint until the first half of 2022, at least. But is it -- are there any signs that it's stabilizing at that levels? What I mean, or just like not getting worse and to what degree are freight and logistic issues -- logistical issues still like a big issue or worse.

Jack Kienzler

Yeah. So, I think there's a few moving pieces. We are, of course, optimistic that things will improve. We haven't seen a ton of green shoots necessarily just yet on that front. What we have seen is a pretty steady call it a $100 million a quarter supply chain costs headwind every quarter from supply chain as we've moved throughout this year. The difference is that the piece is making up that bucket have shifted a bit. So, in the first part of the year that was largely driven by premium freight. We were kind of bending over backwards to meet customer demand and scrambling a bit as there was just so much volatility in the production and supply chain landscape that has sequentially improved as we've moved through the year.

And what's offsetting that now is, of course, a rise in some of the standard freight rates, which have offset some of the decreasing the premium freight activity. But more importantly, a rise in sort of supply chain inefficiencies if you will. And so, we're operating in an environment where end user demand is quite strong, as we talked to OEMs, they share that sentiment. And so, we're all gearing up for -- which should be ramping production as we move into next year. And so, we're obviously usually pretty quick to get a control -- get control on costs today, as the cycle goes down. We're hesitant to do that here because that's not really what's happening. It's just a short-term production constraint.

And so, I would say probably operating at higher inefficiency levels in the supply chain space than we generally would, because it's going to take a lot of action to correct that knowing that demand is sort of right around the corner. So, I think it be a pervasive issue for Q4. And then from there it feels like it's a sort of a sequential, improving environment. Hopefully those costs will be getting to return it back to normal levels. And then as production increases, we'll get the benefits of that volume as well.

Jamie Cook

Okay. And then, one of the things I think you also commented on earlier is you -- you're talking about 2023 and you said pre-buy, and so with carve 2024 not too far away, I mean, Rusty was talking about that today too. I mean, I think he said, he thought -- he said, no one knows what the cost is, but it's probably anywhere from 15 or I don't remember if he said 12 to 20, or 15 to 20, but it's a big number. And so, do you have any view on, does this create a pre-buy and the incremental cost to the truckers, it's still too early to talk about it.

Jack Kienzler

Yeah. It's still too early. I think, to hone in exactly on what the cost premium will be. To my knowledge, the OEMs haven't come out with. They're fully confirmed, product lines, which would kind of dictate that. But I think it's certainly fair to say to your point that there'll be a decent premium. It's a pretty meaningful advancement in technology. And so with that, of course, comes at a higher priced product. It feels to us like there's probably going to be multiple solutions that will be deployed to meet the regulations. I mentioned natural gas earlier, which certainly can meet them. I think, clearly some of the zero emissions products can meet them, but I think you also see some advanced diesel, maybe even some hybrid type applications that are rolled out.

So, we'll see what would shape that takes. But I think, all things considered, it definitely feels like there's some pre-buy, likelihood for 2023 and thus we may see a bit of a longer cycle in the markets with not the wild peaks and troughs, just more of a steady state elongation of the cycle, if you will.

Jamie Cook

Okay. And I guess shifting over and realizing we're 15 minutes here and I haven't asked about new power systems, which I'm sure you're getting a lot of questions on today. I mean, but when I was with Tom last, it sort of sounded like he felt like Cummins was better positioned sort of in hydrogen fuel cell. And on the EV side, he's still trying to figure out the right strategy there, because there's a lot of players in that market. I mean, any thoughts there, any changes there, any reasons to be, thinking about incremental M&A on that to sort of accelerate your path or do you think the market is too far -- or won't be too far away that we don't meet -- like we don’t really need to -- in your power systems, Jack.

Jack Kienzler

Yeah. I think a couple of things. I think if Mark or Tom were here, they would express a similar sentiment that it feels to us like we're being sort of discounted a bit on a couple of fronts, certainly from a evaluation standpoint, right? If you think about our new power business, there's a lot of sort of strategic things, technology, advancements, all of that to be had as we move forward. But if you look at our revenue is stacked up against the peer set, we feel pretty confident in our position. You then couple that with a lot of the intangibles that we can bring to the table, service network, application knowledge, longstanding customer relationships, we feel just as well positioned as anybody else. And so, you look at some of the valuations in this space and feel -- if you can't help it feel a little discounted on the new power front.

And then if you think about the core, similarly we're getting discounted a bit there as well. We feel like there's still plenty of room to run, frankly, a growing market position overall and some other nice catalyst as we talked about in China from a component standpoint that we feel can offer some compelling outgrowth in addition to a really compelling cash flow stream. So, all of that considered, we feel I would say really well positioned, albeit undervalued and certainly be shedding in a bit more light I think on that as we move into February.

If we think about M&A, I would put it in kind of two buckets, right? So, we continuously look at particularly the new power space as we think about ad-ons. We -- I think you probably saw that we made a minority investment earlier this week, saw in power and the battery space. And I think you'll see some stuff where we look to either partner with others or invest in others, or even acquire others to continue to build out that technology portfolio and make sure we have the right solutions to address a wide array of end markets, both on the battery side, as well as on the hydrogen side.

I think the other piece …

Jamie Cook

U.S., sorry, Jack.

Jack Kienzler

The other piece of M&A that we always look at is, is some of the larger opportunities in the market. We will continue to look at those and assess whether or not those make sense. Right now there's nothing eminence or anything like that, but we will continue to update folks. We are uniquely positioned at least from a balance sheet standpoint to have some capacity to make some moves, whether that's a new power or elsewhere. And until then we'll continue to generate a lot of cash flow back to our shareholders.

Jamie Cook

And is there a preference for new power versus core at this point? Or is it you can't say or?

Jack Kienzler

No, not necessarily. I mean, I would say that really we feel pretty well positioned from a technology standpoint. I think that's why you've seen a lot of focus on some of these partnerships as we look to bring that technology to markets and partner with local incumbent players who have market access. That's essentially what we've done in China historically with our OEM joint ventures. It's what we now are doing with Sinopec in China to address the electrolyzer market. It's what we've done with Iberdrola in Spain to address the electrolyzer market broadly in Europe, and we'll continue to seek out those partnerships, not only in electrolyzers, but also in fuel cells and maybe even in battery electric to continue to gain traction from a commercial standpoint and as well as to enhance our technology portfolio.

Jamie Cook

Okay. And then, so it sounds like at the Investor Day, we'll get an update sort of on new power systems and hopefully by financials and where do you think the portfolio is going? The other thing I think the market under appreciates or a wonder fuel address is, if we think beyond 2023, we start to think sort of mid decade, what I mean, all of these market share wins that will come into the mainstream and how that reduces the cyclicality. What I mean, your business, at least over the medium term. So, I'm wondering if we'll hear more about that and potentially timeline for more wins on the market share side, it sounds like you are already saying, they need to make decisions about what to do in ICE incremental to what they've already said.

Jack Kienzler

Yeah. Absolutely. I think as I mentioned there, there's a lot of dialogue going on in this space. There's a lot of frankly investment needs. The most obvious being, new tech -- new investments needed to meet new emissions regulations, but there's a lot of investment needs for OEMs, both in the on and off-highway space. In any time that that's the case, it feels to us like the OEMs are seeking out partnership opportunities with trusted suppliers who they know can bring a credible solution to them. And so, we have a long standing history of partnering with many different people and have a proven track record there. We have the scale and ability to continue to invest where others cannot, which kind of uniquely positions us to increase our position in many of these markets from an internal combustion engine supplier standpoint. And we expect to continue to increase our share, even if long-term, at some point the internal combustion engine market starts to decline as the new power markets take share.

So, we're excited about that. That's not only a first fit engine opportunity. It's a components opportunity. Obviously long-term, it's a ever-growing installed base, which will generate a lot of aftermarket activity as well. So, we think that there's a really nice long compelling revenue and margin story there as well as a significant cash flow story.

Jamie Cook

And then just on -- I don't think we're going to touch on the electrolyzer business. You've done a lot -- you've announced a lot of sort of nice partnerships, but sort of timeline to see sort of…

Jack Kienzler

Yeah. I think, there's sort of two broad aspects of that market that we've tried to focus in on. There's the smaller megawatt projects, which are a bit more steady state and sort of hum along if you will, on a quarterly basis. So, we continue to have good traction there and we'll focus on that as sort of a recurring revenue stream. The announcements as of late have been focused a bit more on the large scale, electrolysis projects in the 150, 200 megawatt range. We're obviously incredibly excited about those and those are going to drive significant chunks of revenue in the future. And once you kind of develop a pipeline in a steady state backlog of those that, that leads to ever growing and rapidly expanding business.

I think that from a timing perspective, it's just -- it'll take a bit of time to engineer those projects and secure government funding and whatnot. To put it in perspective, the largest facility today is the one we commissioned with Air Liquide in the second quarter Quebec, which is a 20 megawatt facility. And so when you're talking about a 200 megawatt facility, a significant expansion in the amount of hydrogen you're envisioning producing. And so, it takes a bit of time, of course, to design the product. It takes a bit of time for the overall project to be specked out all the EPC work to take place. And then, obviously securing government funding to help with the economic equation is a big piece of that. And so that takes a bit of time to.

So, we're seeing a lot of traction, a lot of optimism in the market and we're incredibly excited about it. I think it would just take a bit of time and hence our goal of 4 million, which we highlighted hydrogen day for the middle of the decade, we feel well on track to outperform that. It's just a question of -- it'll take a bit of time between where we stand now and in that time period to start to see that recurring revenue stream.

Jamie Cook

And then on the filtration side of the business, I mean, I know we're going to get an update in February. But I mean, is it still sort of looks more IPO spin versus strategic buyer that's like sort of think about things and then, I mean, this just adds to cash.

Jack Kienzler

Yeah, indeed. So, yeah, the plan is still the prime path, if you will, is still a public market separation, the form which remains to be determined, whether it's an IPO splat or a spin. But -- and the reason for that, of course, is it's a fairly low -- given it's a home grown business, fairly low tax basis. And so, the valuation trade-offs between an outright sale or are not insignificant from a tax leakage standpoint, of course, doesn't mean we're ruling anything out and we're open for conversations on that front, but that's the prime path. And so, we continue to make progress towards that. A lot of work, of course, goes into that. And so it takes a bit of time to get ready, but we'll provide an update on that in February and probably do the first step of that call it the middle of next year.

To your point, yeah, that further increases the cash position. And on top of a portfolio, that's generating a lot of cash already. And so, we'll continue to assess different opportunities to deploy that cash. We talked about M&A, which of course, we're well positioned to pull the trigger to the extent opportunities arise. We'll continue to invest not only in the new power business, fairly heavily, but also in the core base business. As you move into what we kind of call the messy middle of technologies, moving from a diesel world to a messy middle, and eventually a zero carbon world, there are going to be a lot of needs from an investment standpoint, both in form of R&D and then capital. So, we'll meet those needs as well. And all the while return a significant amount of cash flow to our shareholder base, kind of provide that steady state return. So, we feel good about where we're at and continue to update as the filtration process takes place.

Jamie Cook

So this will be an interesting Analyst Day. There will be things to be said Jack, right?

Jack Kienzler

Yeah. It will be a full agenda as everyone can probably imagine. Yeah, it's a -- there's a lot to update on quite honestly, across the base business, which we feel still has a really compelling growth story, of course, update a bit on the near term margin opportunities for the base. And then, diving into the new power business, we have quite a significant portfolio of products and technologies. And so helping people understand what the addressable markets are, how our portfolio is designed to go after those markets. And, of course, what the financial implications of that may be. So, we're looking forward to it. Yeah, there's a lot of time being spent on that. But we look forward to providing it in February and crossing our fingers that we can do so in-person with yourself and everyone else.

Jamie Cook

Okay. And I think we are out of time. We are out of time in 30 seconds. So, I appreciate your time. As usual, say hello to everyone, happy holidays. And I'm hoping we'll see in-person in spring, in next year, you'll be able to come to our conference in Palm Beach versus Virtual.

Jack Kienzler

Absolutely. Thanks so much, Jamie.

Jamie Cook

Thanks Jack. Take care. Bye-bye.

Jack Kienzler

Yeah. Bye-bye.