Cummins Inc. (NYSE:CMI) Cowen 2020 Global Transportation & Sustainable Mobility Conference September 10, 2020 9:45 AM ET
James Hopkins – Director of Investor Relations
Conference Call Participants
Matt Elkott – Cowen
Good morning, everyone, and good afternoon to participants around the world. I’m Matt Elkott, Cowen’s transportation equipment analyst. We’re very pleased to have Cummins with us today. I’m happy to welcome James Hopkins, Director of Investor Relations; and Matt Ruch, Manager of Investor Relations as well.
James will start with some opening remarks and then we’ll do a fireside chat and audience questions. If you’d like to ask a question, please type it into the box at the bottom of your screen. You can do this at any time during the presentation and I’ll read it to James.
With that, James, I’ll turn it over to you.
Great. Thanks, Matt. Really happy to be here. Thanks for the invite this morning. I’ll just give a couple of brief comments on kind of the first half of the year, a couple of forward-looking thoughts and then we can jump right into Q&A. So as many of you are aware, the first half was a challenging period for us in terms of end-market demand.
We had planned for some lower demand in a couple of our end markets this year. That kind of started as we expected in the first quarter. But then again unexpectedly we saw the impact of COVID hit pretty hard there in the second quarter. Given the revenue that we’ve experienced in the first half of the year, we’re very happy with the profit pull-through that we’ve been able to accomplish. Part of that has been related to good operational performance, apart from restructuring we started last year and then some temporary salary reductions we put into a place as well in mid-April.
Looking forward, we’re definitely seeing some improvement in our end markets. That varies by region and by end market. Specifically, probably, North America truck has come back the most quickly. The last couple of months, truck production in North America has been pretty similar levels to pre-COVID, kind of, February March levels, while other markets are taking a little bit longer to come back. And in China, where we had record demand across almost all of our end markets in Q2, we’ve seen a little bit of softening from those record levels, but still very high levels of industry demand in China.
Looking forward, feeling good about our market share in our major markets and opportunities to increase that share for a variety of different reasons and then continuing to invest in our new power business unit, which is where our battery, electric fuel cell, electrolyzer technology is, and feel well positioned as we see certain markets start to adopt that over the next 10, 20 years.
Q – Matt Elkott
That’s great, James. Thanks for the comments. Yes. I have some specific questions about the different business segments, but I want to start with kind of a bigger picture question regarding the growth opportunities. What do you see as the biggest growth opportunities over the next few years? And has the pandemic and the new realities that it’s created worldwide, has that changed anything about the long-term growth outlook and priorities?
I guess, probably too early to tell if the pandemic has structurally changed kind of any of our end markets. In terms of general growth, I think one of the benefits you get from investing in Cummins is that you get multiple avenues of revenue growth. So a couple that I’ll mention that we’ve talked a little bit before and I’ll give a bit of additional context, we continue to see this worldwide trend to having more stringent emission standards.
And so, we’ve seen that over the last 10 years or so in North America, but we’re seeing more of that in emerging markets. So between India and China, we were moving to kind of an equivalent EPA 2010 Euro 6 emissions regs. We’ll see about $600 million of incremental revenue as India and China go up that curve.
India moved to that in April of this year. China has been moving kind of over time, but the biggest piece of the country is moving to that regulation in July of 2021. So that will definitely drive business for our Components group, primarily the aftertreatment business. We’ll also see continued growth in that Components group from transmissions.
So we started our Eaton-Cummins joint venture a couple of years ago, very successful in North America, very high adoption rates of automated manual transmissions. There’s still a piece of the product portfolio we need to fill out within North America, which will drive some incremental revenue.
And then the next big opportunity for our business there is in China, whereas we continue to see the development of professional fleets. And as we see these fleets look at total cost of ownership and not just simply initial purchase price, we continue to expect kind of a pretty meaningful increase in the adoption of automated manual transmissions.
We’ll sell about 1000 of our AMTs this year in China. And of course, that’s generally over a one-million-unit market. So plenty of opportunity for that to grow over time.
Outside of components, we’ve got a couple of other things I’ll point to. So one is the aftermarket our parts business. So if you look at engines in the field that has continued to grow over time both as market sizes have increased and then as our market share has gone up in some key markets primarily North America medium-duty truck And then having more engines in the field and more complex engines has driven pretty consistent growth in our parts business.
A bit of a blip in Q2 because of COVID. But over the last 10 years that’s grown on average 7% to 8% a year. And so we think we continue to have opportunities to grow that into the future given what we already know as our engines in the field population.
Outside of that, I think, we’ve talked in broad terms about opportunities to increase market share in existing markets. So to the extent, we grow market share that will help us outgrow our end markets. And then we have our new power business. So adoption, we expect to be slow and steady in those markets, but that starts essentially from a base of zero. And we continue to sell an increasing number of full battery systems for buses. Lots of interest in our electrolyzer business.
We’re just about to finish up the largest green PEM electrolyzer in the world in Canada and just announced the largest in the U.S. And then of course, we have the entire fuel cell infrastructure there as well where we’re starting to sell those systems whether it’s to trains, trucks, buses and potentially other applications over time.
And since you ended on the new power segment in this conference event and has sustainability focus to it, within the new power segment, James which encompasses electrification fuel cell, hydrogen cell and natural gas. Where do you see the biggest growth opportunities? And does that — are those opportunities — do they coincide with the best prospects for probability?
Yes. I think that we have broad opportunity across the subset of products there. Adoption is going to differ by end market, by region. And even in end markets that we consider almost homogenous today, I don’t think that necessarily will be true in the future. So if you look at this year and last year, most of the revenue in that business unit has been for battery electric system for buses in the United States.
So there’s about 200 of those rolling around the U.S. right now whether it’s transit buses or school buses. And they’re performing well. Very happy with it. That has been driven by specific dynamics within that industry whether it’s been subsidy money that’s available or whether it’s the fact that generally speaking when you buy a bus you keep it for your entire useful life.
So there is no concern or less concern there about resale value and there is essentially no resell market for this technology today. So that essentially allows those transit authorities to take the arbitrage from the delta between the running cost of the battery electric system versus diesel or natural gas over let’s say a 15-year time horizon.
As we look at fuel cells for example, one of the first areas we’re seeing some adoption is actually trains and primarily right now trains in Europe. So we’ve had two trains running in Europe with Alstom since the end of 2018 and they have now 150,000 kilometers on them and we’ll have 40 on the road by the end of 2022. And the reason that makes some financial sense in Europe right now is that it’s the lower cost green technology.
So if you look towards Europe and their desire to reduce emissions on the rail network, you essentially have two options. You can electrify more of the network which costs a couple of million dollars a mile or you could move to hydrogen trains. And while those hydrogen trains are going to be more expensive than a diesel train that you have today, it’s substantially less expensive than actually electrifying the line. So I think that’s almost just a good example of a unique case where it actually makes financial sense for the operator to do that, but there’s kind of an externality that comes into play. And in that case it’s the cost of electrifying the railway network.
So that’s kind of one example on the fuel cell network. The area that I think there is most opportunity revenue-wise in the short, medium-term is our electrolyzer business. So for those that aren’t aware an electrolyzer is a piece of technology that essentially will take electricity and produce hydrogen. There’s a lot of interest in that technology right now in terms of green grid balancing. So if you have a solar farm, wind or hydropower station, there’s periods of time where you’re producing more power than you can sell into the system. So whether you sell that at a loss, or whether you frankly just throw it away, if you utilize some of this electrolyzer technology, you can take that excess power at peak time and you can produce hydrogen with it.
Over time potentially you can use that energy as — the hydrogen as an energy storage device to get back into the grid with a fuel cell. But right now most of the time what people are doing is taking that hydrogen and selling it into existing industry that uses hydrogen. And our partner in that electrolyzer business is Air Liquide, one of the biggest suppliers of those services in the world. So a great partner for us.
So, we’ve got a couple of those big projects in North America going. We have electrolyzers from the biggest in the world like I mentioned green grid balancing in Canada all the way to a little alkaline electrolyzer in a hydrogen fueling station, where you could just plug that into the local grid and make a small amount of hydrogen just to support kind of one filling station. So, a lot of interest in that space, I think it’s an enabling technology.
The more of that that you have out there, the more hydrogen will be available at a reasonable price, which I think will drive the adoption of fuel cells over time. So excited to be really heavily engaged involved and a leader in enabling technology, which I think will drive more revenue in the short-term until you get the cheaper hydrogen, which drives the fuel cell adoption more broadly.
And while we’re on the new technology and new power segment topic, I want to get in one audience question since it’s relevant here. Do you have plans to increase CNG engines for the heavy-duty fleet? Are you seeing increased demand for CNG, while electric becomes available?
Yes. Good question. We’re very much a proponent of natural gas technology as a way to very quickly reduce emissions, and we’re a leader in that technology. So in North America, essentially all natural gas engines for commercial vehicle application are Cummins engines. We also of course have that product portfolio within our power generation business as well.
So a very strong product portfolio there, whether it’s our 6.7-liter, 9-liter or 12-liter engine continue to build those, improve those products and to work with partners on adoption. We have not seen a significant increase in adoption of that technology frankly over the last couple of years, which I think has been surprising to some people. There’s been a couple of challenges around infrastructure on the fueling side. So you tend to see people using natural gas trucks today, where they actually have the infrastructure themselves, whether it’s a natural gas fueling station at their facility something of that nature. And then we continue to have challenges on resale value, so most truck purchases in the U.S. are large fleets. Many of those large fleets keep their trucks for about four years and then look to resell them and the resell market for that technology has really never taken off.
So, most of the people buying them today are in the business of keeping them for say 15 years, which is a much smaller piece of market. So it’s a good technology. It’s an environmentally-friendly technology. We’re the market leader. I’d be more than happy to see more natural gas engines in the world.
We think in certain situations you will see a little bit more of that, but then some of those challenges that has been facing the industry in terms of natural gas engines are going to be similar as we kind of move through with fuel cells and battery electric frankly over the first 10 years of that technology and the adoption whether it’s that infrastructure lack of resell market things of that nature.
Got it. That’s very helpful. I want to ask you a question on the truck side. So the truck OEMs tend to do a bit more vertical integration during down cycles in order to control cost. North America had been on the cusp of a down cycle prior to pandemic, but the shutdowns brought more challenges, but they also created some tailwinds for fleet owners, such as lower interest rates and lower fuel prices. How are all these factors positive and negative manifesting when it comes to vertical integration by your customers? Have you seen any notable changes in vertical integration trends over the last several months?
I don’t think we have no. So, our product in the field continues to perform exceptionally well, which I think is leading to current market shares that we’re quite happy with, not that we don’t want to see them increase further from the levels that we have today. So, in the medium-duty truck market in North America, we’re around 80% year-to-date. We tend not to see a fluctuation in that based on the cycle frankly because we have such a high share.
In the heavy-duty space, we do tend to see some fluctuations through the cycle, but frankly they’re generally pretty moderate. So, in the second half of last year when you actually saw pretty meaningful reductions in truck production rates you saw market share drop from the low 30s to the high 20s.
And at that time we kind of talked about why that is and people emptying out their own supply chains. And as they do that we have a temporary impact really to our demand. But ultimately, our product was performing very well and we expect that to normalize through time. Ultimately, it’s the end users that designate what engine they want. And so these blips can’t last forever if that’s going to be what’s driving the engine choice.
And in the first half of this year in one of the most challenging markets in the history, frankly, of the heavy-duty truck space, our market share has been 33%, an improvement over the second half of last year. And that essentially is the normalization of the end users really pulling back through what engine that they really want in their chassis.
So, 33% in one of the worst markets in living memory I think is very good. We’re very happy with that. And as we look forward, I think we have some opportunities to grow share in both of those markets.
So, in the heavy-duty market, we announced that our X12 engine will be available on Cascadia regional hall chassis with freightliner, a very valued partner there. Our X12 engine I think is a very compelling product paired with our Eaton-Cummins joint venture transmission lightest engine on the market by quite a way.
And I think demand for that has been quite positive so far from an order perspective. So, that 12-liter essentially will go against the existing 13-liter products in the market that we don’t participate in today. So, every one of those that we sell will be helping our market share.
In the medium-duty market earlier this year we announced that Mack who is producing a new truck in that space in that medium-duty market will be exclusively using Cummins powertrains as they launch that.
So, again, either supportive or — of maintaining existing share or maybe a little bit higher in medium-duty truck. And then in heavy-duty truck you’ve got that X12 which should help us over time as well.
I want to read because we’re starting to push up against the time here another audience question and it relates to truck, but it’s — the question goes, there’s a thesis out there that massive verdicts and plaintiffs favor in U.S. truck accidents means more demand for safety technology like ADAS, which means more demand for new trucks that actually have that technology which of course means more engine sales. Do you agree? Your customers are — you have customers that use the different types of accident mitigation and autonomy features. So, any thoughts on this question would be helpful.
Yes, it’s a good question. Every time I think we go into a truck cycle there are several new items to consider whether it’s safety systems cycle, whether it’s driver shortages, whatever it might be. I think there’s new aspects that we ask ourselves will this impact the magnitude of the cycle the shape of the cycle or does it fundamentally change kind of a replacement level demand for the market?
The last few cycles I would say there have been some very good thesis around what could change it but the cycles have not really fundamentally changed all that much. I’m not sure whether safety systems will or will not change. What I will say is there is definitely a significant amount of demand for those systems. And at the same time, it’s only been over the last couple of years that it’s true that when you buy a new truck, this truck will have better fuel economy than your old truck given the work that’s been done with emission standards and things of that nature.
In 2013 or 2015, you were generally actually buying a truck with worst fuel economy. It was better for the environment, but maybe not necessarily for your pocket. But today that has changed with the investments we’ve made in after-treatments and the pairing with our transmission.
So, if you get a truck today you will get better fuel economy. You’ll also get the benefit of those safety systems which is clearly something that I think fleet is very interested in. And at the same time there’s other features on these new trucks. I think they’re pretty popular whether it’s the chassis and the driver comfort aspect or telematics things of that nature. So maybe that does support a little bit of a incremental buying cycle this time. But I think it’s probably too early in the cycle to determine if that’s the case or not.
Yeah. Certainly the insurance premiums have gone up significantly over the past year or so. And the insurance companies don’t give credit for having Bendix or Detroit Assurance or any type of drive our assistance program, but those programs theoretically should help the safety records, which is a key variable — probably the most key variable in determining what your premiums are.
Another question came in on the truck side, does the recent long-term Navistar agreement hold even if there’s a change of control in Navistar?
Yes. Navistar has been a great partner with us for over 80 years with a variety of different products and currently take the majority of their engines from Cummins in the medium-duty space and of course our leading 15-liter engine in the heavy-duty space. We also sell a significant number of components to their own engines. I think we’re very happy with the deal that we signed with Navistar continuing that agreement for a variety of reasons that are beneficial to both sides. So I won’t — I can’t comment on kind of specific contract language. Only to say we’re very happy with our relationship with Navistar have been for many years and then also have a good relationship with Traton as well and sell to several of their brands whether it’s Scania who we have a joint venture with; whether it’s MAN who we sold engines to in Brazil for many, many decades. So we have good relationships with almost all of the global OEMs and support them in different ways.
I want to get a couple of questions in before we run out of time. James you mentioned that things have softened a bit in China. I know there was a big 2Q rebound in both construction and truck and it had been expected to subside, but it lasted through July and into August. Can you talk a bit more about the slight softening I think you mentioned? And is it both construction and truck? And do you think we could see another 600,000 trucks in China in 3Q?
Yeah. It’s — I think given the industry data that’s come out so far probably 600,000 probably not on the cards but still an exceptionally strong quarter. Q2 annualized was somewhere around 2.3 million truck units. The biggest ever full calendar year in China is about 1.4 million, so just an incredible amount of production in a short period of time. Some of that was catch-up from Q1. Some of that we think is really based on some initiatives by local governments to increase the amount of scrapping of older trucks and support production of new trucks. So we think that’s going to support the market this year by 250,000 to 300,000 units. And so while demand has come down in Q3, it remains at historically very, very high levels. It’s simply sequentially lower than what was the best quarter in China ever by quite a long way.
Got it. And then staying on China, but switching to a trade themed question. Much of your business is primarily through JVs in China. Can you talk about the effects that the China-U.S. trade tensions have had on the business, over the last few years? And what you guys would like to see going forward, on the policy front? And also what percentage of your China business is for China versus the U.S. and other world regions?
Yes. So I’ll start with that piece. We generally manufacture in region. And then, we also have our supply chains in region. There are certain exclusions to that. There are certain parts that you can generally only get from Europe or electronics from Southeast Asia things of that nature. But generally speaking, we have regional manufacturing and regional supply chains. And that is very much the same from China. So very little finished goods go in, very little finished goods go out.
Our relationships in China are very deep and longstanding. So we’ve had these JV relationships in many instances for decades. And what we do with those joint ventures is look to bring value both to Cummins and the partner. So we’re there to make our local partner win, in the Chinese market. So that’s been a very successful model for both, us and our partners over an extended period of time. I think there’s always a risk of operating, in different jurisdictions about what can happen over time especially with trade tensions going on.
But to the extent that we are partnered with strong local OEMs and joint venture setups that they’ve been around for a very long time and that I think that it’s a mutually beneficial relationship to help those local partners win, in their markets. I think we’re sheltered as one company can be probably, in terms of our position within China.
From a trade perspective in general as a company, we’re very supportive of fair global trade. That allows us as a company to leverage technology, manufacturing and supply chains. And from a simply U.S. perspective, that’s beneficial for our employee base in the U.S. We export more product out of the U.S. than we import within the U.S. So export business for Cummins is a net benefit to the United States.
Got it. I think, we’re a minute over time but I want to try to get this final question. And I think we have some wiggle room. There remains a good deal of uncertainty in markets. If valuations pull back and make you more likely to look for acquisitions, what are the priority areas you would target that could have a material impact on the business?
Yeah. So I think the priority areas have remained the same for some time now. So, no major changes there. And of course, as we always got to mention our primary compensation metrics are around ROIC. So we’re looking for things that are accretive to the returns of the company. We’re not looking for things that simply make the company larger. That’s not the intent of our kind of any focus on M&A.
So the areas we’ve kind of talked about before, A, our little technology acquisition. So we’ve done a couple of lease over time, so are there things in the technology space that can accelerate our product or make our product more efficient. And that we want to kind of get a leg up there. So we continue to look at little things like that, but those tend to be pretty minor in the grand scheme of things.
The other thing we’ve talked about there’s, other complementary things, that are closely connected to the powertrain within that infrastructure. And so that’s a space that we’ve been looking at for several years. A good example of something that we did in that space was the Eaton-Cummins joint venture, where you think the pairing of our engine in that transmission has led to pretty good fuel economy benefits and supported a very high market share in North America heavy-duty truck.
So we continue to look at whether there’s an opportunity there. And then we’ve also talked about the large engine space. So something that could be complementary to our power systems group, which has a good product portfolio which serves a lot of different end markets PowerGen mining, oil and gas, marine and rail. But we tap out at 95 leaders from a product range. And so there are options to add something to the portfolio, maybe that broadens that range a little bit.
Got it, and in the interest of time, we’re going to have to wrap it up here. James, thank you so much for being with us today. And Matt, thank you as well. And I hope you guys have a good day today.
Great. Thanks Matt. Appreciate it.