Cummins, Inc. (CMI)
Barclays 2023 Industrial Select Conference
February 23, 2023 10:55 AM ET
Company Participants
Jeff Wiltrout - Vice President, Corporate Strategy
Christopher Clulow - VP of Investor Relations
Conference Call Participants
Adam Seiden - Barclays
Presentation
Adam Seiden
My name is Adam Seiden. I'm the U.S. machinery construction head here at Barclays. Joining us at this session is the team from Cummins. We have with us Jeff Wiltrout, from the strategy team -- Cummins strategy leader; as well as Chris Clulow, who most of you guys know from the Investor Relations side.
Apologies for the delay here. It's kind of like an airport, everything starts picking up on each other as the day goes along.
So maybe just some ground rules for you guys. We're going to do a fireside chat up here. We'll then shift to the audience response questions. There're some gaps on the desk. You guys should be pretty familiar with that by now. And then we'll leave some time for Q&A if you have at the end, if we could.
So with that, guys, thank you so much for being here.
Jeff Wiltrout
Yes. Thanks for having us.
Christopher Clulow
Thanks, Adam.
Question-and-Answer Session
Q - Adam Seiden
Appreciate it. So Jeff, I really want to take advantage of you being here and talking to us, because Cummins is definitely a transitioning portfolio. And the company is obviously focused around the engines business. So what I -- I guess my first question is having been through the ins and outs of portfolio, what do you think is the most undervalued or underappreciated part of the portfolio?
Jeff Wiltrout
Yes. Thanks. It's a good question, one we think a lot about, obviously. There's a couple of things we like to remind ourselves, make sure we're optimizing and also convey to others. One piece is the nature of our distribution business and our channel, the sales and service network that enables us to sell our product, service our products, deepen our relationships with both our OEM customers, but also as much, if not more importantly, the end-use customers that are using the equipment in the field is a big part of our value proposition and unique for us relative to many people in our space. And of course, there's an ongoing debate around this kind of the valuation of our new power business unit and the investments we're making there that we're very optimistic about that we always try and remind, reinforce and highlight. We think that's got a lot of opportunity and growth potential.
Adam Seiden
Got it. And look, even in the past year, you'll be -- Cummins as an organization has done quite a bit. Meritor, Jake Brake, Siemens, just to name a couple of them. How effectively do you think the Cummins team was able to manage that integration between all those individual parts there? And how -- when you're taking on a bunch of those assets, how does that shift some of the time that the management team could spend on focusing on integrating versus managing the business?
Jeff Wiltrout
Yes, sure. You're right. It has been a lot -- is a lot, a lot to go execute, no doubt. All of the acquisitions had different profiles as well. Obviously, Jacobs is in the engine space technology. We're heavily familiar with a supplier to us that we knew quite well. Siemens was more of these newer motors and inverters kind of in the new power space, obviously, Meritor a big multibillion-dollar acquisition. So it's a very different forms. I feel quite happy, comfortable with the work our integration and -- business integration team and business teams have done to integrate all those acquisitions to deliver on the value that we expected to be delivering on.
In terms of management attention and distraction, I mean, we, I think, have a pretty clear set of priorities for this year, the next couple of years to go deliver on, one of which is the set of integration and execution activities to get those right, delivering the new engine platforms we have on our way, investing and scaling up our -- the electrolyzer business like we have the aiming points that are pretty critical and fundamental to us executing on our near-term strategy. And so it's a lot to do, of course, but I feel like we're well equipped and appropriately focused to go deliver on the promise of those key items that unlock what we think of the value here in the medium and long term.
Adam Seiden
Got it. Having, I'm sure done the diligence on plenty of items over time here, how much time does Cummins, spend on the supply chain or pre-existing arrangements and contracts with customers?
Jeff Wiltrout
Yes. A lot, as much as we can, of course. I mean, I think for us, and again, it does vary a little bit deal by deal. Certainly, when we're looking at spaces in the newer technology domain, we, of course, spend a lot of time making sure we understand the nature of customer contracts, in particular, in the obligations and anything there. That's a key emphasis for us. The supply base, again, it depends -- a lot of these are contracts that we are able to get in and get familiar with pretty quickly because they're not entirely dissimilar from a lot of our own relationships experience. We know that pretty well with things like even though it may be different components that tends not to be terribly dissimilar. So that tends to be a more confirmatory diligence exercise to make sure we understand the nature of the contracts, but usually, those look pretty familiar to us. It is in some of the customer spaces especially in some of these newer technology areas that we spend a deeper amount of time to make sure we understand exactly what's in there and what we're signing up for or what the company we are targeting has signed up for.
Adam Seiden
And there was a period of time where there was a wave of new announcements of new business that you guys in Cummins had won. So Daimler, Azusa, Hino, a bunch. I think Hino was supposed to ramp this year, Azusa may already be happening, where Daimler is a bit longer term, but you can do it better than I can. How should we think about the flow of all the individual partnerships and new businesses ramping up?
Jeff Wiltrout
Yes. Yes, I can take that one too. Yes, I think it is underway. In North America, we're in process. We have Hino and have Azusa on the medium-duty side. By the end of '24, we'll have the rest of the Daimler business bringing us up to a good share, I would say, of the business. And then in the latter part of the decade, we pick up the business for Daimler in Europe, Southeast Asia and then South America. All told, it's about 80,000 to 100,000 units, about a $2 billion boost to our revenue. The timing is a little, I guess -- we have the timing locked in by the end of the decade, but some of that is pulling forward when we can accommodate it into our plants. And that's the key pieces. We're not building out a lot of new capital for this. It is utilizing the capital we already have in place and so that we can do that and generate strong margins.
Adam Seiden
Got it. And just to put a fine point on that, the $2 billion, that is cumulative across all of them?
Jeff Wiltrout
Correct.
Adam Seiden
Okay. Got it. So since we've been in Miami, the company made some news about Atmus. So clearly, it looks like the process is underway with filtration or at least more publicly now underway. Just, I guess, from what you guys comment from a Cummins perspective, any sense around the timing, first half, second half? And then yes, maybe start there and I have a couple more.
Jeff Wiltrout
Yes, sure. We're obviously -- have done all the work we feel like we need to do to prepare to move this business and next plan towards the IPO and move that forward. Obviously, the S-1, the public filing here this week reinforces that. And as such, we're looking forward to be prepared to move forward in the first half of the year if the market conditions support that, and that's the big if, of course, but we are -- stand kind of ready to move forward and the leadership team down there is as well and is looking forward to starting to get their story out and publicized and get ready for that next phase. So yes, ideally, it's coming up pretty quickly, but again, that is now subject to timing and market conditions as much as anything else.
Adam Seiden
Got it. And just historically speaking on that business, I was a little surprised about the off-highway, on-highway split. There was a bit more off-highway than I would have thought in there. Just -- is that been consistent over time where you see a similar makeup?
Christopher Clulow
Yes. So it has been fairly consistent over time. I think in the off-highway space from a filtration perspective, they're just harder duty cycles. And that's where you're going to have to work through or uncertain fuel for fuel filters and so forth. So that's where it drives a lot of that, and that can just consume a lot.
Adam Seiden
Got it. And then within there, the -- you talked about 70% of sales that are tied to a bunch of household names in the industry and so forth. If you think more to the components business as a whole, is it generally similar sort of concentration amongst those key customers and so forth on the component side? Or is it split different because of on-highway, off-highway mix?
Jeff Wiltrout
Yes. It is split differently for the on- and off-highway. So there is a little bit different -- filtration is probably the most global of it and from a distribution perspective as well because the products you use everywhere, particularly off-highway products, you get the high horsepower space, that equipment in mining, oil and gas, marine is used everywhere, so.
Adam Seiden
Got it. So maybe shifting to Meritor. So if we think about Meritor, there were some margin improvement quarter-on-quarter versus where you are. The company is projecting further margin improvement into 2023. Just curious, the significant drivers behind that margin growth and your level of confidence that you'll be able to see that recognized in next year?
Jeff Wiltrout
Yes. I'll start and you add. A lot of us folks would have heard as we've talked to that is as we closed on Meritor in August the first several months, there was a lot of activity and work to do specifically aimed at pricing and doing some catch-up work based on the inflationary cost increases that Meritor was saying. And so huge amount of energy in September, October, November to the balance of the year to basically drive that pricing, and that would be the single biggest driver that kind of gets us back to a run rate earnings profile much closer to what they were doing pre-acquisition.
And then, of course, to supplement and complement that we are starting to execute on the synergy delivery that we have publicly announced and committed to, and that continues to go well. The first pass of that was -- has gone smoothly and is in line with what we expected. And now we're, of course, into the secondary elements that require little bit more time and energy to unlock, but that's exactly where we're at right now and still feel quite confident that we, over the next 3 years, we'll deliver that number we publicly committed to and as such, start to move that Meritor earnings profile closer towards what our components business unit runs at over those next 3 years.
Adam Seiden
Continuing on with the transition, the engines and so forth if you think about the fuel agnostic engine, it's a step forward, of course, for the Cummins powertrain platform. There's been some news around PACCAR and so forth around there. But how big of an opportunity could that be? And what's the timing on it? And then more to bring it back home to this year, what's the CapEx requirement that's going to be involved to standing that up?
Jeff Wiltrout
Yes. Yes. It's certainly a big investment. This is -- essentially, we're renewing our whole lineup for the engine business, a 6.7-liter, 10-liter, 15-liter as we go forward towards EPA 2027. And this is -- our fuel-agnostic engine has the same bottom end of the engine and then different top ends, depending on whether it's diesel, natural gas, hydrogen -- really, propane, gasoline, anything you can really burn. So I think that's a step forward. We get economies of scale, same fit in the trucks. The OEMs very much like it. I think there's been a lot of positive momentum in the natural gas space where people are seeing that. You can see renewable natural gas, which you can argue is a negative carbon footprint, utilized in that space. So we're really gaining good momentum there.
The investments we've shown, you can see it in our R&D numbers and our capital numbers for this year. We're committed. We're in for 2027. We'll be there. I think it's going to be a big ask for everybody to get to the same space. I think it's made us even more competitive in the space, particularly in the gaseous fuels, which we think has a lot of opportunity to grow, first into natural gas and then eventually into hydrogen internal combustion before moving on to the new power eventually.
Adam Seiden
Got it. And continuing along here. There's a lot to talk about on the transition there. But now let's go to electrolyzers, so -- Reliant Robin. Electrolyzers, I think you spoke to a tripling, right, off of a -- it's a very low base. So clearly take that into account. But that could be a nice size growth opportunity, of course, for you as well, and you have very good technology around it. So just thinking about what -- how big of a step forward you could see in that backlog by the end of this year? And then more from like a profitability side from new power, how important is electrolyzer to getting to that breakeven point by 2017?
Christopher Clulow
Yes, I can start that one. So I think the momentum on the demand is definitely there. So even before the Inflation Reduction Act, the momentum in North America was strong. Same in -- and Europe is starting to free capital to actually get the cash to the projects. So we're continuing to build that backlog and probably have this similar exponential pace that we're seeing now. And so really, the focus in that business is building capacity.
So we announced 4 capacity expansions last year in Europe and North America, and we still have some more to come in China. And so we're really focused on that with both internally and then with our suppliers and building that out. And it's already starting to progress where it's forming -- the market is, I would say, cleaning up to a few big competitors and forming up into a good economic market. So like the demand is very strong, demand is outstripping supply. So that leads up to generating good margins, Cummins average margins is where we project in the long term. And that's the first new power market that's going to move before battery electric before E-Axle, before fuel cell. And so that will help us get to that 2027 breakeven point. It's a key piece of that puzzle.
Adam Seiden
That's fair. All right. Before we transition to a bit more of the topicals up-around Power Systems so forth, I just want to move to the audience response questions here for a second. This is the same slide that's been up our whole time here. So I'm trusting it's ready. There is perfect. So do you currently own the stock? Yes, overweight, market weight, underweight or no? All right, potential shareholders.
Christopher Clulow
All right.
Adam Seiden
Moving to next one here. What is your general bias for the stock right now, positive, negative or neutral? There's our count down. All right, relatively evenly split, a bit more positive.
Moving to the next question. In your opinion, through cycle EPS growth for Cummins will be above peers, in line or below? There it is, if you could just answer -- answer again. Thank you. In line with peers.
Moving to the next question. In your opinion, what should Cummins do with excess cash, bolt-on M&A, larger M&A, repos, duties, debt pay down, internal investment, to bring this back home for Mark?
Christopher Clulow
Yes, I won't be giving a swing on this one, but okay.
Adam Seiden
I don't know, that's not helpful.
Jeff Wiltrout
Yes, I don't know what we're going to take.
Adam Seiden
Well, there's always next year.
Christopher Clulow
And you're saying generate more cash.
Adam Seiden
Yes.
Christopher Clulow
Yes, have more if it. Yes, okay, have it.
Adam Seiden
Moving to the next slide, please -- question sorry. In your opinion, on what multiple of '23 earnings should Cummins trade, less than 10x all the way up to higher than 21x, again, standardized ranges for this conference. Suspect the split might not be as even on this one as the last one.
Christopher Clulow
It may not.
Adam Seiden
Okay. So 13x to 15x rolls a day. Moving to the next question. What do you see as the most significant share price headwind facing Cummins, core growth, margin performance, capital deployment or execution strategy? All right now 3 answers if you have -- answer. Okay. A bit split between core growth and execution strategy.
And then the last one, which is new for this year, does ESG play an active role in your investment decision relating to the company? Yes, CSG is positive. Yes, it's negative. No, it doesn't play a role or just no. Also our timer starts guys. All right. No, it doesn't play a role in our assessment of the company.
Again, for context, I feel like a broken record now, having done this a few sessions now. It feels this is pretty much the standard answer. We can almost have this up on every single company, the director board. Yes, I feel good enough now 1.5 days into this thing that I can say that.
So maybe, Jeff, I wanted to touch on, you spent a good amount of time in Power Systems along those lines there. First, I'm curious, how does that business compete for capital versus the rest of the overall portfolio?
Jeff Wiltrout
Yes. So that's -- all right a good question. I would say, we don't feel like tend to drive too much capital deployment significantly one way or the other. I mean, Power Systems has its own return thresholds and profile. We expect them to generate a return on certainly the internal capital deployment we're making in that business around the R&D, capital investments and the like.
From a strategic and inorganic perspective, obviously, that is an area we have traditionally and we'll continue to look for adjacencies and interesting things that might be additive to that portfolio and also generate the return. So when we think about investments like obviously, Meritor are much more focused to the on-highway trucking space, we've had a whole bunch of conversations, analysis and engagement around areas that would be in and around the Power Systems space. So that is at a Cummins level, obviously, a decision we make in a prioritization call we do. But I mean, it's not as if we are saying choke off Power Systems in exchange for investment elsewhere. So we think it has the return profile, the growth opportunity to justify an appropriate level of capital to help support that growth. Yes.
Christopher Clulow
Yes, I think that's right. The one thing I'd add is we're starting to finally get some questions on Power Systems because for a long time, it was just kind of bumping along.
Jeff Wiltrout
Yes.
Christopher Clulow
And I think in third quarter last year, turned the corner on profitability corner, we hope to continue to keep turning and raising our profitability in that space and the markets are quite strong now and they tend to stay strong for a number of quarters, so.
Adam Seiden
And maybe on that note, Chris, could you help us think about this business now with your '23 guidance is going to hit new highs on margins going back a bit, at least from -- in the current iteration of the segment. Could you help us think about how much the business has changed versus like the 2018 peak, how much cost has been taken out? And ultimately, is there a room for higher margins from where we are -- where you guys guided to already now for '23?
Christopher Clulow
Yes. I think we do see a path to higher margins. I think we have turned the corner largely was driven by pricing. I think we -- they're long lead time products. So we were -- would be lagging a little bit behind on pricing, which we hit in the third quarter, continue to hit through 2023. But from the cost side, I think there's some opportunity. Jenny Bush, who ran our North America distribution, that kind of transformation was able to generate about 200 basis points of margin improvement in North America. And I think she's taken some of those tools and some of those keys and seeing what can we drive in Power Systems to generate better margins. So very helpful there.
Adam Seiden
That's good. And just one quick one for the last one would be, if you think about PowerGen, right, data centers has been a very strong growth area for you. I think there was a couple of head scratching when you heard you guys talking pretty positive still not because the market hasn't been positive, it has, just there's been some more cautious commentary out there on those [builds]. So just curious how you see that playing out. Is there more of a first half way versus second half way?
Jeff Wiltrout
Yes. We had this conversation, it feels like every year for the last several when the data center market is going to stop building and we just have not seen it yet. So I would say my short answer is no, not really. I mean I think we expect to see pretty consistent growth. It has regional dynamics that varies as you go around the world. But by and large, we expect to see a continuation of some of the, I mean, not massive growth, but pretty reasonable growth in that segment here through this year and beyond.
Adam Seiden
All right. So I have one more because people should me that I'm answerable -- ask this China as a while. So what are we thinking on China? So I'll just give it to you there.
Christopher Clulow
Yes. I'd say we see as kind of a slow steady recovery is -- in our guide. I would say what we're doing is preparing for a faster one. So we're, from a capacity standpoint, working with our suppliers, if it bounces fast. We don't expect it to do something like it did in 2020. But we're going to be prepared if it does. I would say the -- we kind of have a clear feel now that we moved past the COVID spikes the -- in the regulations and the market is clear of NS5 vehicles. So now we have NS6 coming in. I think we're in a really good competitive space and the fundamentals are strong in the market. It's just when does consumer confidence start bouncing.
Adam Seiden
Got it. And you guys saw the response so -- the responses on capital allocation. It was a bit evenly split on that one. But I guess maybe to wrap up here, Jeff, how active are you going to be over the next year or 2?
Jeff Wiltrout
Well, I mean, to the other question, our focus right now is execution. Like we feel like we have made the right set of investments for the near-term that put us in a really solid position. We are working to continue to make sure we're in the right capital position to be active when it's attractive in where we need to be. But certainly, the near-term emphasis is on making the most and unlock the value associated with the investments we've made both inorganically with the deals we alluded to earlier as well as the investments that we discussed on the engine platforms and the electrolyzer business, that is our near-term focus because we think that sets us up quite effectively for the balance of this decade. And then we'll kind of reset and re-evaluate where we may get more active as we get into the back half of this year and into next year.
Adam Seiden
Perfect. All right. Well, join me in thanking the Cummins team for being here. Really appreciate it. Thank you.
Christopher Clulow
Thank you.
Jeff Wiltrout
Thanks, Adam.
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Cummins, Inc. (CMI) Presents at Barclays 2023 Industrial Select Conference (Transcript)