For those that don't know me, my name's Felix Boeschen, Senior Machinery and Trucking Analyst here at Raymond James. Today, we're very happy to have Cummins here with us. Presenting is the VP of Investor Relations, Chris Clulow.
Good morning.
I think what we'll do, Chris, if it's okay, this is more of a generalist conference. If you don't mind maybe just giving quick five to 10-minute background on Cummins.
Sure.
Who you are, key markets you play in, and then we'll kinda go into a true fireside chat after that.
Yeah. Sounds good. Thanks, Felix. Yeah, thanks for attending, everybody. Yeah, we work with Cummins, so we're a global power leader. Traditionally grew up in the internal combustion, the diesel space, so for a 103-year-old company now, and really global. We are operating in 190 countries and territories, so think of everywhere that's legal for a U.S. company to operate, that's where we are. And I think that's one of the big advantages that we have is, you know, two big ones for us is technology driven, continuing to drive to lower emissions products around the world, and then our global scope and our economies of scale.
We are able to support our customers wherever they may be, and whether that's in power generation markets, whether it's in diesel truck markets, whether it's in mining markets, we can support our customers wherever they are, and I think that's really worked to our advantage. I think over the last few years, it's been a very interesting time to be within the company, 'cause we've always had this existential threat of being vertically integrated out. So that was a threat for over 100 years, or it seemed like, and which has flipped.
As the OEMs continue to have more pressure and more different investment needs, they're looking more and more for us to supply their internal combustion engines, whether it's diesel or moving, as I'm sure we'll get to, natural gas, hydrogen, other internal combustion needs. At the same time, we're building out our New Power business, which is electrolyzers, battery electric, fuel cell electric, and eAxles. Continuing to make big investments in that space for as this transition goes, which we believe will be somewhat long and probably pretty messy as we look around the world. It gives us the advantage of we can offer the products to all of our customers, whatever their needs may be. We know those applications quite well.
Having supported, having very strong relationships with our end user customers, allows us to know what they need, even more so maybe than the OEMs know. I think that really is a big advantage as we continue to support those end users. It's been a good ride. One of the other things I should mention, given the audience, is we continue to pride ourselves on expanding our margins and growing. We are a cyclical business. We continue to grow and continue to expand our margins, you know, from trough to trough and peak to peak of our cycles, continue to get better and stronger. I think that's what the mantra we followed for many years and something we'll continue as we go through the next several years. Was that helpful?
No, that's perfect. you know, before we go into sort of the questions I prepared, you did have an announcement out this morning, I wanted to ask you about. It's all about, I think, accelerating towards zero emissions. Could you maybe just touch on what it is, what we should expect tomorrow?
Yeah. I think we should, yeah. The teaser was out there. We, we have an announcement coming tomorrow morning, which is really just showing our commitment to this moving towards the zero emission space. I wish I could share more, Felix, but there's more to come tomorrow just as we continue to make progress in this space. Exciting steps for the company as we're moving forward. We'll see you tomorrow.
Yeah. Well, maybe I'll ask it this way, but there's obviously quite a bit happening, you know, cyclically, but also on the secular side a s we think about decarbonization. You know, you obviously acquired Meritor. You talked about eAxles, you talked about electrolyzers. We're also still going through some diesel changes. Can you maybe talk to us how you think about Cummins portfolio broadly as we kinda think about the next three , five, 10 years from here?
Yeah. Yeah. I think we feel really happy with the portfolio we have now. It is, you know, with the acquisition of Meritor, gives us a really full set of portfolios for the new power space. We have the eAxle, we have battery electric, we have the inverters, we have kind of the fueling tanks if it's hydrogen, fuel cell electric. We have a full portfolio to add contents to the truck. Meritor gives us even more breadth to serve our customers with the axles, with the brakes. Same customer base, so we're having the same conversations with them, just a more broad portfolio of products. We're feeling really, really strong there. We continue to make investments.
I think the big investment we're making now is in our fuel-agnostic engine, which is a same bottom end of the engine and different heads of the engine, depending on whether it's diesel, natural gas, hydrogen, propane, gasoline. We can serve many fuels, and that'll help us through this transition, particularly as we go towards EPA 2027, which is the next big emissions change. This change in platform, we've redesigned all of our platforms really is a big step forward for us. That's the big investment we're making now, as well as the investments we're making in New Power. One of our competitive advantages, I think, is we've always continued to invest in R&D and technology regardless of the cycle and come out stronger as the market cycles.
This is another case where I think that fuel-agnostic engine is gonna give us more and more advantages, helps us meet emission cycles, helps our customers meet their ESG goals, as well as drive their emissions down overall.
I do want to talk about 2027 later on, but maybe before we get there, could we talk about Meritor a little bit? You know, maybe what has surprised you know, since the completion of that deal? Frankly, you know, I was quite surprised at the margin guidance for 2023. Could you maybe help us understand how much of that is the core business versus how much of that is some of the synergies already impacting your model next year or this year?
Yeah. Yeah. Meritor, it's coming quite well. Integration's going great. I think we are continuing to. You know, we guided to $130 million savings at the end of year three. We're feeling really confident with that number. We'll give updates as we get in deeper and deeper. No surprises on the downside, which is good. I think the one thing as it acquired in, as we saw in our results last year, the margins were lower than probably we all expected. I think we were behind on pricing as we acquired them. Something that we hit quite hard and worked with the OEMs to address going into this year. The margins step up from 7.2% last year up to 10.3%-11% this year.
It'll build throughout the year, a lot of that pricing, but it's cost reductions to your point as well, Felix. We're continuing to drive those, to help us step up to the, you know, mid-tens % margin for this year. Over the next few years, we're driving towards getting to our components average margin, which is, you know, 14%-15%. We feel confident in our ability to do that, just driving some of the harder synergies, whether it's supply chain and leveraging that or other pieces of the puzzle. It's, it's gone quite well in terms of the integration.
I guess the one positive surprise is our tax group continues to find some things that we hadn't built into our original models on the positive side, whether it's cash savings or tax savings. I think that we've realized the complexity of the legal structure we need to do some work on. It'll just help us in the long run.
You know, if I think about the Cummins portfolio, the other big thing that's changing obviously is the Filtration business. You know, can you maybe update us on the timeline there? Then, you know, my bigger picture question is really around capital allocation and what you might do with some of the proceeds.
Sure. Yeah. You may have seen recently we had the S-1 filed publicly for the initial step of the public offering of the Filtration business. The first step will be to have the public offering, and it'll be, you know, soon, I think is the best answer I can give. We're all set for it to stand alone on its own merits. It'll be less than 20% initially that goes through the public offering, and then six months later, we'll spin off the rest through kind of a share exchange. We're working that process. Everything's in good shape. My predecessor in this role was Jack Kienzler, who's now the CFO of our Filtration business, Atmus, as it goes public.
They're in, I think, in really good shape. They've been, I know, busy. I talked to Jack yesterday, and he's definitely not running out of gas, but he's certainly tired. He's been hitting the road quite a bit, building this up. I think we're in good shape. What we're gonna do with the proceeds. There's proceeds from the initial IPO, and of course, we'll kind of give them some debt as a parting gift, which they love. I think that is the proceeds for us initially. There's the share exchange, which will reduce our share base in the second step. The proceeds largely will go towards debt reduction, I think is our primary focus this year, given where interest rates are.
We're not as leveraged as many of our, I guess, peer companies. We tend to operate with a pretty conservative and strong balance sheet. It's helped us in the past, and something we'll probably work to get back towards.
Yeah. I was hoping we could talk a little bit about the current environment as well. I know there's a couple of end markets that you play in. I thought maybe we would start on North American heavy duty. You know, I think here's the dynamic that some folks are maybe wrestling with. I think everybody understands, you know, there's the average age of the equipment has gone up. You know, at the same time, if you look at some of the freight indicators, it's certainly gotten a whole lot worse. Maybe help us understand, you know, what are you seeing right now from a demand environment, specifically in North America?
Yeah. This is as complex as it's ever been in North American cycles because we never did cycle up. We never did peak out. The cycle's been drawn out. The, you know, the economy and the freight rates are coming down a good bit. The truck ages are quite old. We continue to see strong orders. The back half of last year had huge amounts of orders going to the OEMs. January was down a bit, February bounced back up, it continues to add to the slight confusion as to what the outlook is. Our view is that we think the market will start to moderate maybe in the fourth quarter, not to a significant degree, but we'll see. We could be wrong on that estimation.
The other complicating factor in this is just people are starting to look further out. The end customers, the OEMs are looking further out, and they're even looking at 2027 emissions, which they never would look that far into the future in the past. Going through the past few years where they weren't able to get trucks for two years, they're thinking, "Well, I wanna maybe pre-buy for before 2027 emissions come and prices go up. Should I start thinking about that now?" It's all complicating the cycle and just drawing it out further. That's on the heavy duty side. The medium duty side continues to be strong, and we expect that through the remainder of the year and into next year 'cause it's been deprioritized by the OEMs.
The ages of those fleets is even older, and those end customers really need new equipment. I think that's gonna last longer. It's adding up to the market will remain pretty resilient barring a big economic downturn. I think the market's in good shape. We do have some slight moderation in our guide for Q4, though.
Just wanna make sure I understand that comment on the slight moderation in 4 Q. Was that a comment on North American build rates?
Yeah. It's more to do with if the OEMs start to see, come 2024, that the orders are gonna start to come down and might be a little bit lower, they start to take a little bit less from us. It might be if they're taking 50 a day, it might go down to 48 a day, and they just stair step it down.
Got it.
They tend to eat into the backlog and live off the backlog for a while and try to smooth out the cycle, which works well for all of us. The smoother, the better. We're hopeful that the cycles are starting to get more moderated, similar to what they are in Europe, where the cycles are a little more gentle, because that is the benefit of the OEMs, the end customers, us. I think that seems to be the direction we're going now that there's more, I guess, of a European presence in the OEMs with TRATON and others.
You know, I wanted to ask you about your aftermarket business. Can you first of all remind us sort of how big is it as a percent of total for Cummins? Then, you know, my second question is, you know, I would think usually in a cycle you would see some of the old engines, the parts maybe come offline, and you would see some weakness there. Have we seen any of that? Where are we kind of in that dynamic?
Yeah. That is one of the early warning signs we look at as aftermarket starts coming down in the heavy duty space in particular. It's usually a sign that the rest of the market will come down. It's about 30% of our revenues right now are aftermarket across the whole company. We own our distribution network largely, so that's why it makes up a larger piece. I think the two big drivers for us in aftermarket are the heavy duty market, particularly North America, and then the Power Systems market, the large engine market, mining, oil and gas. Those continue to be very strong. The heavy duty market has continued to be strong. W e haven't seen any drop off yet.
They continue to do a lot of work. The trucks, the population continues to go up. Where there might be a little bit of drop off, the population continues to buoy it and keeps the aftermarket sales strong. We haven't seen a drop off yet in that.
You mentioned 2027 earlier, and I wanna spend some time on this. Can you maybe explain to us, you know, first of all, what is the emission standard? How big of a deal is it from a complexity standpoint and maybe from a price perspective too?
Yeah. The next step in as we move to EPA 2027 is just another big reduction in NOx emissions. I think what it takes to get there is a really-- for if it's an internal combustion solution, a very finely tuned engine. So you can have any waste, any inefficiencies in the process. That's why we're approaching it with a new platform, a really finely tuned platform. Some added componentry, some more aftertreatment on it as well. Whatever emissions come out, go through the aftertreatments and come out and meet the emissions standard. There's some added content which will drive more pricing. The other big differential is it takes your warranty period up through end of useful life. From what is maybe a five-year period now goes through, goes to a maybe a 10 or 11-year period.
Of course, we'll price for that as well. It's something that we supported our products through their end of useful life anyway, so we have a pretty good view of what that takes, whether it's— That, that'll help us drive some aftermarket through maintenance parts and other things. I think that's, those are the big differentiators. We haven't given a number, we actually don't know what that number will be on term, what the price markup will be, but there will be a step up in price for sure as we go to 2027. It's a tough standard to meet, and that's, you know. I think some of the OEMs might be able to tune their engines, their heavy duty engines to get there, but it's something that we'll continue to watch.
You know, just kind of thinking about 2027 then, you kind of mentioned this, you know, when we talked about the North American truck cycle, so to speak. you talked about customers looking out, you know, maybe toward 2027. I mean, it sounds like you think there might be a pre-buy. To what degree do you think there could be a pre-buy, and when do you think that could impact orders / build rates?
Yeah. Yeah. I think that the early speculation now, talking to the OEMs and the end customers is the expectation there will be some level of pre-buy here. It could be substantial. I think that's, it's starting to, like I said, flow into thinking now. I think it would certainly impact 2026 engines. It'll be probably in 2025 as well. 'Cause these new platforms that we're launching to meet the emissions, they're not all coming out January 1st. They'll start in, you know, late 2025 through 2026. We'll launch them in over time, so that we continue to support. We're not launching all new engines all at the same date. So that it'll help drive some of that through. I think it's probably 2025 and 2026 impacted.
Okay. Then, you know, we talked about. Your opening remarks were around the threat of vertical integration. You know, I would think now as the OEMs become increasingly stretched between different powertrain options, they have to spread their R&D dollars across different platforms at this point. You know, how do you think about, you know, that actually driving maybe some opportunity for you guys over time? You know, I'm trying to think through, you announced the big Daimler medium-duty win. Could you replicate some of that on the heavy duty side? How does that work?
Yeah, that's the hope. That's the hope for us, is I think the medium duty side, we continue to, you know, gain share in North America. We're pretty topped out come next year. We'll pick up pieces around the world. The medium- duty wins between Daimler and Hino and Isuzu will add about $2 billion in revenue to us by the end of the decade. We're continuing to stage those in. The good thing about those wins is we can manufacture all in our own plants. It's just adding absorption.
We, you know, have to add a bunch of capital to do so, which is it's a nice benefit as well. The heavy duty side, I think, is kind of the last frontier, where most the OEMs still have their own products. They use ours as well. I think we sell to all of them. It's their kinda equation they have to add up. Is it worth it for them to stay in? I think the big question for them is what is the total tail for ICE? How long is it gonna last? If it's gonna be around for a while, they probably wanna stay in. We'll continue to work with them, have had the conversations, continue to have the conversations.
If they wanna look to us to provide them, we'll be more than happy to at the, of course, at the right economic deal for our investors and ourselves, so.
You mentioned the $2 billion. I think when you first announced Daimler, I thought the date on it was around 2025. Correct me if that's wrong. Maybe help us understand, you know, as you scale that business, when do you think you'll start seeing more and more volumes come into the Cummins model?
The North America will come in over the next year or so. We'll get the remainder of that, bringing the share up to about 95% of the market in North America. The European business will come in 2025. The South America and India business is scheduled by 2027, 2028, but that could potentially move forward. We're having those conversations now, so it could be in that 2025 realm. We do have the capacity to build it, so we could do it earlier.
Okay. That's super helpful. We're talking about the current environment, so I have to ask you about China.
Of course, yes.
I think if I'm not mistaken, you guided JV income flat to up 10% year on year. Maybe put in context to us what you're assuming there in the Chinese truck market and maybe what you're, you know, what you're seeing now, you know, just over two months into the year.
Yeah. Yeah. I should mention, we're probably, for those unfamiliar with our story, we have probably more JVs than anybody's ever seen. That's how we operate in China and in India as well. It's been a tried and true model. It's worked quite well. What we're seeing in the, in the truck market is in our guidance is a kind of more slow, steady recovery. I will say that the good thing is, like, there's no barriers in the way to recovery in China. I think it is. You know, they've got through the massive COVID super spike over the last couple months. They've gone through a change in emissions, the NS5 inventory is gone. Now they're onto NS6.
It's now kinda smooth sailing, and it's just a matter of really consumer confidence coming back. We're watching that closely. We have a slow and steady recovery built into our guide. What we're gearing up for is a fast. We with our suppliers, with our capacity, we're making sure we're in a position where we can ramp up fast if needed, 'cause we've seen it before in 2020 after, you know, they went through and went from zero to record in a little over a quarter, and we were able to keep up capacity and meet the demand. That's what we're girding for. We don't expect that level of quick recovery. It wasn't the healthiest thing in the world 'cause it led to 2020, 2021 overbuild.
I think it'll be somewhat moderated, but we'll wait and see. My guess is as good as yours at this point, but we're hopeful that we'll see some good recovery this year.
I don't think I can be here on stage and not ask you about supply chains. Could you maybe talk about what you're seeing out there? It certainly feels as though the OEMs are raising build rates in North America very steadily at this point. You know, where do you kinda see still pain points? Where has it eased?
Yeah. Yeah. I think it has gotten better, I think, in terms of flow. Cost is flattened out as well, plateaued. Hasn't come down yet, but it has plateaued. I think there's still some pain points in, like, for us in the medium duty space, where suppliers, whether they're labor constrained or they don't still wanna add capacity this late in the cycle. That's, that's capping out things to some degree. Power Systems is in the same space where they lag behind in the supply chain constraints by a couple quarters, so they're still in the thick of it. I will say it has a bit of a ceiling in spaces, but it also has a floor.
It's not a war room every morning for two hours, like, worried about X and Y and Z suppliers. It's more of, like, more slow and steady, helping them build up a little more capacity and build stability. It is overall improvement. I think we're seeing a good improvement there, and hopefully the cost will follow.
Maybe we should talk about price cost. Could you maybe remind everybody, sort of, you gave 2023 guidance. Could you maybe remind us, sort of, what you have embedded on price cost? What I'm also specifically curious about is, you know, when we went from 2020, 2021, 2022, you consistently called out premium freight headwinds. As that normalizes, you know, I'm trying to understand, do you keep all that? Do you share some of that with your customers? Just trying to kinda think through margin puts and takes.
Yep. Yeah. I think as we go into this year, we have been, you're right, battling costs for several years. We did better on price last year. We were able to, you know, price cost last year was, for the overall company, was about 150 basis points better to the positive. This year, it's about 220 basis points, and most of that is price. It's about 200 basis points of price and just a little bit of 20 basis points, 10 basis points or 20 basis points of cost. There's still some upside on cost. You're right. The premium freight, the freight costs in general have been a huge headwind over the last few years. We don't expect to get all the way back to where we were in, say, 2019.
There's still a ways to go. I mean, I think they're getting better. It's kind of the two edges to the coin. Like, we want freight rates to stay high to drive demand, but we also want them to come down to drop costs. Can't have your cake and eat it too, though. I think we are seeing some moderation. We've done well on premium freight. That has dropped consistently through last year. Unfortunately, it was offset by standard. Standard freight remained really high last year. That's starting to moderate a bit and come down, but it's not coming down nearly as fast.
You know, if we look at 2021 combined, and 2022 combined is probably $400 million of headwind versus like 2019 of total freight. We got a ways to go, and we think some efficiencies there. That's one of the things that we're actually as one of our early cost wins on Meritor is we're putting them now onto our freight contracts, driving that down. That's really helped us on the cost side.
You know, your Power Systems margins looked really strong in the back half of 2022. I know you mentioned it's a bit of a lag pricing mechanism. Could you maybe help us understand, is that really what drove most of it? How sustainable are some of these margins as you think about going into 2023, 2024, 2025?
Yeah. I would say that was the principal driver, along with really strong quality results. That was the principal driver was pricing. They lag behind. It's an area we're hitting harder. I said 200 basis points of pricing across the company. It's more like 350 basis points in our Power Systems business. That's where we're pushing pricing harder and faster 'cause there are long lead times. Like I mentioned, we're taking orders into 2024 now, so these are very long lead times. It's capacitized. Total market is capacitized. I think it is something where we can push price a little bit more freely, and we will continue to do so.
I think that's the focus really now is if we can add a few engines of capacity here and there, we'll be able to sell them for sure, because the demand is really high, whether it's power generation, mining, oil and gas, marine, all of the big markets are up. There's a lot of demand out there.
You know, maybe coming 360 here, we started on decarbonization. We haven't talked about the New Power segment in detail. Could you maybe give us an overview, sort of in that New Power segment as you're ramping revenue today? Just talk about the split between electrolyzers, the split between eAxles. What else kind of sits in there?
Yeah. The split right now, as I go back to last year, was pretty well split between battery electric, which is mostly buses at this point in time, 'cause from a cost competitiveness standpoint, that's where the municipalities will be able to invest, but it's not getting into the, into the, you know, truck market yet, other than test vehicles and things like that. The other piece is electrolyzers, which is probably the fast grower, and that's gonna be the one that's gonna be growing through the course of this decade, probably the fastest. Demand continues to rise, Europe, North America and China, and now India is starting to chip in a little bit on demand. Electrolyzers is gonna be one of the early movers.
Last year was sub $100 million in revenue, but we think it'll be $400 million in 2025. Based on our targets on the low end of the range, $3 billion-$4 billion in 2030. We're getting to good gross margins, you know, positive gross margins at quote. That's getting to a place where it's like turning the corner on profitability, and that will lead the way. Like I said, demand is high. The Inflation Reduction Act just fueled even more demand. It actually didn't need that extra kick, but it will take it. I think that it's now just kinda project after project keeps coming up and our focus is on capacity. We had announced four capacity expansions last year, and we just continue to build capacity, 'cause the demand is certainly there to grab.
Can you maybe talk about-- Maybe it's too early to talk about maybe steady state margins as that business scales, but you are certainly spending quite a bit of money in various powertrain technologies within R&D, and a lot of it fits in that segment. can you maybe help us understand how you think about the timing of maybe New Power losses peaking? What I'm trying to understand, you know, as you grow the revenue, how do you think margins ultimately pan out and when do we peak on the losses?
Yeah. I would say if we don't have a change in strategy, we think that 2023 will be about the peak losses. 2024 might be about similar, then we'll start working our way out in 2027, towards the 2027 break-even point for the whole business. Electrolyzers, again, will lead the way with gross margin and earnings profitability. I think that's gonna start turning the corner now that we're getting up to scale production, automated production, more assembly line production versus cell builds. I think that's really gonna lead the way. Long term, we think margins will be comparable. Where we play in the market is gonna be comparable to where we sit now as a tier one supplier.
It's comparable to Cummins margins currently is what we're driving towards, and we see a clearer path towards. Electrolyzers is probably the most current one where we see that. Battery electric and fuel cells still got some time to shake out in terms of how does that margin shake out. That's the goal for sure.
Chris, that takes us to 30 minutes already. I'm gonna say thank you very much.