Cummins Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 6, 2024

There are 12 speakers on the call.

Operator

Greetings. Welcome to Cummins, Inc. 4th Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen only mode. Please note this conference is being recorded.

Operator

I will now turn the conference over to Chris Kroulow, Vice President of Investor Relations. Thank you. You may begin.

Speaker 1

Thank you. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the Q4 and full year of 2023. Participating with me today are Jennifer Rumsey, our Chair and Chief Executive Officer and Mark Smith, our Chief Financial Officer. We will all be available to answer questions at the end of the teleconference. Before we start, please note that some of the information that you will hear or be given today will consist of forward looking statements within the meaning of the Securities and Exchange Act of 1934.

Speaker 1

Such statements express our forecasts, expectations, hopes, beliefs and intentions on strategies regarding the future. Our actual future results could differ materially from those projected in such forward looking statements because of a number of risks and uncertainties. More information regarding such risks and uncertainties is available in the forward looking disclosure statement in the slide deck in our filings with the Securities and Exchange Commission, particularly the Risk Factors section of our most recently filed Annual Report on Form 10 ks and any subsequently filed quarterly reports on Form 10 Q. During the course of this call, we will be discussing certain non GAAP financial measures, and we will refer you to our website for the reconciliation of those measures to GAAP financial measures. Our press release with a copy of the financial statements and a copy of today's webcast presentation are available on our website within the Investor Relations section at comens.com.

Speaker 1

With that out of the way, I'll turn you over to our Chair and CEO, Jennifer Rumsey to kick us off.

Speaker 2

Thank you, Chris, and good morning, everyone. I'll start with a summary of 2023 and discuss our Q4 and full year results. And then I'll finish with a discussion of our outlook for 2024. Mark will then take you through more details of our Q4 and full year financial performance and our forecast for this year. As I reflect back on 2023, I am incredibly proud of what Cummins and our employees accomplished for our stakeholders I feel energized about the opportunities ahead for us as we continue to demonstrate our relentless focus on being a global leader in clean energy technology and innovation.

Speaker 2

We made significant progress in achieving our Destination 0 strategy and it continues to be clear that this dual path approach to reducing greenhouse gas and air quality impacts of our products is the right approach to meet our customers' needs today and continue to grow our business and impact. We did this by advancing our core business as well as developing new 0 emission solutions through Accelera by Cummins. Most notably for our core business in 2023, we committed to investing more than $1,000,000,000 across our U. S. Engine network to support the industry's 1st fuel agnostic engine platforms as well as unveiled the X10 fuel agnostic series launching in North America in 20 26.

Speaker 2

Additionally, we initiated several collaborations with our natural gas X-fifteen engine, which will launch in North America this year and further enables our customers to achieve their decarbonization goals. This is the industry's 1st natural gas engine designed specifically for heavy duty and on highway truck applications, offering customers the opportunity to realize reductions in nitrous oxides and greenhouse gas without compromising performance. We are continuing to see strong interest from both OEMs and end users ahead of the launch later this year. In our Accelera business, we announced a joint venture with Daimler Trucks buses, PACCAR and EV Energy to accelerate and localize battery cell production and the battery supply chain in the U. S.

Speaker 2

We further announced this quarter the selection of Marshall County, Mississippi for the 21 gigawatt hour factory that is expected to create more than 2,000 U. S. Manufacturing jobs with production anticipated to begin in 2027. Accelera also reached a further milestone this year of electrolyzer order backlog totaling over $500,000,000 In order to meet the growing electrolyzer demand, we began production at our 1st U. S.

Speaker 2

Manufacturing location for electrolyzers in the Cummins Power Generation Facility in Fridley, Minnesota. Lastly, we are resolute about the leading role we play in the energy transition emissions compliance continues to be a critical element of this work and central to our values. We were transparent about this in December when we announced that we reached an agreement in principle to resolve U. S. Regulatory claims regarding our emission certification and compliance process for certain engines primarily used in our pickup truck applications.

Speaker 2

After 4.5 years of working diligently with the regulators, Reaching an agreement was the best way for us to achieve certainty on this matter and move forward with certifying our new products and advancing our Destination 0 strategy. We have expanded and strengthened our emissions compliance program to help ensure our Products comply with increasingly stringent emissions regulations around the world. Our Product Compliance and Regulatory Affairs Organization, which we launched in 20 has a reporting line directly to me and positions Cummins to meet global product compliance requirements and deliver solutions for our 2023 and cover some of our key markets. Demand for our products remained strong across many of our key markets and regions. Revenues for this quarter totaled $8,500,000,000 an increase of 10% compared to 2022, driven by strong demand across most global markets.

Speaker 2

EBITDA was a loss of $878,000,000 or negative 10.3 percent compared to positive $1,100,000,000 or 14.2 percent a year ago. 4th quarter 2023 results included $2,040,000,000 of costs related to the agreement to resolve U. S. Regulatory claims, $42,000,000 of costs related to a voluntary retirement and separation program and $33,000,000 of costs related to the separation of the Atmos business. This compares to the Q4 2022 results, which included $19,000,000 of costs related to the separation of the Atmos business.

Speaker 2

Excluding those items, EBITDA was $1,200,000,000 or 14.4 percent of sales compared to $1,100,000,000 or 14.5%. EBITDA dollars increased from a year ago as increased pricing and higher volumes more than offset increased selling, administrative research and development expenses and inflation costs. Research and development expense increased in the 4th quarter as we continue to invest in the products and technologies that will create advantages in the future, particularly in the Engine, Components and Accelera segments. In addition, operating cash flow for the Q4 of 2023 was very strong at $1,500,000,000 compared to $817,000,000 in the Q4 of 2022 as we continue to focus on working capital management within the business. 2023 revenues were a record $34,100,000,000 21 percent higher than 2022, Driven by the addition of Meritor and strong demand across most global markets, EBITDA was $3,000,000,000 or 8.9 percent of sales compared to $3,800,000,000 or 13.5 percent of sales in 2022.

Speaker 2

2023 results include $2,040,000,000 of costs related to the agreement to resolve U. S. Regulatory claims, the voluntary headcount reduction program I noted previously $100,000,000 of costs related to the separation of the filtration business. This compares to our 2022 results, which included $111,000,000 of costs related to the indefinite suspension of operations in Russia and $81,000,000 of costs related to the separation of the filtration business. Excluding those items, EBITDA was a record $5,200,000,000 or 15.3 percent of sales for 2023, compared to $4,000,000,000 or 14.2 percent of sales for 2022 as the benefits of higher volume and pricing Exceeded increased selling, administrative, research and development and inflation costs.

Speaker 2

EBITDA percent improved year over year in the Distribution, Components and Power Systems segments. Our Power Systems business in particular finished 2023 with a full year EBITDA of 14.7 percent of sales, up from 12.2% in 2022. This segment completed the 1st year of their focused business transformation effort and the improvement in performance is encouraging. You will see from our guidance that we expect further margin gains this year. In addition to our segments, Meritor finished 2023 with full year EBITDA of 10.8% of sales, up from 7.4% in 2022 as our employees did a tremendous job of executing value capture opportunities across the business.

Speaker 2

I'm very pleased with the performance of Cummins Meritor to date as we continue our program to improve margins in that business and expand its global reach. In addition, operating cash flow for 2023 was a record of $4,000,000,000 A significant increase from $2,000,000,000 in 2022. I'm proud of our leaders and employees' efforts in 2023 as they help deliver on one of our Primary focus areas. Strong cash generation will continue to be a top priority moving forward. Now let me provide our overall outlook for 2024 and then comment on individual regions and end markets.

Speaker 2

Our 2024 guidance continues to include Atmos for the full year, but excludes any costs or benefits associated with the planned separation of that business. We are forecasting total company revenue for 2024 to be down 2% to 5% compared to 2023 and EBITDA to be in the range of 14.4% to 15.4% of sales, as we anticipate slowing demand in some of our key regions and markets, particularly North America heavy duty truck. Early in 2024, we expect the heavy duty market to continue at its current rate, which is slightly off the peak of the first half of twenty twenty three with further softening in our forecast in the second half of the year. Industry production for heavy duty trucks in North America is projected to be 245,000 to 265,000 units in 2024, a 10% to 15% decline year over year. In medium duty truck market, we expect market size to be 140,000 to 150,000 units, down 5% to flat compared to 2023.

Speaker 2

Our engine shipments for pickup trucks in North America are to be 135,000 to 145,000 units in 20.24, a 5% to 10% decline year over year as we to launch our model year 2025 in Q4. In China, we project total revenue including joint ventures to increase 3% in 2024. We're projecting a range of down 5% to up 10% in heavy duty and medium duty truck demand and expect a range of down 5% to up 5% and demand in light duty truck market. We expect replacement demand to be the biggest driver, the effect may be weakened by a sluggish economy and moderating export demand. Despite the slow pace of recovery in the China truck market, We expect to see continued strong performance for the 15 liter natural gas engine as we achieved approximately 20% share for 2023 the heavy duty market.

Speaker 2

In India, we project total revenue including joint ventures to increase 9% in 2024, primarily driven by strong power generation and on highway demand. We expect industry demand for trucks to be flat to up 5% for the year. For global construction, we expect a 5% to 15% decline year over year, primarily driven by weak property investment and shrinking export demand in China. We project our major global high horsepower markets to remain strong in 2024. Revenues in the global power generation market are expected increased 5% to 10% driven by continued increases in the data center and mission critical markets.

Speaker 2

Sales of mining engines are expected to be down 5% to up 5%. While a small market for us, demand for oil and gas engines is expected to decrease by 40% to 50% in 2024, primarily driven by decreased demand in North America. And for aftermarket, we expect a range of flat to an increase of 5% for 2024 as we expect to be largely through inventory efforts and destocking that happened throughout the industry in the second half of twenty twenty three. In Accelera, we expect full year sales to be $450,000,000 to $500,000,000 compared to the $354,000,000 in 2023. We have a growing pipeline of electrolyzer orders, which we expect to deliver over the course of

Operator

the next 12 to 18 months,

Speaker 2

as well as expect continued growth in Electrified Components. In summary, 2023 was a record year for revenues and operating cash flow. Excluding the impacts related to the agreement to resolve U. S. Regulatory claims, 2023 was also a record year for EBITDA, net income and earnings per share.

Speaker 2

While 2023 revenues were at the high end of our expectations, We anticipate moderating demand in North America truck production in the second half of twenty twenty four. We expect this moderating demand to be partially offset by a strong power generation market, resiliency in our distribution business given the strong aftermarket presence and improved Accelera sales. In addition, we are taking steps to reduce cost, optimize our business and position Cummins for continued success in 2024. We are in a strong position to keep investing in the future, bringing new technologies to customers and returning cash to our investors. As I close, I would like to officially announce that our Analyst Day is now scheduled for May 16 in New York City.

Speaker 2

I look forward to further discussing our strategy and expect invitations to be sent out shortly. Now let me turn it over to Mark, will discuss our financial results in more detail. Mark?

Speaker 3

Thank you, Jen, and good morning, everyone. I will acknowledge of a heavy This morning. So if I sound more dour than usual and a little rougher, please take that into consideration. We delivered solid operational results in the Q4 exceeding our expectations for revenue and delivering EBITDA margins in line with our guidance. Compared to 2022, our full year sales grew 21% and our operating cash flow more than doubled to a record $4,000,000,000 reflecting the strong focus of our employees on meeting customer demand and improving working capital.

Speaker 3

Now let me go into more details on the Q4 and full year performance. Q4 revenues were $8,500,000,000 and EBITDA was a net loss of $878,000,000 or negative 10.3 percent of sales. For the full year, we reported revenues of a record $34,100,000,000 and EBITDA was $3,000,000,000 or 8.9 percent of sales. As Jen mentioned, we recorded a one time charge of $2,040,000,000 in Q4 to settle the previously disclosed U. S.

Speaker 3

Regulatory claims. 4th quarter results also included $42,000,000 of costs associated with the voluntary retirement and separation programs. Costs associated with the planned separation of Atmos were $33,000,000 in the 4th quarter and $100,000,000 for the full year, compares to $19,000,000 in the Q4 of 2022 and a total of $81,000,000 in the previous year. Full year 2022 results also included $111,000,000 of costs related to the indefinite suspension of our operations in Russia. To provide clarity on the Q4 and 2023 Full year operational performance of our business, I'm now excluding the costs associated with the regulatory settlement, voluntary retirement separation flow programs, planned separation of Atmos and the indefinite suspension of our operations in Russia in my following comments.

Speaker 3

Q4 revenues were $8,500,000,000 an increase of 10% from a year ago. Sales in North America increased 8%, driven by improved pricing across multiple end markets and stronger demand for power generation products. International revenues increased 13%, driven by strong global power gen demand, particularly for data centers. EBITDA was $1,200,000,000 or 14.4 percent of sales for the quarter compared to $1,100,000,000 or 14 point 5% of sales a year ago. Improved pricing was offset by higher compensation costs, increased investment and development and capabilities now in Accelera segment.

Speaker 3

Higher variable compensation costs were driven primarily by stronger operating cash flow, which exceeded our expectations for the quarter and the full year. Now I'll go into each line item with a little bit more detail. Gross margin was $2,000,000,000 or 23.7 percent of sales, an increase of $201,000,000 or 30 basis points from the prior year. The improved margins were driven by favorable pricing and higher volumes, partially offset by higher product coverage costs and compensation expenses. Selling, admin and research expenses increased by $4,000,000 or 15% as we continue to invest in the development of new products that will drive growth and also due to higher variable compensation costs.

Speaker 3

Joint venture income increased $25,000,000 due to slowly recovering demand in China from a low base in 2022. Other income was $50,000,000 an increase of $17,000,000 from a year ago, primarily due to the recovery of technology fees from customers in the Q4. Interest expense was $92,000,000 an increase of $5,000,000 from the prior year, driven by higher interest rates on the floating rate portion of our debt. The all in effective tax rate in the 4th quarter was negative 13 3%, principally due to non deductible costs associated with the regulatory settlement. All in net loss for the quarter was $1,400,000,000 or negative $10.01 per diluted share, which includes $2,040,000,000 or $13.76 per diluted share of costs associated with the regulatory settlement $42,000,000 or $0.22 per diluted share of costs associated with the voluntary retirement and separation programs $33,000,000 or $0.17 per diluted share of costs associated with the planned separation of Atmos.

Speaker 3

Operating cash flow was an inflow of $1,500,000,000 $642,000,000 higher than the Q4 last year, driven by strong earnings and a lower expansion of our working capital across the business. For the full year 2023, revenues were a record $34,100,000,000 up 21% or $6,000,000,000 from a year ago, driven by the inclusion of a full year of Meritor results and strong organic growth. Sales in North America increased 22% and international sales increased 20%. Within those numbers, organic sales growth was 12%, driven by improved pricing, strong global demand for power generation products, continued strength in the North American truck market and slowly improving economic conditions In China, EBITDA for the year was $5,200,000,000 or 15.3 percent of sales for 2023, an increase of $1,200,000,000 or 110 basis points from the prior year. The increase in EBITDA percent was driven by higher volumes, favorable pricing and logistics costs and a modest and favorable mark to market impact from investments that underpin our company owned life insurance plans, all of that partially offset by higher compensation expenses.

Speaker 3

All in net earnings were $735,000,000 or $5.15 per diluted share compared to $2,200,000,000 or $15.12 per diluted share a year ago. 2023 net earnings include $2,040,000,000 or $13.78 per diluted share of costs related to the regulatory settlement, $100,000,000 or $0.54 per diluted share of costs related to the separation of Atmos, $42,000,000 or $0.22 per diluted share of costs related to the voluntary separation programs that we implemented during the 4th quarter. Full year cash from operations is a record inflow of $4,000,000,000 doubling from a year ago as a result of higher operating income and much lower expansion of working capital across the company. Capital expenditures in 2023 were $1,200,000,000 in line with our forecast and an increase of $297,000,000 from 22 as we continue to invest in the new products and capabilities to drive growth, particularly related to the fuel agnostic platforms within our core business. Our long term goal is to deliver at least 50% of operating cash flow to shareholders.

Speaker 3

And over the past 5 years, we've returned 56% of operating cash flow in the form of share repurchases and dividends. In 2023, we focused our capital allocation on organic investments and dividend growth, returning $921,000,000 to shareholders via the dividend and debt reduction following the acquisition of Meritor. We currently expect that our priorities for cash deployment in 2024 will mirror those of last year. I'll now summarize the 2023 results for the operating segments and provide guidance for 2024. If I need to say it again, I will that the results that I'm going to discuss going forward exclude the costs related to the separation of Atmos, the costs associated with the voluntary retirement and separation and the costs associated with the indefinite suspension of our operations in Russia in 2022.

Speaker 3

Components segment record revenues were record $13,400,000,000 38% higher than the prior year. EBITDA was 14.4 percent of sales compared to $14,200,000 an increase of $540,000,000 or 40%. For 2024, we expect total revenue for the components business to decrease 2% to 7% and EBITDA margins to be in the range of 13.9% to 14.9%. For the Engine segment, 2023 revenues increased 7% to a record $11,700,000,000 And EBITDA was 14.1 percent of sales compared to 14.3% a year ago. In dollar terms, EBITDA increased $74,000,000 or 5%.

Speaker 3

In 2024, we project revenues The engine business will decrease 2% to 7% due to expected moderation in the North American truck heavy duty truck market, most likely in the second half or most prominently in the second half of the year. 2024 EBITDA is projected to be in the range of 12.5 13.5%. In the Distribution segment, revenues increased 15% from a year ago to a record $10,200,000,000 EBITDA increased by 28% and improved as a percent of sales to 11.8% compared to 10.6% a year ago. We expect distribution revenues to be down between down 3% and up 2% and EBITDA margins to be in the range of 11.4% to 12.4% for the full year. In the Power Systems segment, revenues were also a record of $5,700,000,000 or 13% higher than last year.

Speaker 3

EBITDA was 14.7 percent or 2.50 basis points higher than 2022, driven by favorable pricing, strong volume and certain cost reduction actions. In 2024, we Power Systems revenues to be down 3% to up 2% and EBITDA in the range of 15.2% to 16.2%. Accelerate revenues increased to $354,000,000 in 2023 with a net loss at the EBITDA level of $443,000,000 In 2024, we expect Axela, lots of A's and A's. We anticipate that Axela revenues will increase in the range of $450,000,000 to $500,000,000 and net losses to reduce to between $400,000,000 $430,000,000 as we continue to make targeted investments in future technologies whilst improving the operating performance of our current products. We currently project 2024 company revenues to be down 2% to 5% and company EBITDA margins in the range of 14.4% to 15.4%.

Speaker 3

Our effective tax rate is expected to be approximately 24% in 'twenty four, excluding any discrete items. Capital investments will likely be in the range of $1,200,000,000 to $1,300,000,000 as we continue to make critical investments to support future growth. To summarize, we delivered record sales and strong operating profits in 20 cash generation has been and will continue to be a strong focus as we enter 2024, enabling us to continue investing in new products even during times of economic uncertainty, returning cash to shareholders and maintaining a strong balance sheet. As Jen indicated, we do expect moderation in several of our key markets in 2024, especially in the U. S.

Speaker 3

Truck market as reflected in our guidance. We've already taken actions to reduce costs in the business and in a good situation to navigate the economic cycle, improve our cycle over cycle performance in 2024. Subject to our mark to market conditions, Our intention is to split off the remaining ownership in Atlas through an exchange offer as our next step in the separation as we seek to reposition our portfolio for the future. As part of the proposed exchange offer, common shareholders will have the choice to exchange all, Some or none of their shares of common stock, the shares of Atmos common stock subject to the terms of the offer. The exact timing of our decision to launch an exchange offer will, as stated earlier, depend on market conditions, But the launch of the tender could occur as early as in the coming days.

Speaker 3

Our guidance for Cummins for this year assumes the inclusion of Atlas Now consolidated results for the entirety of 2024 and excludes any costs or benefits of the separation. The benefits to Cummins are expected to include a lower number of shares outstanding upon completion of the exchange. We will update our guidance as and when the separation is completed. Thank you for your interest today. Now let me turn it back over to Chris.

Speaker 1

Thank you, Mark. Out of consideration to others on the call, I would ask that you limit yourself to one question and a related follow-up.

Operator

Our first question is from Jerry Revich with Goldman Sachs. Please proceed.

Speaker 4

Yes. Hi. Good morning, everyone.

Speaker 1

Good morning, Jay. Good

Speaker 4

morning, Jay. Jennifer Mar, Chris. So normally, when you folks Have new engine regulations, we tend to see higher margins from you folks. I know we're a couple of years out the 27 regulations, but can you just share some high level thoughts? It looks like the average selling price of engine could double given the embedded warranty increase.

Speaker 4

And I'm wondering if you could just comment on that and then broadly just talk about the parameters of How do you expect the dynamic to play out for your business compared to the margin expansion we've seen on prior mission cycles where you folks increased your value add? Thanks.

Speaker 2

Yes. Thanks for the question, Jerry. So as you've seen from us in the past, as we launch product with new emissions regulations typically we see a content increase, of course, and then also look at creating value for our customers and have an opportunity to price accordingly with them. So we are looking to continue to do that as we launch new products, in particular these fuel agnostic engine platforms. Of course, we also typically see a bump up in our warranty costs because we are beginning to crew in at a high rate until we've demonstrated capability of that platform.

Speaker 2

So that's the other factor to watch as we launch those products. But what you see us doing right now is really focusing on improving operating performance of the business, as well as investing in these key platforms for the future that we believe will bring value to our customers and position the company for profitable growth.

Speaker 4

Okay, super. And then can I ask separately, given the high logistics costs that the industry saw in 2023, can you comment on where your labor hours per unit stand today versus normal? And to what extent Could that be a source of upside relative to the guide?

Speaker 1

Yes, Jay, I think that has been as we progress through 2023 continue to drive more and more efficiency. Some of the supply chain hiccups that we have experienced are beginning to iron out. We're getting better on time delivery And that does allow us to drive more efficiency in our plants. So I think we are continuing to see that as we progress through the latter half of the year. As we expect, as both Jen and Mark mentioned, volumes to particularly in the North America heavy duty truck space come down a bit and moderate a bit, we can continue to drive those efficiencies.

Speaker 1

So I think the cost for labor hour will continue to get better. And I would say the overall costs on labor have somewhat leveled out. We went through, as you know, a long period of them rising. And through the course of the last 6 months, that has settled down and become much more of a flat.

Speaker 3

Yes, I would say in the near term there's a little bit of increased anxiety about events in the Middle East and some shipping delays and some Reversing of the trend we've seen in logistics costs, which have been actually going down for us, Jerry. I don't want to overstate that. It's obviously is a little bit of a concern in the near term.

Operator

Our next question is from Tim Thean with Citigroup. Please proceed.

Speaker 5

Thanks. Good morning. And maybe just one

Operator

A bit

Speaker 5

of a clarification, but on the comments on for engine shipments in North America for on highway, I think You said 100 and call it 140,000 down 5% to 10%. Is that was that relative to the total heavy and medium duty market or was that a comment just on heavy duty

Speaker 1

Yes. So on the medium duty, Tim, we had it down 5% to flat And that's 140% to 150%. The heavy duty market, we have it down at 10% to 15%, and that's Our guide for the year, so.

Speaker 2

And I'll just give a little color. I mean, this has been an unusual cycle. I think you're all Seeing that with very high usage of trucks in the 2021, 2022 timeframe and supply constraints that prevented the industry from Fully meeting customer demand, and that has improved over the course of 2023. We saw the markets peak really in the second quarter and saw some slight drop off in the second half, but to the high end of our guide. It was not as much as we had forecast going into Q1.

Speaker 2

Backlogs look strong, in particular feeling and further softening as we go into the second half of the year. So that just some color behind those numbers is how I would describe that.

Speaker 5

Okay. I have a question on kind of what that implied in terms of the market share, but I can follow-up with Chris after. And then maybe the second one is just On the implied decrementals for the engine segment in 2024 and obviously the kind of a high 30s percent number. The JV income will certainly be a drag on that. But maybe not to go through every single piece, but The parts headwind was pronounced in 'twenty three for Cummins.

Speaker 5

And I'm just curious for that piece specifically, You outlined that the guidance for the off highway parks outlook, but for that And anything else that maybe you'd call out that's relevant to the year over year margin performance for engines? Thank you.

Speaker 3

Yes. Good question, Tim. And the main thing that you didn't cover there was just our assumptions around product coverage. We're not expecting any significant change, But baked into our guidance is a little bit higher product coverage or warranty as a percent of sales in the engine business. We'll see how that plays out, but That's the other factor that's in there that you didn't list.

Operator

Our next question is from David Raso with Evercore ISI. Please proceed.

Speaker 6

Hi, thank you. Just sort of a bigger picture question. I know there's been a lot of costs involved and you're right in the thick of course of a, call it, a decade long energy transition that there's a lot of expenses. I'm just curious if you look out over the next year or 2, is there an inflection point that you see your cost begin to recede? And if not, is there a thought of maybe a larger cost out program?

Speaker 6

I recognize the separation program you discussed, but just something of maybe more substantial size just given relative to other names we look at. They've had a Real strong run on profitability the last couple of years and it's been a little more of a challenge for your margins. So just curious if you see something on the horizon that really changes that, be it cost inflection or maybe an idea you've proactively I mean, sorry, spend inflection coming down or something on the cost side that maybe you can do? Thank you.

Speaker 2

Yes, David. Thanks for the question. First I'll say, I think you said decade long energy transition. I would just Put an S on that, decades long, right? It's going to take time.

Speaker 2

The reality is if you look across our different markets and regions, it's going to take time for that transition to occur. We are in a period though of really peak investment in the engine business. As we invest in these fuel engine platforms, we've got a major investment in R and D and capital to do that. And we think that those engines are going to really position as well with high efficiency diesel products as customers have and continue to decide not to invest in their own platforms and to use Cummins and then also the Fuel flexibility that will help customers as they begin to transition, whether it's natural gas or hydrogen based engine solutions. And so the next few years until we launch those platforms in the 2026, 2027 timeframe, we're seeing higher levels of R and D in those products.

Speaker 2

And then of course, we're also in a period where we've got somewhat lower revenue and higher investments in the in the Accelera business and we are pacing that investment based on how we see the market moving. We're looking at opportunities to share investments While having a leading solution like you saw us do with the battery cell joint venture, As revenues grow, we improve parts of those businesses and electrified components. We've now delivered 1500 buses with Bluebird and ramping up the electrolyzer that will help improve margin performance of the business there. And then the last thing I'd say is, as Cummins has done and we will continue to do. We're looking at how do we improve different parts of our business.

Speaker 2

And so following the acquisition of the North America Distribution business, we had a focused investment on improving margin there and you see that playing out in the distribution business performance. I talked about the focus last year that started in our Power Systems business. You see that playing out there, the Meritor integration and we're continue to look at places that we can improve operating performance of our business and then watch market demands and cost. And so the voluntary reduction actions that we took last year help us as we see some reduction in revenue this year. So all those things come together to allow us to continue to improve our returns to investors while making sure we're investing in key products and technologies for the future.

Speaker 6

All right. Thank you. And just for looking at your mind real quick and I'll hop off. The cadence of the declines in North America truck that you're looking to experience as the year goes on. Can you give

Speaker 3

us a little sense of

Speaker 6

the cadence maybe from an industry perspective And would your declines, the cadence be any different? Just the idea of the lead lag between what's in inventory, How early you ship? Just trying to get a sense for the cadence and how you relate to the industry cadence? Thank you.

Speaker 2

Yes, great. So obviously, there's some lead that we have in supplying engines into truck build. So our engine build rates will slightly lead truck build rates. But as I said earlier, from a guide perspective, we think where we were running as we ended the year is going to hold pretty steady through the 1st part of the year and then we're forecasting some softening toward the end of second quarter and into the second half of the year.

Speaker 3

In a medium duty truck, there really isn't that much difference between the 2, market and ours and then heavy duty, that's where we see Little bit more vulnerability for the market and would largely expect us to move in line with the market. Yes.

Speaker 2

And then the last dynamic is in pickup. We've got the product change that will drive Q4 volumes lower and pickup.

Operator

Our next question is from Angel Castillo with Morgan Stanley. Please proceed.

Speaker 7

Hi, good morning. Thanks for taking my question. I just wanted to unpack that cadence for the second half a little bit more. I think last quarter you had indicated Aftermarket was an area that maybe was giving you a bit of a signal that there was a bit of a softening. And I think you indicated that things came in at maybe the higher end of your expectations You kind of see that continuing into the first half.

Speaker 7

So as we kind of position that second half slowdown and now an expectation for aftermarket to pick up from be kind of flat to up 5% through the year. Can you tell us, I guess, what you're seeing in terms of customer commentary and any kind of signs or what kind of gives you confidence in that second half slowdown and as we think about the year?

Speaker 1

Yes, I'll have a go first go at that question.

Speaker 3

First of all, I just say on aftermarket, we saw a very pronounced, I would say some element of destocking or lower production across our lower demand in parts in Q4, which we largely attribute to Customer cash flow management, we don't expect that to be a continuing trend. We expect to recover from Q4 levels on parts and be pretty steady across the year. On the truck builds, well, of course, you've heard from most of our major customers. So we really don't have much more to say other than The backlog of trucks has been slowly edging down. And then the thing that gives us the broader concern is the spot rates and the health of the truck fleet operators.

Speaker 3

That's our principal concern. It's not our OEM customers. And right now, the backlog And the orders still continue at quite decent levels. It's what's happening to the underlying economics of Freight activity, that's what's giving us the concern combined, which hasn't been moving in the right direction, combined with the slowly easing heavy duty backlog. So it isn't kind of pronounced downturn we might have seen in price cycles at this point, But that's those are the factors that are weighing into our consideration.

Speaker 3

And I think our guidance isn't more conservative than anybody else's. We don't have any other observations beyond those really.

Speaker 7

Got it. That's helpful. Then maybe pivoting to Accelera, I just wanted to maybe unpack that a little bit in terms of curious what you're seeing in the backlog trends from 3Q to 4Q? And As you kind of deliver on at least on electrolyzers over the next 12 to 18 months, can you talk to us, I guess, about the cadence of the profitability of that We kind of exit 2024 and you start to have higher deliveries on those and maybe what kind of foresee the exit rate will be in terms of that profitability?

Speaker 2

Yes. So we are in a period of still pretty heavy investment in the Accelera businesses are really making both R and D and manufacturing investments to scale up the product. And we're fortunate we have existing plant in Fridley that we can invest within to do that, to begin to produce electrolyzers and we continue to see growing demand and backlog is as I noted at a record level for electrolyzer. So that production rate is going to begin to grow and then you'll see margin Performance in the electrolyzer portion of the business improving as the revenues grow, and we deliver that backlog out into the market. Same thing in our components business as we see revenue growth there, you'll see margin performance improvement.

Speaker 2

One thing we have now included in our 24 investment of course is beginning to invest in the battery cell joint venture and we believe that that is a key investment that we're making together to ensure we have a leading sell for commercial vehicles here in the U. S. And domestic supply, which will both allow us and our customers to take advantage of incentives that are available and ensure security of supply over time into this market.

Operator

Our next question is from Rob Wertheimer with Melius Research. Please proceed.

Speaker 8

Yes, hi. I wonder if you could give us some thoughts on what's happening in the data center and large engine market. I mean, obviously, it's very strong. I don't know how many years of visibility you have or what that market looks like. Your primary competitor announced a capacity expansion.

Speaker 8

I don't know where seeing your room to grow into that market if it is a multi year kind of curve. So I wonder if you could kind of give us an update on dynamics there.

Speaker 2

Yes. The data center market is an exciting growth market, has been for several years. The trend with increasing cloud Data storage in the cloud and now with artificial intelligence and other investments, we continue to see very strong demand. We guided up 10% to 15%. Backlog for that market is very, very strong.

Speaker 2

We're looking at our capacity to make sure that we can meet the market demand and feeling good about the product offering that we have. And of course, that business and the focus on improving underlying the performance of that business will help us as that market grows.

Speaker 3

Probably the clearest secular trend over the next couple of years.

Speaker 2

I don't yes, I think it will continue.

Speaker 8

And then do you have room to grow in 'twenty five and 'twenty six? Maybe I don't want to share too much on your capacity, but it seems as though You're probably being asked to quote or to think about capacitor that far out, right? Yes.

Speaker 2

I will just say we expect that that trend of data center market growth will continue. And we are and we'll continue to look at our capacity and how we position to meet that demand.

Speaker 8

Okay, perfect. I'll stop there. If I can sneak one more in on medium duty, there's a bit of a narrative that as COVID just constrained production, the OEMs prioritized large Class 8 over the medium duty and that's reflected somewhat in industry outlooks in year out. I'm just wondering if medium duty has more inherent demand than that being helped by interest rates or anything else or if that's kind of where the market is kind of flattish? I'll stop

Speaker 2

Yes, I mean there were certainly the OEMs experienced a number of supply chain constraints and continued in 2023 and even into the early part of this year frame rails in particular. So we are, as you saw, really expect the medium duty market to continue to hold pretty flat to where it is now. It's quite strong. We, of course, have a strong position in that market and we're seeing continued demand and pent up demand from some of the customers in that market for our product.

Operator

Our next question is

Speaker 2

So less softening there than happy duty.

Operator

Our next question is from Tami Zakaria with JPMorgan. Please proceed.

Speaker 9

Hi, good morning. Thanks for taking my questions. So I think you highlighted, DV adoption scenarios at your last Analyst Day. As of Today, I know you're hosting another Analyst Day this year, but as of today, which scenario the fast versus slow seems more likely and how do you think that affects your Axelera target of $6,000,000,000 to $13,000,000,000 revenue 2030. So any updates on that?

Speaker 2

Yes. As you said, we did kind of a low and a high scenario for adoption at our last Analyst Day and you can expect that we're going to refresh our view of that As we go into the Analyst Day in May, what I would say is that there are regulations and incentives that are helping to start to drive that adoption Maybe more towards the lower end of those scenarios is what we would think and we are continuing to look at pacing of investment to make sure that we're to make sure that we're managing that in line with how we see adoption actually occurring.

Speaker 9

Got it. So if it's more leaning toward, let's say, the slower version, does that have dampening or Somewhat negative or slowing impact on the Axleira targets that you have out there?

Speaker 2

Yes. I mean, we're still within it would still fall within the range that we gave in the Analyst Day consistent with those range of scenarios that we suggested and recall that a portion a large portion of that revenue in 2,030 for Acceleriz and the growth of the electrolyzer business as well.

Operator

Our next question is from Noah Kaye with Oppenheimer and Company. Please proceed.

Speaker 10

Thanks so much. First sort of a housekeeping question, I'm just trying to understand Cash flow dynamics as we exit the year and the leverage profile, obviously the settlement impacts that a bit. But You typically have a target to return 50% of cash flow to shareholders.

Speaker 11

How are

Speaker 10

we thinking about return to capital this year and where you're kind of aiming to end the year on leverage?

Speaker 3

Yes. So Morning, Noah. So we're going to start the year with the same stance as last year, invest in the business, dividend focus And some more delevering, that's the way we started in the year. We'll continue to evaluate that with our Board As we see how the cycle unfolds, at least that's our initial stance. Of course, part of our in years where we've generated more cash than we've needed, then we've returned significantly more than the 50% in any given year.

Speaker 3

But anyway, we think this is the wisest approach right now until we see a little bit more on the cycle.

Speaker 10

So you do expect to delever as we get to the end of the year? Yes. Yes. Okay. And then just the guide for China truck seems a bit wide.

Speaker 10

Can you kind of talk us through the low end and the high end of the range in terms of the scenarios you're envisioning? Is it high end contingent on stimulus? Just walk us What you're seeing and assuming?

Speaker 3

Yes. That really reflects low visibility, right. So we've come off a very Yes, weak base, but there just isn't clear signals yet from the market as to what's actually going to happen, so we can build a case. It's hard for me to think of a case that's a lot lower than where we are today. But just the overall pace of the economy continues to be sluggish.

Speaker 3

And so that upside really leaves room for something unexpected on the stimulus side, which has happened from time to time in China. But we don't have brilliant insight at this point in time. The outlook is cloudy, and the conviction from OEMs is not quite there yet. We're doing well with our customers, launching more products. We're bullish on continuing to outgrow In the market in China, both consolidated revenues and in the performance of the JVs, So we're all set to outperform.

Speaker 3

We just need a little bit of help from the market overall. But it's not as tangible as we'd like at the start of the year. And of course, we'll look at the same data points and provide you with an update. Hopefully, by the end of Q1, tend to have a stronger view of the

Operator

Coming out of the Chinese?

Speaker 3

Yes. And my voice is done for the rest of the morning, I think.

Speaker 2

Chris and I will answer the rest of the questions.

Operator

Our final question is from Michael Feniger with Bank of America. Please proceed. Yes.

Speaker 11

Thank you guys for squeezing me in. Just the share count has been kind of flat to slightly up. There was a comment in the release about a focus on debt reduction, payment of dividends. Can you just flesh out the priorities in 2024 because I know Mark mentioned with Atmos, I heard buybacks. Just maybe you can reiterate the framework of how we should kind of think about Atmos in 2024 as we move through the years, some of the puts and takes there?

Speaker 3

The main impacts of Atmos operation will be obviously they will set off on their own pursuing their growth strategy and is this final step, we will swap common shares for Investors will retire common shares in exchange for Atmoshares. So our share count will go down if the exchange is successful. The reason our share count here in the past 18 months hasn't been changing or drifting up is because We stopped the share repurchases while we delevered post the Meritor acquisition, which we've been telegraphing to investors. We've got a little bit more of deleveraging to go and then we'll continue to evaluate whether we what our opportunities are to generate the best returns through investors either through organic growth or through more capital returns. But that's the basic way it's going to work.

Speaker 3

The share count will go down on the separation.

Speaker 11

Fair enough. And Mark, I want to let you go and get better. Just quick question for you is just on Meritor, I think 23, I think there's revenue about $4,800,000,000 maybe EBITDA a little bit above $500,000,000 Just when we think of the guide for 24 on components, you can help us unpack about how that Meritor in 'twenty three, how that kind of trends in 'twenty four relative to your overall components guide? Thanks, everyone.

Speaker 3

And I will say I'm feeling better than I sound and that's largely because of the record cash flow. So please, as I said at the start, don't read into my breaking voice. Meritor achieved the goals we had for this year. It is not a segment on its own. We provided that data for the 1st full year For transparency purposes to make sure investors had a read on how we were doing after a little bit of a bumpy start when we first Acquired Meritor.

Speaker 3

So that's all rolled into the guidance, but it's safe to say we've got further improvement in Meritor going into 2024 and we're really pleased with how team is doing that, Ken Hogan and his team. So we're excited about that going forward. So thank you. Thanks, everybody. Appreciate it.

Speaker 3

Thank you.

Operator

This will conclude our question and answer session. I would like to turn the conference back over to Chris for closing comments.

Speaker 1

Thank you, everybody. That concludes our teleconference for the day. I appreciate all of you participating and your continued interest. As always, the Investor Relations team will be available for

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Earnings Conference Call
Cummins Q4 2023
00:00 / 00:00