Cummins Q2 2024 Earnings Call Transcript

Yes, maybe I'll start on the sequential bridge, Joe. Thanks for the question. Good morning. So I would say, really as we bridge from the first quarter to the second quarter, it's really primarily a volume story. Volume was up about $8 million in total revenue, which converted to about a 30 basis point benefit. In addition to that, we also saw some benefits from an absorption standpoint, as we had really strong performance across our manufacturing footprint in the second quarter. And as we look towards the back half of the year, we would expect some softening in terms of hours in the plants and production levels.

So that's really what drove. We did have a few other moving pieces if you recall, we had some headwinds from a freight perspective in the first quarter, which did not repeat in the second quarter, and a little bit of tailwinds from warranty. But mostly it was a volume story in the plants and just really strong performance in the second quarter and really the first half overall. Maybe I'll turn it to Steph if you want to talk about kind of the first half, second half story.

Yeah, I think that's great. Hi Joe, good morning. Firstly, as I talked about in my market outlook, I think we see a drop off in the second half relative to the first on volume, and the driver of the margin associated is really very much volume-related. So the two big drivers of the volume declines, second half versus first half is really firstly the first fit decline, which we've been discussing for some time now and is broadly aligned with previous expectations. But in addition to that, I would say on the aftermarket side, freight activity, we were expecting to turn positive by now. We've been in a long and subdued decline on freight activity, but that turn in the aftermarket or freight activity we're now seeing later in the year of 2024 and perhaps early into 2025.

So really volume drivers leading to a lighter second half relative to first half that is driving the margin outcomes. I certainly acknowledge that it implies a challenging decremental margin environment. We have certainly delivered strong incrementals as well, and this still implies a midpoint of 19% adjusted EBITDA in our guide, and that delivers strong incrementals year-over-year is how I'm thinking about it. We are still establishing a standalone company. Obviously, the cost structure that goes with standing up as a separate company and separating activities from Cummins and we expect to see growth into the horizon. So don't really expect to be taking short-term costs out if you like. Hence, the decline you see in margins in the second half is really directly related to the volume story.

So let me talk about the outperformance. We do feel that we've demonstrated outperformance in the first half in share, in aftermarket, and we see that the way that we've assumed in our guide, we believe that will continue here through the second half, and we have strong confidence in that. And so that's, I'd say that continuing at this trend. I think the variable that is a little more unknown for us is just really when does the freight activity turn. There's a lot of uncertainty in the market around that. I think it's certainly a prolonged downturn period that we're experiencing.

And so right now we've assumed that happens into the back half year of 2024. I think there's just a question of how that plays out. But we've taken a view that we're not going to see much recovery of that inside 2024, and we're going to still see downwards pressure in freight activity, and that's what's implied in our guide.

Yeah. Good morning, Tami. Great to speak to you and thanks for the acknowledgement on the strong quarter. I guess two dynamics playing out here that I would club together. I'd broadly say our downturn on market in the first half in aftermarket was about 2%. We offset that by just under 1% in destock in the first half. What we're going to see in the second half is still strong downturn. So down between that 2% to 4% at the -- 3% at the midpoint. And then you've got destocking playing a positive role that offsets that slightly more here in the second half.

We saw destocking really start to -- start with our customers last year in the second quarter, and customers did that at different pacing throughout the year and it spread out through the quarter. So that's the two dynamics at play.

Similarly, declining market conditions offset by more favorable tailwinds on destock in the second half.

That's right, Tami. And the big driver of that is the first-fit market decline. So, particularly in heavy-duty truck or Class A truck, that has certainly been implicit in our guide, but that's the big driver of the decline year-over-year.

Absolutely. Good morning, Rob. Certainly, I just comment on the overall, I think you've crafted it right. We've tried to give a more complete picture in our opening comments, this time on aftermarket. So, I think, we may have got ourselves caught up a little bit in the comparisons between the calls of flat to 5% versus the flat to 2%. The flat to 2% really reflected a view of the market story previously only, and now we've tried to give the more comprehensive view of aftermarket revenues.

So if you think about a midpoint, we were assuming of market previously of 1%, we're now saying that it's between 2% to 4% down. So a midpoint of 3% down, that's what we've seen, is the sort of decline in market conditions in the aftermarket, completely driven by a push out of a positive inflection of freight activity. So that's just a link to the market story.

We've continued to see ongoing share gains in the aftermarket is how I would describe it. Very strong in North America from a geographic perspective is where I would characterize it. Really driven, I would say, by a combination of the activity of improving our distribution network, access to our products. You heard in my opening comments that we've been very deliberate on building brand presence with a new campaign on filtration science and how our fleetguard products protect. And really think that the combination of these factors are building greater awareness of our product in the aftermarket coupled with a much stronger distribution capability to be able to service that, is how I would broadly characterize those wins.

Sure. I was really excited to be able to launch the capital returns program. I know it's something I've been asked about for most of this year as we started out 2024. So I feel really good about that as I think about the share repurchase program. This really gives us now the mechanics and the tools to be able to return cash to shareholders as we move forward and balance that against our stated capital allocation priorities of investing in the growth of the business. And obviously, the flexibility that comes with a share repurchase program alongside M&A is a really good tool for us from our perspective as to how we do that.

Look, I think as this plays out, we'll be able to give more clarity. I think what we can give is clarity here right now is it's great to have the tools and the mechanism in place to deliver on a share repurchase program. We'll, obviously, balance that against opportunities that we see in the M&A pipeline to give us enough dry powder to be able to act on growth opportunities that will create value for shareholders. So that's how I characterize it right now. As the quarters play out, obviously, we'll be able to give further color to this, but really pleased to be able to have this mechanism now in place.

Sure. Good morning, David. We've spoken many times about the strength of our channel to market. We have a particularly strong path to market and channel partners across the U.S. And then, that positioning differs across the world is what I would say. And so, I think, our focus on independent channels and adding those largely has been in more emerging markets like Latin America, as an example. And we've certainly been aggressive there in identifying new partners, and that has contributed to fuelling our growth in that region in particular.

And then, I would say, we're focused very much on other emerging markets as to where we will look to build those independent distributor channels. Certainly, there's still some opportunities still to do that in the U.S., and we expect to still pursue some of those opportunities here in the second half and beyond. But I would say we've got a very strong channel position here in the U.S. that we look to leverage further.

Yeah. So that's the full-year picture, David. Obviously, most of the pricing activities generally occur in the aftermarket. So that's -- that 1.5% heavily weighted towards the aftermarket. And that's up from approximately 1% at the beginning of the year. So, obviously, that difference is a very modest pricing action taken for the second half.

Thanks, Daved.

Morning, Jerry.

Morning, Jerry.

Well, good morning, Jerry. Thanks for that. I'm going to ask Jack to take the piece on margin step up and then maybe I'll circle back on the guide comments.

Yeah, absolutely. So, Jerry, there's really a few different things at play, as I was describing to Joe. So there is a bit of a volume step up sequentially. There really is no impact from a pricing perspective, sequentially from Q1 to Q2. And then there's a few bits and pieces of favorability. So a little bit of favorability from freight, same on materials, same on warranty, all of which taken together contribute to a healthy step up. And then the last piece and probably the biggest piece is just strength in the manufacturing cost environment. That's both evidence of really strong production that contributed to the strength of our ability to deliver for our customers over the first half. And you can see a little bit in our elevated inventory balances as well.

As we think about then what's one time, if you will, in that there's really nothing one time there's just a collection of favorability and then the rest is the volume story from a first half, second half standpoint.

Yeah, yeah. So -- and I might just take up this point on the guide and the comments you made. We believe the guide is a prudent guide as we still head into a declining environment here in the second half, declining on first bit and Class A truck production and not seeing a positive inflection on freight activity, really driving downside in our aftermarket versus our relative guidance -- our previous guidance position. So in terms of the margin performance associated with that, we've certainly been discussing that, I would say, and the way I would characterize it, I don't see a lot of flexibility that I have in the short term to take out fixed cost.

Jerry, we're a brand new company standing up, a capable organization that can deliver on our commitments and while we're separating from Cummins. And so certainly no intention to sort of pull out fixed cost here in the short term. And we do see recovery of the markets that we're talking about. And we want to be well positioned to continue to grow through that cycle in a business that is not very cyclical, frankly, like we're large aftermarket content. And so we really want to be continuing to position our business for long-term growth.

Thanks for that question. We always viewed that capital returns to shareholders will be part of the mix of our overall shareholder value creation. And so we always expected to be doing this in time. Feels good to be doing that a year out of the gates with a modest dividend return, and the balance of that being a flexible program around share buybacks. Obviously, the world of M&A is opportunistic somewhat and based on the opportunities that present themselves, so we really wanted the balance of this capital returns to be in share buybacks so that we could balance capability from an investment perspective to be able to invest in M&A opportunities as they presented it.

In terms of our progress there. We are making really good progress, I'd say, building the M&A muscle, the strength of our pipeline. We've continued to look at a number of opportunities and work through diligence processes on those, and we continue to do so. And we will balance out our foresight to M&A opportunity with returns to shareholders. But very much the premise is here we are looking to enter into industrial filtration to grow our business, to increase overall shareholder return, and that's our driver. And it's certainly not growth for growth sake. And so it's taking time for us to find exactly the right targets there, which is how I would describe it.

Thanks for the question. I think our priority right now was to get a framework in place to be able to return cash to shareholders. And certainly, we'll look to act on that in -- an opportunistic way is a good way to describe it coming out of the gates. And then I expect us to be able to get a clearer view of exactly what that looks programmatically out into 2025 and beyond, and we'd be able to share more as we shape that. But I think right now, the way you should hold it, it's good to have the framework in place. There'll be a base level that we look to build as programmatic that we'll communicate more on as we go forward, and then there'll be a balance that is based opportunistic against our M&A options.

Okay. Yep. Hand that to Jack.

Yeah, absolutely. So, I mean, the biggest is steel, Bobby. And so we've seen the index bumping along a little bit, but we do expect, overall for the year, a favorable impact for our business. As a reminder, as you're kind of tracking the index and thinking about the impact to our financials, there is about a three-month lag. So about a quarter lag relative to movement in that index. The next would be kind of plastics and resin overall, as you think about our products. And then there's a number of other small categories, if you will, media, packaging, things like that.

Thanks, Bobby.

Thank you. Thanks.

Thank you. That concludes our teleconference for today. Thank you all for participating and your continued interest. As always, the Investor Relations team will be available for your questions after the call. Thank you and have a great day.