Cummins India Ltd

NSE:CUMMINSIND

Earnings Call Analysis

Sales Decrease But Margins Improve

The company experienced a sales decrease of 3% to INR 1,871 crores compared to last year's INR 1,922 crores. Despite lower sales, including a 2% domestic decline and a 4% reduction in exports, profit before tax impressively jumped by 27%. The company capitalized on the falling commodity prices, maintained strong pricing, and benefited from a favorable mix of high-margin products, as there was less demand for low-margin, low-horsepower engines. Consequently, all three variables that affect material margins were positive, leading to a significant improvement in material margins. Executives project buoyant growth ahead, anticipating double-digit revenue growth for the fiscal year 2023-24.

Overview of Q2 FY24 Financial Performance

Cummins India Limited reported a mixed financial performance for the quarter ending September 30, 2023. The company experienced a slight downturn in sales, with a 3% decrease compared to the same period last year, resulting in a total of INR 1,871 crores. A closer look reveals that domestic sales dipped by 2%, while exports saw a 4% reduction. Despite the decline in sales, profit before tax tells a more optimistic story, registering a 27% uptick compared to the same quarter in the previous year.

Comparative Analysis Against Last Quarter

When placed against the previous quarter, sales plummeted by a more substantial 14%, predominantly due to a significant 19% decrease in domestic sales. However, profit before tax modestly increased by 3%, signaling tight cost control and perhaps favorable product mix or operational efficiency improvements. In this context, exports slightly bucked the trend, improving by 2%.

Segment Performance Highlights

The power generation segment witnessed a stark contrast in performance, with domestic sales plunging 28% year-over-year and a dramatic 44% when scrutinized quarter-over-quarter. However, the industrial domestic business provided a silver lining, surging ahead by 20% over last year and continuing the momentum by growing another 27% compared to the previous quarter.

Export Dynamics and High Horsepower (HHP) Segment

On the export front, High Horsepower (HHP) exports grew commendably by 13% over the prior year, contributing to a sustained 8% increase over the preceding quarter. Conversely, Low Horsepower (LHP) exports faced headwinds, decreasing by 14% year-over-year, despite recovering by 4% quarter-over-quarter.

Future Expectations and Guidance

The management remains bullish on the firm's future, driven by pervasive domestic market strength. While some uncertainty clouds the economic landscape, the company is gearing up for a robust rally in coming quarters, particularly within its High Horsepower (HHP) segments, which barely experienced a dip and remain largely unaffected by the broader market shifts. The leadership expresses confidence in achieving double-digit revenue growth for fiscal year 2023-24.

Sector-Specific Growth and Resilience

The construction sector is resurging, thanks in part to renewed road building activities. Additionally, varied industrial segments such as rail and compressor businesses have demonstrated impressive recoveries, indicative of solid performance amidst uneven demand cycles. Defense, as a sector, appears to be regaining momentum along with mining, particularly for steel and coal, which fuels optimistic projections for sustained demand improvement across these industries.

Profit Margin Expansion

An impressive aspect of the quarter's performance is the marked expansion in gross margins. This enhancement could potentially be attributed to a favorable product mix that leans towards high-margin offerings, possibly reflecting strategic shifts in the company's sales strategies.

Earnings Call Transcript 2024-Q2

[Operator]

Good morning, ladies and gentlemen. Welcome to Cummins India Limited Q2 FY '23/'24 Earnings Conference Call. [Operator Instructions]

I will now hand the conference over to Mr. Ashwath Ram, Managing Director, Cummins India Limited. Thank you, and over to you, Mr. Ram.

[Ashwath Ram, executive]

Thank you. So good morning, ladies and gentlemen. Welcome to the Cummins India Limited Q2 FY '24 Earnings Conference Call. I'm Ashwath Ram, Managing Director of Cummins India Limited. Joining me on the call today is Mr. Ajay Patil, Chief Financial Officer of Cummins India Limited. Thank you all for joining us on this call today.

The quarterly results this time demonstrate a stable outlook in the domestic market and a resilient Indian economy while the key economies and regions of the world are experiencing slowdown in economic growth rates. I would first like to share an update on our Q2 FY '24 financial results.

For the quarter ended September 30, 2023, with respect to the same quarter last year, sales at INR 1,871 crores are lower by 3% compared to INR 1,922 crores recorded in the same quarter last year. Domestic sales at INR 1,364 crores are lower by 2%. Exports at INR 507 crores are lower by 4%. Profit before tax at INR 426 crores is higher by 27% compared to the same quarter last year.

For the quarter ended 30th September 2023 with respect to the last quarter, our sales at INR 1,871 crores are lower by 14% compared to INR 2,175 crores recorded in the last quarter. Domestic sales at INR 1,364 crores are lower by 19%. Exports at INR 507 crores is higher by 2%. Profit before tax at INR 426 crores is higher by 3% compared to the previous quarter.

I would now like to share the segment-wise sales breakup for the quarter ended September 30, 2023. Domestic sales. Power Generation domestic sales were INR 486 crores, 28% lower compared to last year and 44% lower compared to last quarter. Distribution business sales were INR 549 crores, 23% higher compared to last year and 3% higher compared to last quarter. Industrial domestic business sales were INR 300 crores, 20% higher compared to last year and 27% higher compared to last quarter.

Exports. High Horsepower exports were INR 264 crores, 13% higher compared to last year and 8% higher compared to last quarter. Low Horsepower exports were INR 209 crores, 14% lower compared to last year and 4% higher compared to last quarter.

I'm now providing Cummins India financial guidance. The Indian economy remains resilient to geopolitical events, softening demand in developing economies and the inflationary trends seen both in India and worldwide. GST collections continue to remain strong, indicating underlying trade activities. The Index of Industrial Production, IIP, PMI, et cetera, are all indicating a reasonably stable economic outlook, keeping the Indian economy on course for growth in the range of 6.3% to 6.8% based on various estimates.

Geopolitical events, especially further escalation of conflict in the Middle East, fluctuation in crude oil prices, rising U.S. bond yields and their impact on capital flows are a few key watchouts. The company successfully launched the CPCB IV emission norms-compliant products in the market on time. The prior 2 quarters witnessed some demand shifts as both CPCB II and CPCB IV+ products are allowed to be sold until June 2024. We expect the demand to normalize and sustain for the rest of the year.

With most of the developed markets experiencing slowdown in demand, we are closely monitoring our end market conditions. The company continues to have prudent capital allocation and cost management and have a strong balance sheet and cash position. We remain optimistic about the company's prospects for continued profitable growth. We remain optimistic about the prospects of the company's continued profitable growth and expect double-digit revenue growth for fiscal year 2023, '24.

I now open the session for questions. Thank you.

[Operator]

[Operator Instructions] The first question is from the line of Ravi Swaminathan from Avendus Spark.

[Ravi Swaminathan, analyst]

My first question is with respect to the PowerGen business. During the quarter, it's obvious that we had seen a revenue decline because the prebuy activity, which was there in the first quarter, that is getting normalized. My question is more towards the secondary demand. I mean from the GOEM to the end customer level, how it is, especially in the HHP level, that is above 750 or 800 kVA, it shouldn't have been impacted by this prebuy activity, right? So how that demand is, which sectors are driving growth, if you can share the thought process?

[Ashwath Ram, executive]

Yes. So demand continues to remain robust, especially in the domestic market, and we have seen quite a bit of depletion in the inventories that were built up as part of the prebuy. And we are seeing the demand continue to remain strong, so we are quite hopeful that the remaining quarters we will see a bounce back as far as the numbers are concerned from a domestic market perspective.

[Ravi Swaminathan, analyst]

If you can give it in terms of numbers, like volume growth in the LHP business, how it was year-on-year for this quarter; HHP, how it has been, if you can share that perspective, it will be great.

[Ashwath Ram, executive]

Sure. So for us, we have seen that -- just one second here, I'm just pulling up the numbers here. Right. So we saw demand in LHP of -- drop by nearly 60% versus the last year, and we saw LHP demand dropped by nearly 70% as compared to the previous year, whereas HHP demand, we saw only dropped by 2% because we count HHP at 500 kVA and above. So you can see that the real -- there is hardly any drop in HHP. So your hypothesis that that should not impact HHP is actually correct. And some parts of HHP continue for us to remain under allocation because we continue to build long-term capacity, which takes 18 to 24 months to build out, whereas the LHP and MHP markets have corrected from an inventory perspective, and we expect that to come back to a steady-state level of what we saw in the first quarter, we expect that to come back to those kinds of levels.

[Ravi Swaminathan, analyst]

Got it, sir. And my second question is with respect to the Industrial business. We have seen very good growth of around 20%. Where has this growth come from? Is it from the construction equipment side, compressor side, railway side?

[Ashwath Ram, executive]

Yes. Quite good bounce back on construction as compared to the last year, primarily driven by the fact that road construction has begun again. And we expect that trend to continue because of -- from the stated ambition of building 12,000-plus kilometers of road this year, only 4,000 has been completed so far. So there is a lot of work yet to be done. So that market historically has underperformed, and that is now starting to bounce back pretty robustly.

Also, some of our other businesses in Industrial are a little bit lumpy. You see some spikes happen and then you see steadiness in some quarters or you see a dip in some quarters just because they get delivered. And so yes, we saw some very good delivery of rail in this quarter, driven by [ tower car ] and DETC. We also are starting to see the compressor business start to bounce back. Sometimes, we have seen this trend historically that when monsoons are not that great, people have to drill more for water well and other applications and the compressor market then begins to bounce back.

And we also see other markets, especially areas like defense start to come back. And again, those are lumpy in terms of delivery. So when we have good delivery like we did in the previous quarter, we are able to grow that business. But overall, the -- as long as the core infrastructure continues to keep getting built out, so mining, for example, is much lower in this quarter than compared to the previous year same quarter. But there are many, many, many tenders out there because mining for steel as well as coal is actually beginning to scale up quite significantly. So we are quite optimistic that the demand will continue to improve in that segment as well.

[Ravi Swaminathan, analyst]

Got it, sir. And my final question is with respect to the gross profit. Gross margins have expanded very significantly. Is it because of the mix being in favor of the higher-end [just to speak] (0:13:00) sold and coupled with [indiscernible] and going down. So is that the case?

[Ashwath Ram, executive]

So like in some quarters, we get a perfect storm of bad news. This time we have a perfect storm of good news, in that, we were able to control the material [indiscernible] all the advantages we had of continuing commodity corrections benefit us. We continue to hold on to pricing. And we also got favorable mix because lower-margin products in low horsepower, et cetera, were -- the demand was significantly lower. So all 3 variables which impact our material margins were favorable, and that's why the material margin improved significantly.

[Operator]

The next question is from the line of Parikshit Kandpal from HDFC Securities.

[Parikshit Kandpal, analyst]

Ashwath, congratulations on a great quarter.

[Ashwath Ram, executive]

Thank you.

[Parikshit Kandpal, analyst]

Yes. So my first question is on what was the mix of the forecast in this quarter, because I think last quarter...

[Operator]

Sorry to interrupt. Mr. Kandpal, your voice is muffled. I would request you to kindly use your handset, please?

[Parikshit Kandpal, analyst]

Yes. So in the mix, what was the contribution of the CPCB IV+ in this? Because last time, I think, we have said that we will be targeting [ about ] 24% for the full year. So any positive surprise we are seeing? I was seeing on your social media handle you've been promoting with your dealers all these CPCB IV+ compliant engines. So how has been the feedback from the channel from the end customers? So any earlier trends of picking up of demand despite the prices being higher and still some time before it gets implemented?

[Ashwath Ram, executive]

Right. So actually, it's pretty positive news, especially in the areas like the NCR region and the big cities, people are switching over to CPCB IV+ despite the pricing advantages of CPCB II just because the product is newer, it has better, longer life, better performance, et cetera. There are some lows where we are actually now scaling up capacity to be able to supply CPCB IV+ product, but that is only true in the big cities. In all the other regions, CPCB sale continues to be strong. I can't give you exact numbers, but I would say that greater than 70% of the sales for the quarter were with CPCB II products. But the very fact that CPCB IV+, I was expecting 5% to 10%, but the actual demand is a lot higher than what I was anticipating.

[Parikshit Kandpal, analyst]

Have that also impacted our gross margins, I mean, slight better mix in CPCB IV+, because I think...

[Ashwath Ram, executive]

Little bit. Little bit, but not yet significant enough because the ratios are so skewed in favor of CPCB II+. It's more to do with us not selling as many low horsepower assets as compared to just selling more CPCB IV.

[Parikshit Kandpal, analyst]

Was there any one-offs in this quarter in the margins -- gross margins? I mean, despite, if I even take the degrowth in the low horsepower engines, still the margins look better. I mean, the benefits -- I mean, we've been holding on to the volumes, not much of a degrowth [ feel. ] So were there any other one-offs [indiscernible] just as you said commodity benefits and just the pricing being holding on?

[Ashwath Ram, executive]

No. Actually, this is just -- sometimes you get the positive effect of all the work you've been doing for a long time. So no one-offs, but yes, we are pretty happy that -- we are happy with good news sometime.

[Parikshit Kandpal, analyst]

Okay. And just the last question on the exports market, sir. I mean, how is your strategy on the CPCB IV+? I mean, you've been doing promotions in India, your channel network. So how has been the response during the promotions and marketing being done for the CPCB IV+ compliant engines in the export markets?

[Ashwath Ram, executive]

Right. So until the last quarter we were focused on launching the CPCB IV products in the domestic market. So all the fine-tuning, testing, validation, approval, branding, all of the work was 100% focused on the domestic markets. Once the launches were complete and once we got the news that in India we have decided to push out the implementation for another year, we are now focusing all our energies on trying to figure out how to sell the same products into other markets.

The first market where these products can be used well are in the European Union. And so now efforts are on to take the product and get the required approvals in the EU, get them customized for those markets and those applications. And there is a global plan which has been put in place stage-by-stage on how the product will be transitioned firstly to EU and then to markets in Americas where the voltages as well as the frequencies at which those gensets operate are completely different.

And so we are going to have to do some modifications on the product to be able to meet those specifications. We expect to get all of this engineering work done in the next couple of quarters. And so to answer your question, work is going on, and we are pretty focused on trying to push these products on a global scale because we feel these are world-class products, and we have a very good price positioning to be successful globally.

[Operator]

The next question is from the line of Ankur from HDFC Life.

[Ankur Sharma, analyst]

Just touching back on the domestic power gen segment. So if you could just highlight again how is the inventory in the channel with your GOEMs, especially post the prebuy and now, of course, we've seen some normalization in Q2. So do we -- and correct me if I'm wrong, but do we expect Q3, Q4 to be more normalized quarter now that most of this prebuy and the normalization being over. So what kind of growth do you think for the full year is possible?

[Ashwath Ram, executive]

Yes. So we think inventories are pretty much back to the normal inventory levels the channel had before the prebuy, and which is why we think that Q3 and Q4 will be, from a demand perspective, what I consider regular quarters, which means we continue to attempt to deliver the domestic market at 2x of the GDP in terms of growth. So that's where we think we will be able to get to by the end of this year.

[Ankur Sharma, analyst]

And on a related note, you were talking of some supply chain -- or potential supply chain issues because you're making both the II and the IV engines. So is that largely sorted?

[Ashwath Ram, executive]

Some parts of it are sorted, but some parts of supply chain are not fully sorted because they take a couple of years to put the incremental capacity in place. And we are already making all the investments for that. We started making the investments nearly 2 years ago, but it takes time for setting up some of these large engine capacities. And so we are meeting demand, but we are not able to have excess supply available to meet unconstrained demand. So it is still constrained demand.

So we expect by, I would think, by early part, middle of next year, to be in much better position as far as supply is concerned. The other part of supply is the global electronic supply chain is still in crisis. So despite this being the reason I've been stating for almost 3 years now, the -- it is still in allocation. So we are not getting 100% of all the electronics that we need to meet all the demand in the market.

So it's still -- we are keeping strategic inventory. We're doing all the necessary things negotiating. We're setting up more suppliers. We are doing all the things. But if there is a spike in demand in certain other markets around the world, sometimes we are not getting all the parts that we need. So it is still constrained. So it's not yet a situation where I can say that every piece of demand will be met. It's still a wait and watch on some notes.

[Ankur Sharma, analyst]

Sure. And on the export piece, while it's obviously grown Q-on-Q, we're still seeing a slight decline on a Y-o-Y. But surprisingly, the HHP growing and the LHP declining, so if you could just help us -- and I understand Q3 typically is the weakest quarter as we head into the calendar end. But how do you see the export piece kind of playing out next couple of quarters? Will '23 end be the bottom and maybe start seeing better numbers going into '24? How should we look at it?

[Ashwath Ram, executive]

Yes. So this quarter, HHP was robust because we were still fixing and delivering on backlogs. And we are seeing pretty much all markets around the world start to slow down a bit. There are some pockets in Africa, which continue to do okay. There are some pockets in Latin America, which are okay. But when I you look at the overall trend, whether it be Europe, whether it be China, whether it be big chunks of the Middle East, we are starting to see demand drop pretty significantly.

It's -- we are trying to counter that by trying to launch more products and do those kinds of things. But when cyclically some of these markets go down, they go down. And we have been able to hold out for this quarter, but I am -- from the way I see the order board show up, I think it will continue to weaken for the next quarter and maybe start to pick up in the fourth quarter.

[Ankur Sharma, analyst]

Got it. And just sir, last one is on the defense side, and there was some news flow about Cummins being selected to supply the engines for the light tank project, the Project Zorawar. So if you could just help us what is the kind of supplies you're going to do here? Is this from Cummins India, the listed entity time lines for delivery, et cetera?

[Ashwath Ram, executive]

Yes. So these are long-gestation projects and here, on this project that you are mentioning, our partner is Larsen & Toubro. We similarly work with many of the OEMs in India to supply them engine products. And this order has been one after many years of work. And it's right now in trial stage, et cetera, and as the draw outs come from the customers, they will be supplied.

This product is made in North America and some value-add is done in India and then supplied to this customer. It's a very specific and special purpose designed defense product. So it's not a mainstream product, which has just been adapted. It's a very special product just designed for defense, which has been used by Cummins in markets in North America and other places. Just to provide clarity that is just for this order. There are many other defense projects which we are working on, which are all localized product as well. I was referring to the very specific order that you mentioned earlier.

[Operator]

The next question is from the line of Jonas Bhutta from Birla Mutual Fund.

[Jonas Bhutta, analyst]

Congratulations on a great set of numbers. So 2 questions. Firstly, given that it's been more than a quarter now that we are selling both CPCB IV and II engines, what are the sort of early indications that we are seeing in terms of the absorbable price increase? Because I remember that you told us prior to the launch that anywhere close to 20% upwards would be the pricing impact. But in reality, what is that on the ground in terms of the price rise that we've been able to pass through without impacting demand?

[Ashwath Ram, executive]

The price indications that we have given, those are the exact price indications that we have launched the product within the market. And this is the first quarter where we've started to see demand. And we are -- in the areas where the demand is the highest, which is the NCR region and in the big cities, we are not seeing that as impacting demand. As a matter of fact, we are getting greater demand despite the pricing because the product is that much better.

So we don't see, once the overall transition happens by middle of next year, that this incremental price is something the market will struggle with. This kind of transition has happened in multiple markets around the world and in multiple products where there is a psychological resistance to start off with. But when -- it is the same for every manufacturer. The industry has changed. Everyone just aligns to that and moves ahead.

And the company has also been looking at alternate means to be able to work with banks and other financing agencies to help people finance these products, et cetera. So the net impact on individuals is not as significant as one might think.

[Jonas Bhutta, analyst]

Got it. So in a full year, so say, starting June '24, if volumes remain as is whereas in terms of the demand, it's next year, potentially then our Power Gen sales by the virtue of -- does the sales mix should be up at least 15% or -- because that's going to be the pricing impact. Is that a fair assessment?

[Ashwath Ram, executive]

It's a fair assessment, but that doesn't really hold true for all products. There are some products where the -- just because of volume and the change in platforms, there's a higher content of imports and even if prices go up, but margins don't necessarily go up in the same proportion.

As a portfolio, we will continue to do better than what we have done. But that does not mean that this just translates into like today we're making 20%, next year, we'll make 40%, the math doesn't work out that way. And our ambition is to continue to grow our overall margins by 100 basis points year-on-year.

[Jonas Bhutta, analyst]

So which was what my follow-up question was, sir, now -- since we now have an indication of the pricing being absorbed, also, could you help us understand the gross margin differential between the CPCB II and IV+ now, given that the supply chains are, in a way, stabilized? So where are we settling now? And then what is…

[Ashwath Ram, executive]

No, it's very difficult to give you this at this stage because, first of all, we are just coming out of a quarter where utilization is incredibly low. We are burning off inventory from an older cycle. We have just started to ramp up a new cycle. So it's very, very difficult to give you an answer to say what a stable situation will look like. All I can tell you is that once we reach steady state and the percentage of CPCB IV becomes greater than that of CPCB II, margins will maintain this positive trend line of improvement.

[Jonas Bhutta, analyst]

Got it. Sir, my second question was on the VRS scheme that we've launched. If you can walk us through the rationale? Because if the going is so good and then capacities are coming up, what is triggering the VRS?

[Ashwath Ram, executive]

Sure. So first of all you have to keep looking at people cost in India. People cost in India is rising at the rate of roughly anywhere between 10% to 15% on a year-on-year basis. And so it's almost keeping pace to the rate at which growth in sales is happening. And we continue to look at opportunities to improve cost efficiency, whether it be material cost efficiency or people cost efficiency.

Also, given the softening demand and uncertain economic outlook in some of the global market, we need all of our employees to help reduce costs, lower inventory and just manage our efficiency as we continue to meet our goals for profitability and cash flow. So this is an ongoing exercise of cost management, of pruning or cutting, of trying to get more and more efficient as we move along. This is not something which is new that the company has done. There's a lot of focus on cost management throughout the year and over the last couple of years, but we continue to face growing costs. So we're just looking at ways to keep managing that and getting more efficient.

[Jonas Bhutta, analyst]

Sure. And my last question, if I can just squeeze in, sir. The export sales, in your commentary, suggests that developed markets seem to be softening in terms of demand. Could you please remind us in the first half or in FY '23 developed markets accounted for what percent of exports? And again, is it fair to say that these are markets where our margins are relatively better than that in the emerging markets because there we have, in emerging markets, we run our own distribution channel, while in the developed markets, largely to the parent entities. If you can give us that that will be helpful. That's my final question.

[Ashwath Ram, executive]

Actually, it's pretty complicated because it depends on what products and it's a whole bunch of Cummins. But all I can tell you is that the developed markets of Europe and North America have dropped like over 50%. So as compared to Asia Pacific, Middle East, Latin America, which are dropping more like 5% to 10%. So the proportionate drop is significant in the developed markets. But it's difficult to say how that impacts margins because the products and the mixes are completely different for each of those and they keep changing.

[Operator]

The next question is from the line of Renu Baid from IIFL Securities.

[Renu Baid, analyst]

Congratulations on very strong results. My first question -- the first question is coming back on the export side. While you did mention a glaring decline in U.S. and EU, is part of the decline also attributable to significant inventory destocking which these markets are witnessing after the pandemic now, given average inventory in these markets of various products have shot up very sharply and customers are pruning inventories to keep the cash profits better? So can you give some more color on this?

[Ashwath Ram, executive]

Yes. Certainly, that is a fact. As a matter of fact, when Cummins Incorporated announced their results, they did mention that significant amount of inventory correction has happened and will continue to happen. So that is a factor -- a big factor. And especially for the next quarter, it will be a big factor because as companies come to the year-end, they try to optimize inventory as much as possible. But that doesn't take away from the fact that because of all these Middle East crisis, oil prices going up, Ukraine-Russia are still not getting resolved, entire China market still recovering slowly, there is slower demand in -- from all -- pretty much all over the world.

So that has also got a part to play. We continue to push aggressively to try to compensate the loss in demand from the overall market by attempting to gain share, et cetera. But the reality is that there is softness in base demand itself.

[Renu Baid, analyst]

Sure. And when we talk about attempts to gain share and presence in export portfolio. Typically, these would be for which type of applications, which type of gensets that we're talking about?

[Ashwath Ram, executive]

These are what we earlier have said that we had done our Fit for Market 1, Fit for Market 2. Now we are in the purpose of launching Fit for Market 3. And what we're trying to do is to try to develop products which are very, very suitable to specific regions. Earlier, we used to have 1 product, which was the same product for Europe, for Africa, for Middle East, for America, everywhere, the product was the same. Then, in the Fit for Market 2, we did some percentage of delineation of product based on the geographic location.

Now Fit for Market 3 does that even more, and it also tries to take some of the products developed for CPCB IV+ and applicate them into other markets. So the combination of all of these efforts, more local understanding and then developing products to meet those markets is what will -- what we are working on to improve market share even in a declining market.

[Renu Baid, analyst]

Got it. Secondly, on the margins, while you did highlight that 2Q was the perfect quarter in terms of mix and various other elements. As we move in the second half of the year, commodities remaining benign and volume growth coming back, on the domestic PowerGen business, can we assume, a, gross margins to sustain that 32%, 33% levels? And from a longer-term perspective, you tend to highlight that company would target 35% kind of gross margin from a longer-term perspective. So how should we read into the margin trends expected for second half of the year? And from a medium-term perspective, how long it may be for us to reach 35% kind of gross margins?

[Ashwath Ram, executive]

Yes. You're referring to material margin at 35%.

[Renu Baid, analyst]

Material margins, yes.

[Ashwath Ram, executive]

Gross margins are a lot lower. But material margin, like I said, it's a perfect storm of everything going well. We expect certain parts of it to act negatively compared to 35%, which is almost like an all-time best kind of number. And we expect with the mix changing in subsequent quarters with larger low horsepower being sold, more of the data center PDI markets being served, et cetera, that at least a couple of percentage points will drop from the material margin with that.

But our endeavor is to not give up all the gains and somewhere go between 32% to 34% is the number we are continuously striving to hit. And when it goes below that, it makes us grumpy. When it goes above that, we are slightly pleased. But 32% to 34% is the range we are trying to -- as our sweet spot of where we would like to remain consistently.

[Renu Baid, analyst]

Got it. And lastly, any updates that you would like to share in terms of new product introductions or launches across different application in the industry business?

[Ashwath Ram, executive]

Yes. Quite a few – they just keep happening. I think the gentleman earlier spoke about some of the defense launches. We have finished introducing all the PowerGen domestic markets. We've introduced RECD kits. We are selling more products into the rail market. We also launched some special propulsion engines into the marine market. We have launched some new gensets into the -- also into the marine market. In the mining market, we are trying to build some orders for QSK23-based engines into that market. What else have we launched?

[Renu Baid, analyst]

Anything on the Vande Bharat and electric locos in the trains that we are looking at?

[Ashwath Ram, executive]

Those are in final stages of approvals. So those are what we call hotel load converters, and those are in final stages of approval. So we haven't yet finished that work. That is all incremental. So that is in time-testing right now. So once those get approved, we will be talking about different types of numbers as compared to what we're seeing now. We've also been able to launch some of our L-series engines for the defense market with customers like Bharat Forge. So yes, lots of things being launched in parallel. So that's going to be an ongoing effort. And every quarter, we will attempt to launch more products.

[Renu Baid, analyst]

And lastly, any updates that you can share on the likely CapEx for fiscal '24 and for '25 or coming from there?

[Ashwath Ram, executive]

It's pretty much in line as what we have indicated. No special CapEx other than for launching products or for upgrades to products, et cetera. So it's likely to be in line with what we were doing this year, maybe 5%, 10% more because sustenance increases as the asset base increases.

[Operator]

The next question is from the line of Bhavin Vithlani from SBI Mutual Fund.

[Bhavin Vithlani, analyst]

Ashwath, congratulations for good numbers.

[Ashwath Ram, executive]

Thank you.

[Bhavin Vithlani, analyst]

So Ashwath, the question is when we actually anecdotally see the construction equipment market, we see a significant increase in market share for the Chinese players. And we have a large market share in the construction equipment segment. So if you could just give us an outlook on how are we seeing this market? Are we also able to maintain our share with supplies to these Chinese equipment suppliers?

[Ashwath Ram, executive]

Yes. Certainly, the Chinese are very strong, not only in India, but around the world. And Cummins having a presence in pretty much all markets around the world also has relationships in terms of supplier, customer with many of these companies. And so when they bring their product to India and then they have to meet local value-add and content requirement, they certainly approach us and they look at us as prime partners to supply them the powertrain. And we are working with pretty much all of those OEMs, but we also continue to work with our traditional OEMs from America, from Japan, from Europe to supply them product. This is a sweet spot for Cummins around the world and we intend to continue to improve our position in this space.

[Bhavin Vithlani, analyst]

Sure. And on the competitive landscape in this segment, because Weichai has also set shop here. And similarly, on the PowerGen side, if you could just talk about the competitive landscape because certain other capital good companies have been complaining about a sudden surge in the Chinese imports and which is hurting them.

[Ashwath Ram, executive]

Certainly, those companies are pretty aggressive, and they are state-run companies, and they are able to deploy scale like we cannot. So certainly, we are under competitive threat. And certainly, we do pitch to the government in cases where we find unfair prices or dumping of goods at unreasonable prices. We do write to the respective government agencies to -- that we are happy to compete on a fair basis, but when pricing is unfair, it becomes a challenge. And customers are not so discerning in the end markets. For them, prices everything.

So yes, we do lose some kinds of orders. But when it is compared spec to spec on product technology, et cetera, we have an advantage. When it compares -- we also have huge amounts of localization. So we are able to stand toe to toe and fight with them even on prices. But when it is unfair pricing in certain cases, we have seen that, then it becomes a challenge, but it's not a significant challenge as of today, but it can be in the future.

[Bhavin Vithlani, analyst]

Sure. On the exports, so historically, we had a larger share in the African and some of the developing markets. If you could just help us with the geographical share and the ongoing currency volatility in some part of Middle East and Eastern Europe. How is it impacting our outlook there?

[Ashwath Ram, executive]

So Asia-Pac, I can give you the breakup of how the INR 507 crores of exports was region wise. So Asia-Pac was INR 122 crores, Latin America was INR 137 crores, Middle East was INR 111 crores, Europe was INR 64 crores, Africa was INR 63 crores and the U.S. was INR 8 crores. So we have seen the biggest drop, as I mentioned, 50-plus percent kind of drops in Europe and North America, whereas we have seen smaller drops in Asia and the Middle East as of now, but we expect that to worsen in the next quarter.

[Operator]

The next question is from the line of Amit Mahawar from UBS.

[Amit Mahawar, analyst]

Ashwath, congratulations on great operating performance. Sir, my first question is, so in H1, we've done around INR 30 billion for the domestic sales, up around 19%. How much of that is CPCB IV revenues. Unsure if I missed that. And is that broadly 80%, 90%, 100% market share in H1 for you at this stage?

[Ashwath Ram, executive]

In H1, I would say CPCB sales are less than 20% of our PowerGen sales.

[Amit Mahawar, analyst]

Okay. And sir, in your assessment of maybe today, we are the only supplier of the new node within the permissible range. Do you think maybe 6 months to 12 months is a time where you will have competition joining in terms of entering the market or it will take much more longer? I appreciate you can't take names, but qualitatively you can help us understand.

[Ashwath Ram, executive]

Yes. I think all competitions have announced that they have product ready because launch was supposed to happen in July. So they may not have been 100% ready, but I think everyone has announced that they have some product ready. So it's absolutely going to be the scenario that when it launches 100%, that everyone will be ready, but it also means that we've had 1 year to further fine-tune these products and make them even better and even more efficient.

So this is an ongoing cycle, and we play this competition throughout the world, and which is why Cummins continues to invest very, very heavily in product technology so that we can remain ahead of competition.

[Amit Mahawar, analyst]

Then my final question is, on FY '25, on a normalized basis, what would be the volume growth for the industry for the power gen?

[Ashwath Ram, executive]

We think that the power gen market, at least for the next few years, will grow at a CAGR of at least 7% to 8% in the domestic market. And it has been our stated ambition that Cummins India Limited grows at, at least 2x of the GDP. So we expect for the next year the GDP to grow at at least 6.5%. So which means you've got the automatic answer that we will aim to grow at at least 13% to meet our own internal aspirations.

[Operator]

The next question is from the line of Rahul Gajare from Haitong Securities.

[Rahul Gajare, analyst]

I wanted to continue from an earlier participant question where you talked about ultimately moving towards sustainable material margin of about 34% to 35% over a period of 18 to 20 months. I think you talked about this almost a year back. Now today, you're talking about material margin moving -- or remaining between 32% to 34%. So is this a clampdown on your earlier thought process of the company being able to move towards 34%, 35% margin?

[Ashwath Ram, executive]

No, I think it's not a -- I guess, what I meant to say is we have already achieved 35%. So -- but that is because we had all good variables work in our favor. That's not going to be the case in every quarter. So what we are attempting to do is if you look at the previous years' material margins, they were closer to 30.8%. So from that framework, to move the entire average up by 5% could be a multiyear journey. But the 32% to 34% range that I indicated, it seems that it can be sustainable at least for the next couple of years as we build up the next series of cost structure and material structure, products, et cetera, which then eventually get us to that 35% kind of level. It would make us extremely happy to be able to get there.

I'm just stating that there are -- it's easy to put out a number, it's quite complicated to work systematically to be able to get there. So the bridge between 30% to 35% indicates that we need to sustain 32% to 34% at least for a period of time before we can build on it and then get to 35% on a consistent basis. So that's where we are -- we think we are going.

[Rahul Gajare, analyst]

Okay. Fair enough. Sir, my second question is, we do understand from our [indiscernible] that the inquiry level have seen material rise in the recent months. But I think your commentary seems to be -- or it appears to be guarded in terms of domestic growth of mid-teens, especially when Q3, Q4 are normally stronger for the company. Can you talk us -- can you talk about this?

[Ashwath Ram, executive]

Yes. Certainly, a little bit of the domestic growth we don't think it will be in the mid-teens because if the market itself grows at 7% to 8%, we are growing even faster than the market. So we do think that that itself takes a lot of work. Also, there is a whole bunch of, as I said, inventory is burning out, but it doesn't burn out evenly across all the nodes. There are certain nodes where there is slightly higher inventory, there are certain nodes where there is lower inventory.

So when we try to create a portfolio of all of this, it then causes us to think that there will be a little bit of muted growth as compared to what the real demand in the market is.

[Rahul Gajare, analyst]

Okay. Sir, my final question is, I mean, you did talk about various industries, but can you talk about what is the situation as far as demand from data centers is concerned?

[Ashwath Ram, executive]

Very strong.

[Rahul Gajare, analyst]

Can you quantify some -- that demand, please?

[Ashwath Ram, executive]

Year-on-year, we have -- the data center business is -- our whole business is growing at 12% to 13%, data center business is growing at a CAGR of 25% plus.

[Operator]

The next question is from the line of Puneet Gulati from HSBC.

[Puneet Gulati, analyst]

Congrats on your numbers. In the beginning you also gave a guidance of double-digit revenue growth. Is it possible to break it up between domestic and exports and also how much of this growth could be attributed to volume versus pricing?

[Ashwath Ram, executive]

It is difficult for us to give you that exact breakup on where we think growth will come from at this stage. But our ambition has been that irrespective of which markets go up or down, as a company, we demonstrate that double-digit plus growth. So that has been our endeavor at least for the last few years, and so far we have been successful at that.

[Puneet Gulati, analyst]

Specifically, for FY '24, when you guided, possible to break it in volume and pricing?

[Ashwath Ram, executive]

It's always a combination. It's very difficult to give you an exact answer on that. Certainly, volumes, as I mentioned earlier, the Powergen and some of these markets grow at 7% to 8%. So you have to do the math. So if the market grows at 7% to 8%, we get some market share and then the rest is all pricing.

[Puneet Gulati, analyst]

Understood. Secondly, if you can give more color around what's driving the distribution part of the business so strongly for you. If you can highlight…

[Ashwath Ram, executive]

So we have believed that historically we have underserved our own entitlement of the distribution business. But we certainly saw strong demand coming from parts, quite robust commitment from customers in terms of service contracts, especially from rail and from big customers in mining, et cetera. And even our rebuild business saw very good demand pickup. So the nature of the business for us has changed quite significantly and we expect to see this kind of trend continue.

[Puneet Gulati, analyst]

Is there room for further gain in market share in the distribution business or have you achieved the optimal level yet?

[Ashwath Ram, executive]

No, the answer is, yes, there's always room for improvement, doing better. And if the overall company has to grow at 2x the GDP, every business needs to continue to grow at this proportionate level to the market.

[Puneet Gulati, analyst]

And lastly, on the exports, there was a divergent trajectory for LHP and HHP. If you can guide to what drove the difference and…

[Ashwath Ram, executive]

Yes. So it's very clear that HHP has always been in a backlog situation. So when you're in a backlog situation, even if the inventory corrections happen and demand starts reducing you're first fulfilling whatever was already in the pipeline. So the drop is not significant in HHP until the previous quarter, whereas low horsepower, there has never been any supply constraints in those markets.

So as the demand corrects, you see a direct correlation of that. So that's why LHP and HHP are a little bit divergent. And also a big chunk of HHP goes directly into product, into some of our internal application. So those -- that demand remains a little more steady than the end user market segments, which react more rapidly. So when it goes up, it goes up faster. When it goes down also, it goes faster. There's a typical trend you see different in LHP versus HHP.

[Puneet Gulati, analyst]

Right. And would the similar trend have prevailed in LHP segment as well? You alluded to a 60% decline in the domestic market. So that's similar in some sense.

[Ashwath Ram, executive]

That is correct.

[Operator]

[Operator Instructions] The next question is from the line of Koundinya Nimmagadda from Jefferies.

[Koundinya Nimmagadda, analyst]

Most of my questions have been answered, but just one question on the CPCB IV engines. Sir, when you try to [ contact ] with your channels, what is the kind of feedback that you're getting with respect to competition -- I mean, with respect to the price point at which they are launching new products. And do you see any tilt or sense towards downtrading in the industry? Can you provide some color on that, please?

[Ashwath Ram, executive]

Not seeing the down trade in the industry, so we'll start with that first. Product is very, very, very well received in the market. Channel is quite excited about the product. As a matter of fact, channel is pushing us to give them even more product. In some nodes we are lagging in terms of supply because we didn't think the demand would be pulled through as fast as we would have liked.

As far as pricing is concerned, the pricing is being absorbed. We're not seeing any resistance to the pricing from the market at this stage. And as far as competition is concerned, company has also announced product and announced sale of product. And we don't have enough data as of now to be able to say how well they are doing, but I can tell you about us, we are doing well with the product.

[Operator]

The next question is from the line of Amit Anwani from Prabhudas Lilladher which will be the last question for today.

[Amit Anwani, analyst]

My question is with respect to, there were some developments on the hydrogen-based IC engine. And a couple of months back, I think Cummins in JV with Tata announced some new factory set up. And also on the electrolyzer, there has been talk of Cummins Inc. looking for India market. So just wanted to understand on all these new product initiatives, including battery-based powertrains and SOFCs and hydrogen-based IC engine, how the Indian entity will be in shape to gain business in coming years?

[Ashwath Ram, executive]

Right. So let me first talk about hydrogen internal combustion engines. So hydrogen internal combustion engines are where we take and create a new engine which can burn gray hydrogen as well as green hydrogen. And for those kinds of models to be successful you need a scale. And -- so the first applications that have been successful anywhere around the world have been in the automobile space. And so the joint venture with Tata -- Tata-Cummins joint venture is getting into that phase and they are going to create hydrogen internal combustion engines and then they're going to use it in automotive kind of applications, the target -- that's going to be set up in the state of Jharkhand and they're going to start supplying into those markets.

From a listed entity perspective, the listed entity will have access to those technologies which are produced in scale, and we will be able to applicate them into multiple of our applications, including construction, including power generation, et cetera. And as the market develops, we will use those products and applicate them into those markets, so we will have access to all of that technology.

As far as batteries et cetera is concerned, the listed entity is working on tendering for bids, et cetera. And those -- there are batteries which are being developed with a partner like Tata, but that is for mobility. Mobility battery applications don't really work very well for the industrial scale grid kind of storage. And there the listed entity is working and trying to find some partners from where we can get some of that technology and then deploy it into the field. So that is still an exploratory field. We are filling out some tenders, we're working on that.

On the other part of applications of hydrogen, including in the rail, marine and other applications, Cummins India continues to bid out tenders for that, and that technology will be made available for deployment into those applications.

As far as electrolyzers and the production of hydrogen is concerned, Cummins has formed a new division called Accelera, and that division is looking at the best entry into the India market strategy on how -- what is the best way, who are the best partners to be able to produce hydrogen with because these are incredibly high CapEx kind of equipment, which also has very, very, very long gestation period for recovering as the market matures. So that strategy has not been finalized, it's still being worked out. And as we make progress, certainly, we will keep everyone posted.

[Amit Anwani, analyst]

Sure, sir. My next question on the data centers. You did highlight it that being a very strong growth of, I think, 25% upward, so wanted to understand, how was the absolute contribution or percentage contribution for H1 within PowerGen from data centers? And seeing the trend in data centers that there still will be much more higher traction in data centers in coming [indiscernible] are we seeing much higher growth than this or the similar trend will continue?

[Ashwath Ram, executive]

I can't give the exact contribution of data centers into our revenue, but I can certainly tell you that it is one of our top 10 market segments. The second thing I can tell you is that this trend of our data centers is likely to continue at least for the next 3 to 4 years.

[Operator]

Ladies and gentlemen, that was the end of our question-and-answer session. I would now like to hand the conference again over to Mr. Ashwath Ram for his closing comments. Over to you, Mr. Ram.

[Ashwath Ram, executive]

Thank you, everyone, for your active participation and engagement today. We always ask the most interesting and tough questions. Cummins India believes that the domestic market will continue to have strong growth, while export markets are experiencing a bit of softening of demand in the near term. Geopolitical events, continued conflicts between a few countries and their impact continues to present some uncertainty for global trade. Therefore, we remain cautiously optimistic about the short term. And -- but from the medium and long term, we are absolutely bullish and optimistic.

I would like to assure you that the company continues to leverage its strong balance sheet, world-class infrastructure, on the ground manufacturing, engineering and best-in-class talent and teams. We are confident of sustaining our growth trajectory. Before I close out, I want to wish you, your family a very happy, prosperous and safe Diwali. And on this happy note, I close this call. Thank you.

[Operator]

Ladies and gentlemen, on behalf of Cummins India Limited and the leadership team, we would like to thank you for joining us today and making it an engaging session. We are ending the conference now, and you may now disconnect your lines. Thank you.