Cummins Inc

NYSE:CMI

Earnings Call Transcript 2020-Q4

[Operator]

Greetings, and welcome to the Cummins Inc. Fourth Quarter 2020 Earnings Conference. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Jack Kienzler, Executive Director of Investor Relations. Thank you. Sir, please go ahead.

[Jack Kienzler, Executive Director of Investor Relations]

Thank you, and good morning, everyone and welcome to our teleconference today to discuss Cummins' results for the fourth quarter and full-year of 2020. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our President and Chief Operating Officer, Tony Satterthwaite; our Chief Financial Officer, Mark Smith; and the President of our Components Business, Jennifer Rumsey. We will all be available for your 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 Exchange Act of 1934. 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 on the forward-looking disclosure statement in the slide deck and our filings with the Securities and Exchange Commission, particularly the Risk Factors section of our most recently filed annual report on Form 10-K 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 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 at www.cummins.com, under the heading of Investors and Media.

With that out of the way, we will begin with our Chairman and CEO, Tom Linebarger.

[Thomas Linebarger, Chairman and Chief Executive Officer]

Thank you, Jack, and good morning, everybody. If that voice sounded different to you, because it was, that was Jack Kienzler, not James Hopkins. And I want to welcome Jack to the Investor Relations function and to this quarterly earnings call. Jack is not new to Cummins. He has been with the company since 2014. He has worked in Finance, he has worked in Strategy. He has a great understanding of our business and our financial performance. He will be a terrific addition to the Investor Relations team. And he will, I think continue James’ efforts to not only improve communication with investors, but make sure that you have the insights in understanding your need of our business and financial performance. James also worked with managers across the company to make sure that we understood what you as investors need from us. And for that, I am very grateful. James is now working in the Engine Business and Strategy, and I know he'll do a terrific job. So thanks to James.

Before I go through the summary of our fourth quarter and full-year results, I want to take a moment to acknowledge and thank our employees for the sacrifices they've made over the course of 2020. In the second quarter, we faced the most severe decline in quarterly sales in our history, followed by a rapid recovery in demand and supported by a supply chain that was severely impacted by the pandemic. Our employees have worked tirelessly to navigate the many challenges caused by COVID-19 across the globe in order to support our customers and operate with financial discipline. I can't thank them enough for their commitment, their agility and their resilience.

Now I’ll summarize our fourth quarter and full-year results and finish with a discussion of our outlook for 2021. Mark will then take you through more details of both our fourth quarter financial performance and our forecast for this year. As a reminder, in the fourth quarter of 2019, we recorded restructuring charges totaling $119 million pretax or $90 million after-tax. In order to provide clarity on operational performance, I am excluding any references to those charges from my comments.

Revenues for the fourth quarter of 2020 were $5.8 billion, an increase of 5% compared to the fourth quarter of 2019, driven primarily by increased demand in Chinese truck and construction markets. EBITDA was $837 million or 14.4% compared to $682 million or 12.2% a year-ago. EBITDA percent increased due to higher revenue, stronger joint venture income and benefits from restructuring actions taken in the fourth quarter of 2019, partially offset by higher product coverage costs. Fourth quarter EBITDA included $36 million of reorganization and facility closure costs associated with actions taken to improve future performance primarily in our distribution business.

For the full-year, Cummins sales were $19.8 billion down 16% year-over-year. Our EBITDA margins were $3.1 billion or 15.7% of sales compared to $3.7 billion or 15.8% of sales in 2019. In our Engine business, sales decreased by 20% in 2020. Lower demand in most of our major regions and markets was partially offset by record levels of demand in the on-highway and construction segments in China. EBITDA was 15.4% compared to 14.6% in 2019 as the benefits of higher joint venture income, restructuring and temporary salary reductions more than offset the impact of lower volumes.

Sales for our Distribution business decreased by 12% in 2020, driven by lower demand for engines and power generation equipment. In addition to lower utilization of our products across many of our regions driving lower aftermarket demand. Full-year EBITDA increased to 9.3% compared to 8.6% in 2019 driven by the realization of benefits of our transformation activities, especially in North America and other cost reduction actions.

Full-year revenues for the Component segments declined by 13% due to lower truck production in North America and Europe. This more than offset increases in revenue associated with new products designed to meet Bharat Stage VI emissions regulations in India and record levels of truck demand in China. EBITDA was 16.0% compared to 16.2% in 2019. The decrease in EBITDA percent was primarily due to lower volumes, which more than offset the benefits of restructuring actions, temporary salary reductions and lower warranty expense.

Power systems sales decreased by 19% in 2020. Sales of our power generation equipment declined by 14% as lower demand for standby power generation equipment in North America, India and Asia, more than offset continued strong demand in data center markets, especially in China. Demand for engines and industrial applications declined by 26% due to lower demand in oil and gas and mining markets.

EBITDA was 9.4% compared to 11.7% in 2019. The decrease in EBITDA was primarily driven by lower volumes, which more than offset the benefits of prior restructuring actions and temporary salary reductions. In our New Power business, revenues increased by 89% to $72 million, primarily driven by electrolyzer demand. Full-year New Power EBITDA was a loss of $172 million in line with our forecast as we continue to invest in new products and technologies ahead of widespread market adoption.

And before I move on to some of our key markets, I'd like to take a moment to provide an update on the progress we made in New Power in 2020. First, we delivered a 20-megawatt PEM electrolyzer system to generate green hydrogen in Bécancour, Québec, making it the largest operation of its kind in the world. The Cummins electrolyzer system is installed in an Air Liquide hydrogen production facility and began commercial operation late last year.

The Cummins PEM electrolyzer can produce over 3,000 tons of hydrogen annually using hydropower. In addition to the Bécancour installation, we delivered four-megawatts of electrolyzers to nine additional customers in 2020. We provided fuel cell modules to ASKO, Norway's largest grocery wholesaler that were integrated into four Scania trucks. The fuel cell electric truck pilot is the first of its kind as ASKO aims to reduce its energy use by 20% and ultimately become a self-sufficient provider of clean energy, using 100% renewable fuel.

Cummins also supplied fuel cells for FAUN, a leader in waste collection vehicles and sweepers in Europe, for their electric refuse truck program. Cummins is also the largest supplier of fuel cells for the rail industry. And we are using experience from rail applications in our design for other heavy-duty transportation applications to provide best-in-class solutions.

In the battery electric market, we delivered 147 fully-electric powertrains to Blue Bird in 2020 for use in the school bus market, and 19 powertrains to GILLIG for use in the transit bus market. Our products are now powering over 250 school buses, which are actively in service today in addition to transit buses operating in municipalities around North America.

Finally, we formed the NPROXX joint venture in 2020 to provide customers with high pressure tank and storage solutions in hydrogen and natural gas markets. We have a strong portfolio of distinctive platforms and are continuing to invest in key technology areas for the future. We are targeting our focus and investment at the markets where commercial opportunities exist today or will emerge in the near or medium-term.

The experience we are gaining in the field is providing us opportunities to continuously improve our products and leverage prior investments into new applications. In addition to the technical experience we are accumulating, our sales and service channel customer relationships and global footprint will position us well when broader commercialization of fuel cell electric powertrains and battery electric powertrains take place.

Now I will comment on some of our key markets in 2020. Starting with North America, and then I'll comment on some of our largest international markets. Our revenues in North America decreased 21% in 2020, primarily due to lower demand across our segments in response to that COVID-19 pandemic. Industrial production of heavy-duty trucks declined to 187,000 units, a decrease of 39% from 2019 levels, while our heavy-duty unit sales declined to 63,000, a decrease of 36% from 2019.

We began shipments of our X12 engine to Freightliner for use in their Cascadia Day and sleeper cab models in 2020. In addition to sales in various vocational applications, our entry into the regional haul market with a low weight X12 engine will further support our leading market share in this segment. The market size for medium-duty trucks was 101,000 units in 2020, a decline of 28% from 2019 levels, while our unit sales were 78,000, a decline of 32% from 2019.

We shipped 125,000 engines to Chrysler for use in their RAM pickups in 2020, a decline of 14% from 2019 levels. Engine sales to construction customers in North America decreased by 42% as non-residential construction spending declined and rental companies cut capital spending.

Engine shipments to high horsepower markets in North America decreased by 11% from last year with lower demand from oil and gas and mining segments, partially offset by increased shipments to marine and defense customers. Power generation revenues decreased by 13% year-over-year, driven by a lower demand for standby applications resulting from lower non-residential construction spending.

Our international revenues declined 7% in 2020 with weaker demand in most markets, more than offsetting a record year in China. Full-year revenues in China, including joint ventures were $6.9 billion, up 25%. The increased revenue was driven by record demand in the truck, construction and data center markets. Industry demand for medium and heavy-duty trucks in China was 1.8 million units, an increase of 35% driven by increased incentives to scrap, older trucks and the increase in government stimulus following the easing of COVID-19 restrictions. Our units sold including joint ventures were 286,000, an increase of 47%.

The light-duty truck market in China increased 17% from 2019 levels to 2.2 million units, while our units sold including joint ventures were 189,000 units, an increase of 24%. Industry demand for excavators set another record of 328,000 units in 2020, an increase of 39% from 2019 levels. Our units sold were 53,000 units, an increase of 58% as our domestic partners gained market share.

In our power systems markets, demand for power generation equipment in China increased 8% compared to 2019, driven by growth in key markets, such as data center, infrastructure and healthcare. Industrial engine sales declined 34% from 2019 levels, primarily driven by weakness in oil and gas and mining markets. Full-year revenues in India, including joint ventures were $1.2 billion, down 26%. Industry truck production declined by 54% in 2020, demand for construction equipment dropped 28%, and power generation revenue declined 40% in 2020.

Our Components business was the one major bright spot with revenue up 17% as a result of new products designed to meet the Bharat Stage VI emissions regulations introduced in April in addition to new customer wins. In Brazil, our revenues declined 11% driven by weaker demand in most end markets.

Now let me provide our overall outlook for 2021 and then comment on individual regions and end markets. We are forecasting total company revenues for 2021 to increase 8% to 12% compared to 2020, driven by an increase in heavy-duty and medium-duty truck production in North America, Europe and India offset by China, while we expect demand to moderate after a record year in 2020, particularly in the second half of the year.

We expect demand for construction equipment to increase in North America and Europe and decline in China from record levels experienced last year. We are forecasting higher demand in global mining, oil and gas and power generation markets and expect aftermarket revenues to increase by 10% compared to 2020. Industry production for heavy-duty trucks in North America is projected to be 245,000 to 265,000 units in 2021, a 30% to 40% increase year-over-year.

In the medium-duty truck market, we expect the market size to be 120,000 to 130,000 units, a 20% to 30% increase from last year. This year, we will begin selling engines to Isuzu for use in the medium-duty truck markets. We have been working with Isuzu on multiple collaboration initiatives since 2019, including the delivery of next generation low-emission products, and are excited to take our partnership to the next level.

We have delivered some initial units which are being incorporated into vehicles in North America now, and plan to begin serial production in the second quarter of 2021. In 2023, we expect to supply engines to Isuzu for truck applications in Japan and Southeast Asia. Our engine shipments for pickup trucks in North America are expected to be up 5% compared to 2020.

In China, we expect domestic – we are projecting domestic revenues, including joint ventures to be down 20% in 2021. We currently project a 30% reduction in heavy and medium-duty truck demand and a 5% to 10% reduction in demand for the light-duty truck market. We expect demand to be heavily weighted towards the first half of the year, particularly in the first quarter, and primarily driven by pre-buy ahead of the broad NS VI implementation in July and OEM efforts to increase inventory levels to mitigate supply chain constraints.

Industry volumes of NS VI product will increase in 2021 as the new regulations are implemented more broadly across China from July onwards. We first launched engines to meet standards similar to NS VI in the United States 10 years ago, and have leveraged our knowledge in powertrain technologies to develop a range of products for Chinese markets that we expect to be well received by end users.

Industry sales of excavators in China are expected to decline 20% from last year's record levels. We also expect demand in the first half of the year for excavators to be stronger than the second half, driven by infrastructure projects and a strong housing market, which is expected to decline in the second half of the year as the government stimulus tightens.

In India, we project total revenue including joint ventures to increase 25% in 2020. We expect industry demand for trucks to increase 20% in 2021. The new emission standards in China and India will result in significantly more content for each Cummins engine we sell. For example, we expect to increase sales of after-treatment systems by over $250 million in 2021. We project our major global high-horsepower markets will improve in 2021.

Sales of mining engines are expected to increase by 10% to 15% in 2021 with greater demand following a recovery in commodity prices. Demand for new oil and gas engines is expected to increase by 55% in 2021, albeit off a very low base, primarily driven by increased fracking activity in North America. Demand in global power generation market is expected to increase 5%, driven by continued growth in data center markets and strong RV market in North America.

In New Power, we expect full-year sales to be between $110 million and $130 million. We have a backlog of approximately 65-megawatts in electrolyzers, which we expect to be delivered over the course of the next 12 to 18 months. We will continue to deliver fuel cell systems for use in the European rail market. We also expect to provide modest volumes of fuel cells for truck applications in 2021 as some fleets try out the new technology.

We are continually innovating across our broad portfolio of power solutions from diesel and natural gas to fuel cells, hybrid and fully-electric options. We plan to provide our customers with the right technical solution for their application at the right time, and to continue to be leader in power for commercial and industrial equipment. While current indicators point to improving demand in a number of key regions and markets in 2021, significant uncertainty remains, requiring continued strong focus on managing costs and cash flow as our markets continue to recover around the world.

We are still operating under a pandemic with extreme safety measures in place, and our suppliers and customers are doing the same. This is presenting challenges to global supply chains as our industry response for rising demand across multiple end markets. Having effectively managed through an extremely challenging 2020, Cummins is in a strong position to keep investing in future growth and continuing to return cash to shareholders.

In summary, we expect full-year sales growth of 8% to 12% and EBITDA to be in the range of 15% to 15.5% of sales. The benefits of higher volumes and ongoing cost reduction activities will be partially offset by lower joint venture earnings, investment in new products and some additional costs with supply chain inefficiencies and the year-over-year impact of restoring full salaries following temporary salary reductions between April and September last year.

Now let me turn it over to Mark, who will focus on our financial results and discuss them in more detail. Mark?

[Mark Smith, Vice President and Chief Financial Officer]

Thanks, Tom, and good morning, everyone. I'll start with a quick summary of our financial performance in the fourth quarter and full-year 2020 before moving to our outlook for 2021. As a reminder, in the fourth quarter last year – 2019, we recorded restructuring charges of $119 million pretax or $90 million after-tax. I'm going to exclude any references to those charges in my subsequent comments to provide clarity and consistency on the underlying operating performance.

There are four key highlights this quarter. First, the pace at which customer demand for Cummins products rebounded and our employees’ agility in responding to the higher customer orders. Second, we delivered solid profitability, especially when we peel back the expenses associated with cost reduction activities and some elevated costs tied to – tightness in global supply chain. Third, we converted the sales into cash, delivering $1.1 billion of operating cash flow, our second consecutive quarter of delivering more than $1 billion in cash. And fourth, we increased cash returns to shareholders in the fourth quarter as a visibility to improving demand increased.

And I will let me go into more details on the fourth quarter and full-year performance. Fourth quarter revenues were $5.8 billion, an increase of 5% from a year ago and snapping a five-quarter run up declining sales. While the origins and depths of each of the downturns in the past 20 years have varied, each one has yielded negative sales growth for Cummins of between four and six quarters.

Sales in North America were flat and international revenues increased 12%. Currency movements in aggregate had a minimal impact on revenues in the fourth quarter. EBITDA was $837 million or 14.4% of sales compared to $682 million or 12.2% of sales a year-ago. EBITDA dollars increased by $155 million with the positive impact of higher sales, the benefits of restructuring and lower variable compensation expense, more than offset higher product coverage costs and additional supply chain cost.

Fourth quarter EBITDA included $36 million of expenses associated with the reorganization activities and facility closures primarily driven by transformation initiatives in our distribution business. That $36 million was equally split between gross margin and our operating expenses. Gross margin of $1.4 billion or 23.3% of sales increased by $48 million, but decreased as a percent of sales by 20 basis points year-over-year.

Higher product coverage expense and additional costs associated in meeting rising demands more than offset the positive impact of higher volumes and the benefits of restructuring leading to a slight reduction in gross margin as a percent of sales. Combination of a sharp recovery in demand in nearly all of our end markets and the ongoing COVID-19 pandemic have led to tightness in global supply chains.

We leveraged our global footprint to respond to the rapid increase in demand, but did incur additional freight and labor costs in doing so, which reduced fourth quarter margins by approximately 60 basis points. We anticipate that these elevated costs will continue through the first half of 2021 and have incorporated them into the midpoint of our guidance for this year.

Selling, general and administrative expenses decreased by $56 million or 9% due to the benefits of restructuring, reduced discretionary expenses and lower variable compensation. Research expenses decreased by $16 million or 6% from a year-ago. Joint venture income increased by $36 million, primarily due to continued strong demand for trucks in China, which we converted into earnings growth and higher profits in our India operations.

Other income of $24 million increased by $4 million from a year-ago. Net earnings for the quarter were $501 million or $3.36 per diluted share compared to $390 million or $2.56 from a year-ago. The effective tax rate in the quarter was 19.7%. Operating cash flow in the quarter was an inflow of $1.1 billion, $304 million higher than the fourth quarter last year. Higher earnings and lower working capital contributed to the strong cash generation.

Now I'll move to the full-year 2020 commentary. Revenues were $19.8 billion, a decrease of 16% or $3.8 billion from a year-ago, the largest dollar decline in sales in company history. Sales in North America decreased 21% and international revenues decreased 7%. Currency movements negatively impacted revenues by 1%. EBITDA was $3.1 billion or 15.7% of sales for 2020 compared to $3.7 billion or 15.8% of sales a year-ago.

The benefits of restructuring, lower compensation expenses due to temporary salary reductions, lower variable pay and record joint venture performance in China were more than offset by the impact of lower volumes. The record performance in China is remarkable when considering the COVID-related restrictions faced by all people in operations in the first quarter last year, and throughout much of the remainder of last year.

Net earnings were $1.8 billion or $12.01 per diluted share. This compares to $2.4 billion or $15.05 per diluted share a year-ago. Importantly, our results in 2020 extended our track record of raising performance over successive cycles with earnings per share, 46% higher than we delivered in the prior downturn of 2016. Full-year cash from operations was an inflow of $2.7 billion, our second highest year. Solid profitability and lower working capital in the second half of the year contributed to the strong cash generation.

Capital expenditures in 2020 were $528 million down $172 million from 2019 as we reprioritize and reduced our plans in response to the pandemic-induced global economic contraction. We returned $1.4 billion of cash to shareholders or 52% of operating cash flow in the form of share repurchases and dividends in 2021. We repurchased 3.9 million shares throughout the year at an average price of $164.

After pausing share repurchases at the end of the first quarter in the face of unprecedented uncertainty, we resumed repurchases in the fourth quarter. In doing so, we completed the ninth share repurchase program approved by our Board of Directors and began repurchasing under our 10th program. In October, we raised our quarterly cash dividend by 3% as visibility to improving demand increased.

Moving on to the operating segments. I will summarize the 2020 results and provide our current forecast for 2021. For the Engine segment, 2020 revenues decreased 20% from a year-ago, while EBITDA increased from 14.6% to 15.4% of sales. In 2021, we expect revenues to grow between 10% and 14%. While this increase primarily driven by higher truck production in North America and stronger aftermarket revenues also in North America.

2021 EBITDA projected to be in the range of 14% to 15% compared to 15.4% sales in 2020. The benefits of higher volumes are expected to be more than offset by lower joint venture income, which I’ll comment more a little later, and an increase in product coverage costs associated with new product launches.

In the Distribution segment, revenues decreased 12% from a year-ago to $7.1 billion. EBITDA increased as a percent of sales to 9.3% compared to 8.6% a year-ago. We expect 2021 distribution revenues to grow between 6% and 10% compared to 2020, but this increase primarily driven by a stronger aftermarket activity in North America. EBITDA margins are expected to be between 9.6% and 10.6% up from 9.3% in 2020, as we continue to realize the benefits of our North American transformation work and other improvement actions in international markets.

Components segment revenues declined 13% in 2020, while EBITDA decreased from 16.2% of sales to 16%. This year, we expect revenues to increase 9% to 13% primarily due to higher industry truck production in North America and incremental revenues from new products in China and India following the implementation of National Standard VI and Bharat Stage VI emissions regulations.

EBITDA is projected to be in the range of 14.4% to 15.4% of sales compared to 16% in 2020, primarily due to lower joint venture income in China and launch costs associated with some of our new NS VI products in China. In the Power Systems segment revenues decreased 19% in 2020, and EBITDA declined from 11.7% to 9.4% sales. In 2021, we expect revenues to increase between 7% and 11%, primarily due to higher demand for mining engines and power generation equipment. EBITDA is projected to be between 10.1% and 11.1% of sales up from 9.4% in 2020, primarily due to the benefits of higher volumes.

In the New Power segment, revenues increased $72 million in 2020, and our operating loss was $172 million. In 2021, we anticipate revenues between $110 million and $130 million. Net expense is projected to be between $190 million and $210 million as we continue to make targeted investments in our technology portfolio consistent with the projections we made at our Hydrogen Day.

As Tom mentioned, we are projecting 2021 company revenues to be between 8% and 12%, company EBIT margins expected to be in the range of 15% to 15.5% of sales compared to 15.7%. The benefits of higher volumes are expected to be partially offset by weaker joint venture income and the impact of restoring compensation following temporary salary reductions in 2020.

Weaker demand in China following a record year in 2020 and lower earnings in India following tax and other one-time benefits last year are the main drivers of the lower joint venture income. As Tom mentioned, our guidance for joint venture income assumes that truck demand in China will decline sharply in the second half of 2021 following the country-wide adoption of National Standard VI emissions regulations.

At this time, we have limited visibility to industry demand beyond the first quarter and we will continue to provide updates in this important market as the year progresses. We are projecting our effective tax rate to be approximately 22.5% in 2021, excluding discrete items. We expect our 2021 capital investments will be in the range of $725 million to $775 million.

As we've discussed in prior years, our base case is to return 50% of operating cash flow to shareholders, and in years when we expect our cash flow to exceed the needs of our core business to return more. In 2021, we currently plan to return 75% of operating cash to shareholders in the form of dividends and share repurchases.

To summarize, we delivered strong results in 2020 in the face of unprecedented challenges, extending our track record of raising performance cycle-over-cycle. The solid financial performance was only made possible by our employees who work tirelessly to support our customers, managed through customer shutdowns and amidst significant fluctuations in demand. They managed all of this, while adjusting the way they work and maintaining financial discipline throughout.

As we enter 2021, we are well-positioned to capitalize on strengthening markets to deliver another strong year. We will continue to invest in the products and technologies that will fuel profitable growth in the future and return capital to shareholders, while maintaining the flexibility to ensure that we can weather any volatility that may lie ahead.

Thank you for your interest today. Now let me turn it back to Jack.

[Jack Kienzler, Executive Director of Investor Relations]

Thanks, Mark. Out of consideration to others on the call, I would ask that you limit yourselves to one question and a related follow-up, and if you have additional questions, please rejoin the queue. Dana, we are now ready for our first question.

[Operator]

Thank you. [Operator Instructions] Our first question is coming from Jamie Cook of Credit Suisse. Please go ahead.

[Jamie Cook, Credit Suisse Group AG]

Hi, good morning.

[Thomas Linebarger, Chairman and Chief Executive Officer]

Good morning, Jamie.

[Jamie Cook, Credit Suisse Group AG]

Good morning. I guess a couple of questions. First, the commentary on China. Just wondering, I think you said you only – just wondering if you could clarify how much visibility you have into that market or what the OEs are telling you about production relative to – relative to that your forecast is down 25% to 30%, and given, I think January was up about 60%. So I'm just trying to figure out how conservative that forecast could be or what you expect first half versus second half?

And then my second question, the market is talking a lot about supply chain issues. You talked about that in the fourth quarter and rest into 2021. So if you could sort of elaborate there and what are the supply chain risks and costs embedded in your guidance? Thank you.

[Mark Smith, Vice President and Chief Financial Officer]

Yes. Jamie, this is Mark. So I'll cover China here. So we do not have concrete forecasts for the full-year, of course. In any situation demand varies due to a number of considerations, but we are hearing a very cautious tone from our OEM customers in China about demand in the second half of the year. It is true that demand held up strongly through the second half of 2020. And yes, you're right. The industry is off to a strong start in Q1. We don't expect to see that significant decline in Q1, that's for sure. So hence we may clear our assumption and we will keep you updated, but we don't – we don't have concrete visibility.

[Thomas Linebarger, Chairman and Chief Executive Officer]

Jamie, just one thing to add on China. I think you hit on the key point. The first half to second half is going to be really different and so it's really going to be hard to tell whether our assumption is conservative or not in the first half. We will just see. It just seems like the number of trucks and excavators being produced, it just seems like a lot for us relative to the economies ability to absorb it. Again, that's just from history and experience and we'll see. I mean last year was a – it's just an enormous production build.

And as Mark said, OEMs are cautious about the same thing, but nobody has a firm grasp on it. And then there's the emissions change in the middle, which also seems like a good impact thing. So we're using our experience and history here to make this call. We did the same thing in 2020 and got it wrong. It ended up being strong all year. So we'll see, but the first half is likely to be good. And then we'll know a lot more as we get through the end of the second quarter about how the second half is going to go.

Let me let Tony talk a little bit about the supply chain. There's a lot to say about that. And Tony has got a lot of details about what we're doing to try to work through with our customers and our suppliers on supply chain issues.

[Livingston Satterthwaite, President and Chief Operating Officer]

Good morning, Jamie. Just very quickly, I just want to say that the most interesting thing that's happening is the rate at which demand has increased. We've never seen an increase in demand happened as quickly. And that combined with COVID and the pandemic has really stretched the supply chain. Mark mentioned, we did have elevated freight costs in the fourth quarter of last year. And as he said, we expect those to continue through the first half.

We are working with all of our suppliers. The supply base is generally tight, not just semiconductors, which has gotten a lot of press, but many of our components, are on longer lead times. Our suppliers and we are struggling with absenteeism due to COVID. And we are working very closely with our customers to remain connected and to continue to supply them as best we can. We are working through all of these issues on a daily basis, and the cost that we expect are included in our guidance. And we expect to be able to supply what we believe our market forecast is that Mark said earlier.

[Jamie Cook, Credit Suisse Group AG]

Are you going to give what the costs are? And then I guess is, are the supply chain issues – to what degree are they limiting your topline forecast if any? I'm just wondering if your topline forecast is more conservative because you're just worried about supply chain issues and that sort of a headwind to your guide outside of just costs.

[Livingston Satterthwaite, President and Chief Operating Officer]

Just to clarify. So the costs are about 60 basis points of a hit in Q4. We'd expect that level to continue in Q1 and Q2. And after that, our guidance assumes that starts to get better.

[Jamie Cook, Credit Suisse Group AG]

And is there anything limiting your topline guide Mark, in terms of like you just assuming sales are lower because the industry has bottlenecks?

[Mark Smith, Vice President and Chief Financial Officer]

I mean, it's clear. In the short run, it's tight. We anticipate that supply chains ease in the second half of the year. That's the best way to say it. But no, we've given our range of market sizes and we expect to be able to meet all of those.

[Thomas Linebarger, Chairman and Chief Executive Officer]

But Jamie, if you step back from it, there's no question that supply chain constraints are impacting everybody's view of what the production is going to be. So OEMs, suppliers like us first tier, and then second tier, everybody knows that their supply chain limits. It's hard for us to see as because our customers are driving our demand, how much they're weighing in their own limitations versus what they see customers ordering and things. But just as every conversation, supply chain comes up. So I just assume that it's having some impact, but we are expecting to be able to fulfill our customers’ needs as Tony said throughout the year. It's just hand to mouth everyday.

[Jamie Cook, Credit Suisse Group AG]

Okay. Sorry, go ahead, Mark.

[Mark Smith, Vice President and Chief Financial Officer]

It is the most rapid rate of increase that we've seen. So the question is how long will that – at what pace will that sustain? We're optimistic about growing demand, but there's some noise in the system given the supply chain tightens.

[Jamie Cook, Credit Suisse Group AG]

Okay. Mark, I'll let someone else give you a hard time about your margin guidance. Just kidding.

[Operator]

Thank you. Our next question is coming from Ann Duignan of JPMorgan. Please go ahead.

[Ann Duignan, JPMorgan Chase & Co.]

Hi, good morning. I'll skip margin questions and turn to more strategic questions. Yesterday, you were part of an industry announcement on Hydrogen Alliance that was put forward particularly for the U.S., and I'm wondering if you could talk about that. And where do you see the U.S. going in terms of a hydrogen future versus Europe? It's easier to see it happening in Europe given their lack of energy independence, but maybe not the same sense of urgency in the U.S. So just curious to hear your thoughts on that and where you think we go from here with this alliance?

[Thomas Linebarger, Chairman and Chief Executive Officer]

Thanks for that Ann. We appreciate the question. Yes, the Hydrogen Forward Alliance is really just trying to make sure that those of us that are investing in the industry are making it clear to policy makers and other potential participants, what the opportunity is with hydrogen. Because I do think if you just check in with people's imagination about what a low-carbon future can look like. I think everybody from government regulators to my kids understand what battery cars might mean and all that, and they get it. I think the role that hydrogen is going to play in larger energy use more energy dense demand is just not as clear.

And I think we need to be more proactive in helping people understand what it can mean to our entire energy system, and of course, what it can mean to equipment that we might supply. So we decided that since a lot of us have been investing a lot of time and energy in that and see the opportunity, we better start telling people about it. So that of course includes Biden administration and regulators, but it also includes general public. And I think a bunch of industry participants or people who could be participants understanding what investment might makes sense. That's the goal of that initiative.

And I agree with exactly what you said that Europe has moved much faster to understand the role that hydrogen can play both in energy storage, cleaning up a high-carbon industries, steel making and others as well as potentially in transportation like trucks and trains. And I think the U.S. really does lag there. And part of it is, is what I said is just the understanding of regulators and others is not as good. But part of it is also because we kind of went into a different phase, I guess, over the last four or five years where we weren't really doing much for energy planning. I see that changing. We've already had several conversations with members of the Biden administration or transition people about trying to put together a more comprehensive energy strategy that for a low-carbon future.

So I'm optimistic that not only will we have a more comprehensive plan, but that hydrogen will play a role in it and we're trying, of course, to impact that. I think we do believe that for the kind of commercial industrial applications that we're involved with anyway that hydrogen-based technologies can have a big role, so – which is why we're investing in it.

[Ann Duignan, JPMorgan Chase & Co.]

Clearly, and I appreciate that. And I agree with everything. But then during your Hydrogen Day – just a quick follow-up, I mean, you guided to revenues for electrolyzers, but you didn't guide any revenue for fuel cells and in particular, the rail side, is that because in your timeframe those will still not be really material and will have to wait beyond that, or was there any other reason why you didn't guide to any revenue for fuel cells?

[Jack Kienzler, Executive Director of Investor Relations]

Ann, this is Jack. I think there's nothing more behind it besides the fact that we just have a bit lower visibility and the lead time behind those orders is a bit lower than on the electrolyzer side. So as Tom mentioned in his comments, there's solid momentum in the rail space with Alstom and others and as well as on the fuel cell markets with some prototypes with fleets hopefully this year.

[Thomas Linebarger, Chairman and Chief Executive Officer]

And we'll try to give more visibility to what those look like in the future. Again, as you heard from Jack, the rail side, we know what the orders are. We just don't know the rate and pace by which they're going to be able to take them. It's still a pretty low scale operation both on Alstom side and our, so we're working through all that. But we'll give more visibility as we understand. I guess why it might be interesting to those that are watching the industry. So we'll see what we can do to provide more guidance there.

[Ann Duignan, JPMorgan Chase & Co.]

Okay. I appreciate that. And I'll get back in queue. Thank you.

[Operator]

Thank you. Our next question is coming from Noah Kaye of Oppenheimer. Please go ahead.

[Noah Kaye, Oppenheimer & Co. Inc.]

Good morning. Thanks for taking the question. I guess, can you maybe talk a little bit about the priorities for R&D investment this year? You had mentioned some of the launch costs associated with NS VI and BS VI. But as we kind of get through that, we've got advanced clean trucks on the horizon, some other emissions standards plus the ongoing investment on the New Power side. So just kind of highlight for us where the investment is going? And I guess at the end of that, are you kind of looking for R&D to get back to the 2019 level? Are we looking for a step up in R&D here?

[Thomas Linebarger, Chairman and Chief Executive Officer]

Yes. It's a good question, Noah. We will continue to invest significantly in R&D both in our core businesses and in our New Power businesses. As we talk about, maybe it was last year, beginning of last year, we expected R&D over time to increase some over what we’re experiencing when we really just had one technology to invest in. So as a percent of sales, we expect to continue to drive up R&D to some degree because we just now are investing both for low-carbon future and the existing products at the same time. And so there are significant investments for both low emissions diesel products across the world, those are in components and in engines.

We’ve now got new regulations in California to meet plus we've got all those New Power technology. So we have a lot to invest in. So you should expect R&D cost to come back to normal after 2020 and in fact, to continue to grow as a percent of sales, although again, some are shown in the New Power business, some in the Engine business. So they're mixed around, but as a total matter, we are investing more in R&D.

[Noah Kaye, Oppenheimer & Co. Inc.]

Okay. That's very helpful. And then just want to ask about the pipeline for new platform wins. Congratulations, say on Isuzu starting to ramp this year. But do you look at 2021 as kind of a sort of a ratable year of potential new platform wins? Are we maybe getting to an inflection point this year where there are just more decisions being made until you have more short-term goal?

[Thomas Linebarger, Chairman and Chief Executive Officer]

It's a great question. And of course, you know that as we've said, we are having conversations with lots of different customers, partners about this and have been for some time. And I've been thinking that the year it has – that they need to make decisions with the year I mean for the last several years. It's a complicated conversation for all involved because there's a lot of strategic choices for the customer about where they want to invest and where they don't. There's employees and facilities and other decisions to make. So it's a complicated set of decisions. We are talking to a number of customers and do expect some of them to choose to invest in other technologies other than diesel in the coming years.

And we think we're positioned well, we'll see, but we think we're positioned well to win some of that business, but we are continuing those conversations. And again, I expect some more to come this year, but then I expected more last year, too. So we'll just see where it goes. But we are having conversations with lots of people. And as you said, with Isuzu, it’s a really – it's a meaningful step in that partnership. That's a good example.

We’ve actually had a collaboration with them for several years now. It's been very meaningful conversations, but it's complicated for them to figure out how to navigate this. And this is an important and meaningful step for them. And I think it’s the beginning of a lot of things we can do together, and I believe that other customers are in the same spot.

[Noah Kaye, Oppenheimer & Co. Inc.]

Okay. Thanks, Tom. Good luck and good health to the team in the year ahead.

[Thomas Linebarger, Chairman and Chief Executive Officer]

Thank you. Noah.

[Operator]

Thank you. Our next question is coming from Jerry Revich of Goldman Sachs. Please go ahead.

[Jerry Revich, Goldman Sachs Group, Inc.]

Yes. Hi. Good morning, everyone.

[Mark Smith, Vice President and Chief Financial Officer]

Hi, Jerry.

[Jerry Revich, Goldman Sachs Group, Inc.]

Hi. Mark, I'm wondering if you could talk about, if we do see a upside in revenue relative to your outlook. Can you just talk about what level of incremental margins you would expect to achieve in that scenario if sales are 5% or 10% above the range that you outlined? How would you expect given the supply chain issues, operating leverage to look relative to the starting point of the initial guide?

[Mark Smith, Vice President and Chief Financial Officer]

Yes. Jerry, I think typically we've demonstrated over a long period of time that if it's products that we're already making and in serial production, and we can get incremental and the supply chain is functioning well, and we can get incremental gross margins in that kind of low 30% range incrementally. I think we've done that consistently over time. The issue becomes when we get these extreme changes. And then we need to adjust and supply chain needs to adjust. But yes, if we get more revenue, we can deliver that efficiently. That's the range of incremental gross margins on current products.

[Jerry Revich, Goldman Sachs Group, Inc.]

Okay. Terrific. And then Tom, in terms of the electrification products that you mentioned, obviously you have strong position on school buses, trains and buses. Can you just talk about based on the production plans for the industry that you have visibility on? Where do you expect your market share to shake out on buses versus trucks? Is that something that you could talk about at this point or if it's too soon, maybe you could just talk about platform share any way for us to pick them out would be helpful?

[Thomas Linebarger, Chairman and Chief Executive Officer]

Yes, it's a great question. And of course, we're all interested in this question because I think you know our strategy as a supplier to the industry is to maintain leadership, irrespective of technology. And we're investing in the key technologies that we think take us from fuel cell today through hybrid, through other fuels all the way up to low and zero-carbon – tailpipe carbon technologies. And our intent is to invest in the technologies and with the customers that we think are going to win. So we end up – we're leading today and we ended up leading then in those new technologies, there's a lot to play for in that. But that's what we're – that's our strategy. That's what we're aiming for.

And the challenge now on the BEV or battery electric vehicle, or even fuel cell technologies, is that they're not in the money in trucks. So when you try to put a truck into production or into operation, you're going to be out of the money at the start. And so they're mostly regulatory-driven or some other subsidy driven, which means that it's not really a strength, technology and performance kind of discussion. And so right now market share is bouncing all over the place. And because there's a lot of different players that can offer a system, that system is unlikely to be competitive long run and even in the systems we offer are not – do not return if you compare them to a diesel system today.

So market share is really, really difficult to say right now because the basis of competition is not technology and performance and costs. It's a whole bunch of other things. But that said, we are intending to win as many partners and as many products as we can. So we can get, a) practice and learning on the technology, and b) help customers understand how they might be able to turn these technologies into winners over time. So we are competing, don't get me wrong, but it's just the basis of competition is not the normal performance cost trade-off we used to do with diesel.

[Jerry Revich, Goldman Sachs Group, Inc.]

Thank you. Appreciate the discussion.

[Operator]

Thank you. Our next question is coming from David Raso of Evercore. Please go ahead.

[David Raso, Evercore ISI]

Hi. Thank you. Yes, my question is on the margins. First, the incremental margins, all in they’re implied only 11%. Obviously the lower JV income is the big drag, but even if we exclude the JV income from both years, the implied incrementals are only 17%. So that's about a $150 million to $250 million of higher costs than you would normally expect, right? Meaning a set of 17% incremental as you would think 25% to 30%. But when you said 60 bps, I think Mark, you mentioned it was 60 bps of a drag expected for the next two quarters, $150 million to $250 million, call it $200 million midpoint. That's like a 400 basis points of drag. So can you help us understand how do we bridge that? Can you talk about some costs that you already know can be quantified?

And then I have a quick question on the JV income related to margins. China, how big of the decline do you expect from the total company JV income going down about $125 million year-over-year? How much do you expect that to be from China? Because China was about $215 million last year. I'm just curious, how much of the total $125 million do you think is from the JVs from China decline?

[Thomas Linebarger, Chairman and Chief Executive Officer]

Yes. Good questions and your math is all right, David. So that makes it a lot easier for me to answer your questions. So of the JV income, you need to remember that we had about $54 million of income in India, which was more one-time in nature. $37 million from the change in the tax legislation, which reduced our prior accrued withholding taxes on our JV earnings in India, and we also had a fairly large tech fee in the first quarter of 2020. So that’s $50 million, and then the balance is really market decline in China.

On to your other question…

[David Raso, Evercore ISI]

[Indiscernible] real quick, though. The China decline, if you went from $215 million all the way down to say $140 million, right, that's accounting for the rest of the total company decline. JV income in China hasn't been that low in four or five years. And I'm just trying to understand if you know that the decline is coming in the back half was the way you're managing your business. Why would the JV income in China fall that hard? I mean, the JV income hasn't been really even at that level and much below it for a decade. So I'm just trying to square up. Why such a decline in the JV income in China [indiscernible] you're predicting it's coming?

[Thomas Linebarger, Chairman and Chief Executive Officer]

We've assumed its coming. Right now – that's the second half assumption. But it's principally a volume assumption. Again, there are some incremental costs associated with launching products, but the primary reason is the volume decline. There is always some other bits and pieces and all the other 54 joint ventures. But these are the base of the basic. Two things, David, there's nothing else I'm trying to not share with you about the numbers.

When we get back to the bigger margin, you're exactly right. Yes. The piece that's missing, which I've been trying to telegraph to everybody is $165 million in salary reductions last year. Normally, we expect to deliver 20% plus incremental margins. You're absolutely right. What was abnormal about the actions we took in 2020 was that salary reduction, which was a $165 million. That's really – yes, our incentive comp will be, if we hit our targets slightly higher this year. When you add those, they take those two items alone, take about a 100 basis points off the margin. And that's the piece I think that's missing, there's other puts and takes.

[David Raso, Evercore ISI]

So the price cost to be fair provides a little bit of risk than, if it's the comp coming back, that reduces it from 25%, 30% down to 17% for the core business price costs. I assume then you must not have too much of a negative price cost in the guide.

[Thomas Linebarger, Chairman and Chief Executive Officer]

No, we are kind of 0% to 50% positive on those.

[David Raso, Evercore ISI]

Okay. That's helpful. I appreciate it. Thank you.

[Thomas Linebarger, Chairman and Chief Executive Officer]

All right. Thanks, David, and thanks everybody else. Jack, I think we are at the top of the hour.

[Jack Kienzler, Executive Director of Investor Relations]

Yes. That concludes our teleconference today. As always thanks to everybody for your continued interest in Cummins. I will be available for questions after the call.

[Operator]

Ladies and gentlemen, thank you for your participation. You may disconnect your lines at this time and have a wonderful day.