Cummins Inc
NYSE:CMI
If you don’t study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards.
Utilize notes to systematically review your investment decisions. By reflecting on past outcomes, you can discern effective strategies and identify those that underperformed. This continuous feedback loop enables you to adapt and refine your approach, optimizing for future success.
Each note serves as a learning point, offering insights into your decision-making processes. Over time, you'll accumulate a personalized database of knowledge, enhancing your ability to make informed decisions quickly and effectively.
With a comprehensive record of your investment history at your fingertips, you can compare current opportunities against past experiences. This not only bolsters your confidence but also ensures that each decision is grounded in a well-documented rationale.
Do you really want to delete this note?
This action cannot be undone.
| 52 Week Range |
223.75
377.39
|
| Price Target |
|
We'll email you a reminder when the closing price reaches USD.
Choose the stock you wish to monitor with a price alert.
This alert will be permanently deleted.
Cummins Inc
You don't have any saved screeners yet
Greetings and welcome to Cummins Fourth Quarter 2021 Earnings Conference Call. [Operator Instructions] Please note this conference call is being recorded. I would now like to turn the conference over to your host, Jack Kienzler, Executive Director of Investor Relations. Thank you. You may begin.
Thank you. Good morning, everyone and welcome to our teleconference today to discuss Cummins’ results for the fourth quarter and full year of 2021. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our President and Chief Operating Officer, Jennifer Rumsey; our Chief Financial Officer, Mark Smith; and our Corporate Controller, Chris Clulow. Mark is dealing with a bit of a cough today, so Chris is going to read his remarks this morning. 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 future results could differ materially from those projected in such forward-looking statements because of a number of risks and uncertainties. More information regarding such risks and uncertainties is available in the forward-looking disclosure statement in the slide deck 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.
Thank you, Jack and good morning everybody. Before I jump into our results though, I do want to welcome Chris Clulow to our Investor Relations function. So yes, he is our Corporate Controller, but he is replacing Jack as the Head of the Investor Relations function soon. And so Chris has been with the company for 18 years. He has gained valuable leadership experience in roles across the finance organization. During his career journey, Chris has served as the controller of the engine and components businesses, while also playing a key role in development and strategy. Chris has served as the Corporate Controller for the last 5 years and has a deep understanding of our business and our financial performance. He will be a terrific addition to the Investor Relations team and will continue Jack’s efforts to improve communications with investors, to make sure that you have the insights and understanding you need of our business and our financial condition and to work with our managers across the company to ensure that they understand what investors expect of us. I am grateful to Jack for his contributions to Investor Relations and excited for him about his new opportunity serving as the finance leader for our Filtration business. Thank you, Jack and welcome, Chris.
Now, I will start with a summary of our fourth quarter and full year results and our market trends by region and finish with a discussion of our outlook for 2022. Chris will then take you through more details of our fourth quarter and full year financial performance as well as our forecast for this year. Strong economic recovery, combined with high demand for our products, resulted in record full year revenues in 2021. On the other hand, our industry continues to experience significant supply chain constraints, driving elevated manufacturing, logistics and material cost and resulting in margins below our expectations, particularly in the fourth quarter. We have taken a number of actions to significantly improve our margins in 2022 and expect to generate strong incrementals through increased pricing as well as surcharges, combined with cost reduction initiatives in our supply chain and operations. Having effectively managed through a challenging 2021, we expect improved performance in 2022 and are well-positioned to invest in future growth, while continuing to return cash to shareholders.
The decarbonization of our economy is critical to our way of life and our industry and – excuse me, and all of us and it will – and our industry will play a key role in the effort to decarbonize our economy. Fortunately, decarbonization is also a growth opportunity for Cummins. We are confident in our ability to play a leading role in bringing lower carbon technologies to the commercial and industrial markets globally and to generate strong returns due to the unique capabilities that Cummins has built over many years. Specifically, we are a leader in key technologies for zero tail pipe emissions in commercial and industrial applications and are investing further to strengthen our position. We are also a leader in the transition technologies that will be needed in our industry for many, many years. Technologies at lower carbon emissions, while still offering customers economic solutions and hard-to-abate applications.
We also have existing relationships with leading OEMs and customers around the globe and are continually forming new partnerships with market leaders in a variety of industries. These relationships bring us visibility to opportunities and product plans. They drive economies of scale and production and service and they provide the trust of those making key purchase decisions. We have a deep knowledge of our end-markets and applications, each of which has unique technical and performance service – and service demands. We know how to adapt existing and new technologies into our products – into products, excuse me that customers can actually use and operate economically.
We are building a combination of businesses that have both the capability to serve the industry and the agility necessary to quickly pivot our product offerings depending on changes in regulations or infrastructure, advancements in technology and end user preference. We have invested significantly to attract and build the best talent and to create an environment for innovation and long-term success that will increase shareholder value. As a result of the successful execution of our strategy over many years, we are also in a very strong financial position, which allows us to make the sustained investments required to transition our industry to a zero carbon future, while navigating economic cycles and returning excess cash to shareholders. We are excited to tell you more about our long-term strategy during our Analyst Day later this month.
Revenues for the fourth quarter of 2021 were $5.9 billion, which is flat compared to the fourth quarter of 2020 as increased demand in many of our international markets was offset by a decline in North American sales as our customers work to clear their production backlog. EBITDA was $705 million or 12.1% compared to $837 million or 14.4% a year ago. EBITDA decreased as a percentage of sales due to the elevated material and supply chain costs we continue to experience. These impacts were partially offset by lower product coverage costs.
For the full year, Cummins sales were $24 billion, up 21% year-over-year and a record for our company. Our EBITDA margins were $3.5 billion or 14.7% of sales compared to $3.1 billion or 15.7% of sales in 2020. Higher supply chain and material expenses, as well as higher compensation expenses more than offset the benefits of higher volume, higher joint venture income, and lower product coverage expense compared to 2020.
Now, I will cover the full year trends across our key markets, beginning with North America before moving to our international regions. Our revenues in North America increased 17% in 2021, primarily due to higher demand across on-highway markets. Industry production of heavy duty trucks increased 228,000 units, up 26% from 2020 levels, while our heavy duty unit sales were 85,000, an increase of 37% from 2020. The market size for medium duty trucks was 115,000 units in 2021, an increase of 12% from 2020 levels, while our unit sales were 94,000, an increase of 21% from 2020. We shipped 159,000 engines to Chrysler for use in their RAM pickups in 2021, an increase of 27% from the previous year.
Engine sales to construction customers in North America increased by 50% as non-residential construction spending increased and rental companies increased capital spending. Engine shipments to high-horsepower markets in North America increased by 13% from last year, with higher demand from agriculture, rail and mining segments, partially offset by decreased shipments to defense and marine customers. Power generation revenues increased 6% year-over-year, driven by higher demand for standby applications, again resulting from higher non-residential construction spending.
Our international revenues increased 27% in 2021, with higher demand in all markets. Full year revenues in China, including joint ventures, were $7.5 billion, up 8% compared to 2020. The increased revenue was driven by record demand in the truck, construction and datacenter markets, particularly in the first half of the year. Industry demand for medium and heavy duty trucks in China was 1.6 million units, a decrease of 11%, driven by a decline in production in the second half of the year following a significant pre-buy period, ahead of broad NS VI implementation in July. Our units sold, including joint ventures, were 249,000 units, a decline of 13%. The light duty market in China decreased 4% from 2020 levels to 2.1 million units. While our units sold, including joint ventures, were 150,000 units, a decrease of 21% as new regulations drove demand for smaller displacement engines. Industry demand for excavators set another record of 342,000 units in 2021, an increase of 4% from 2020 levels. Our units sold were 56,000 units, an increase of 5%.
In our Power Systems markets, power generation sales in China increased 48% compared to 2020, driven by growth in key markets such as infrastructure, healthcare and mobile power applications driven by the power shortage in the country. Industrial engine sales increased 18% from 2020, primarily driven by strong mining demand. Full year revenues in India, including joint ventures, were $2 billion, up 68%, industry truck production increased by 76% in 2021, demand for construction equipment increased by 55%, and power generation revenues increased 38% as the broader economy in India recovered off a very low base in 2020. In Brazil, our revenues increased 46%, driven by higher demand in most end markets.
Now, let me provide our overall outlook for 2022 and then comment on individual regions and end markets. We are forecasting total company revenues for 2022 to increase 6% compared to 2021, driven by an increase in heavy duty and medium duty truck production in North America, Europe and India offset by China, where we expect demand to moderate after a strong year in 2021. We expect demand for construction equipment to increase in North America and Europe and decline in China from record levels experienced in 2021.
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 2021. Industry production for heavy duty trucks in North America is projected to be 250,000 to 260,000 units in 2022, a 10% to 15% increase year-over-year. In the medium duty truck market, we expect the market size to be 120,000 units or between 120,000 and 130,000 units, a 5% to 10% increase from 2021. We expect our deliveries in North America to continue to outpace the market as the engine partnerships we announced last year continue to phase in. Our shipments for pickup trucks in North America are expected to be down 5% compared to last year.
In China, we project total revenue, including joint ventures, to decrease 10% in 2021. We project a 30% reduction in heavy and medium duty truck demand and a 5% reduction in demand in the light duty truck market. Industry sales of excavators in China are expected to decline 30% from last year’s record levels. Despite the projected decline in China, we remain well-positioned for continued outgrowth across our end markets in the region. Industry volumes of NS VI product will increase in 2022 as the new regulations are implemented more broadly. We first launched engines to meet standards similar to NS VI in the United States 10 years ago and we have leveraged our knowledge in powertrain technologies, along with China local customer and market requirements to develop a range of products for the Chinese markets that we expect to be highly competitive and well accepted by end users. We continue to ramp production, expand our presence in automated manual transmissions, and have launched new natural gas platform, which will play an increasingly important role as the region moves towards a lower emissions future.
Finally, we continue to build momentum in the New Power space, adding partnerships and in-country capabilities to establish a leadership position as the market develops. In India, we project total revenue, including joint ventures, to increase 10% in 2021. We expect industry demand for trucks to increase 20% this year. We project our major global high horsepower markets will improve in 2022. Sales of mining engines are expected to increase by 10% in 2022 with greater demand following continued strength in commodity prices. Demand for new oil and gas engines is expected to increase by 25% this year, albeit off a very low base, primarily driven by increased demand in North America. Revenues in global power generation markets are expected to increase 5%, driven by increases in non-residential construction spending.
In New Power, we expect full year sales to be approximately $200 million. We have a growing pipeline of electrolyzers, which we expect to convert to backlog and 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 and other adjacent markets as adoption gains momentum. We also expect to continue to provide fuel cells for truck applications this year as more end users try out the new technology.
We are continually innovating across our broad portfolio of power solutions from diesel and natural gas to hydrogen and other low carbon fuels to fuel cells and battery 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 the leader in power for commercial and industrial equipment. We expect supply chain constraints to continue to impact our industry during the first half of 2022, driving inflation and elevated costs. We will continue to place a strong focus on managing costs and cash flow and are well-positioned to generate attractive incremental margins as constraints ease across our markets.
In summary, we expect full year sales growth of 6% and EBITDA to be approximately 15.5% of sales. We are projecting EBITDA as a percent of sales to increase versus 2021, primarily due to strong truck production in North America, increased pricing and surcharges and the easing of supply chain costs. We anticipate profitability will be at the low end of our guidance range in the first half of 2022 as the industry continues to manage through supply constraints that are limiting production and adding incremental cost. We anticipate these costs will ease throughout the year, driving stronger performance in the second half of the year.
Now, let me turn it over to Chris who will discuss our financial results in more detail.
Thank you, Tom and good morning everyone. There are four key takeaways from my comments today. Global supply constraints continue to limit growth for our industry in the fourth quarter, resulted in elevated freight and logistic costs and drove inefficiencies in our operations negatively impacting margins. We have been experiencing supply side challenges all year and saw further escalation in global freight rates in the fourth quarter.
On a more positive note, underlying demand in many of our core markets remain strong pointing to another record revenue year in 2022. Fourth quarter margins were below our expectations and we have taken actions to improve in 2022, including pricing, surcharges and a strong focus on cost reduction, which are reflected in guidance for this year. And lastly, we returned $2.2 billion to shareholders in 2021 in the form of dividends and share repurchases.
Now, let me go into more details on the fourth quarter and full year performance. Fourth quarter revenues were $5.9 billion, flat with a year ago. Sales in North America were down 4%, inhibited by supply constraints and international revenues increased 6%. Currency movements in aggregate did not have a significant impact on revenue. Earnings before interest and tax, depreciation and amortization were $705 million or 12.1% of sales for the quarter compared to $837 million or 14.4% of sales a year ago. EBITDA decreased by $132 million versus the fourth quarter last year as higher freight, labor and material costs more than offset lower product coverage cost and the benefits of pricing actions. Gross margin of $1.3 billion or 22.5% of sales decreased by $44 million or 80 basis points. Lower product coverage expense and the benefits of higher pricing were more than offset by higher material and logistics costs.
Selling, administrative and research expenses increased by $86 million or 10% due to higher compensation costs, including higher variable compensation related to stronger full year 2021 earnings and program costs associated with future growth. Joint venture income declined by $1 million due to lower demand for trucks and construction equipment in China versus a year ago partially offset by strength in China power generation markets. Other income of $31 million increased by $7 million from a year ago.
Net earnings for the quarter were $394 million or $2.73 per diluted share compared to $501 million or $3.36 from a year ago. The effective tax rate in the quarter was 22.2%. Operating cash flow in the quarter was an inflow of $732 million $410 million lower than the fourth quarter last year. Lower earnings and higher working capital contributed to the decline in cash generation. For the full year 2021, revenues were a record $24 billion, an increase of 21% or $4.2 billion from a year ago. Sales in North America increased 17% and international revenues increased 27%. Currency movements positively impacted revenues by 2%.
Earnings before interest and tax, depreciation and amortization were $3.5 billion or 14.7% of sales for 2021 compared to $3.1 billion or 15.7% of sales a year ago. EBITDA declined as a percent of sales primarily due to elevated supply chain and material costs and higher compensation expenses, which more than offset the benefits of higher volumes, higher joint venture income and lower product coverage expense. Net earnings were $2.1 billion or $14.61 per diluted shares. This compared to $1.8 billion or $12.01 per diluted share a year ago. Full year cash from operations was $2.3 billion, down from $2.7 billion a year ago. Higher working capital was the primary driver of the lower cash generation.
Capital expenditures in 2021 were $734 million, up $206 million from 2020 when we reprioritized and reduced our plans in the face of extreme uncertainty. We returned to $2.2 billion of cash to shareholders or 98% of operating cash flow in the form of share repurchases and dividends in 2021. In the fourth quarter, our Board of Directors authorized the repurchase of up to $2 billion in shares of common stock upon completion of the company’s 2019 $2 billion share repurchase program, reinforcing the company’s commitment to deliver strong returns to shareholders and confidence in long-term performance.
Moving on to the operating segments, I will summarize their 2021 results and provide our forecast for 2022. For the Engine segment, 2021 revenues increased 24% from a year ago, while earnings before interest, taxes, depreciation and amortization decreased from 15.4% to 14.2% of sales as the impacts of supply side costs more than offset the benefits of higher volumes. In 2022, we expect revenues to be up 7%. The increase in sales is primarily driven by an increase in heavy-duty and medium-duty truck production in North America and higher aftermarket revenues in North America. 2022 EBITDA is projected to be approximately 15.5% compared to 14.2% of sales in 2021. The benefit of higher volumes, increased pricing and lower logistics costs are expected to more than offset lower joint venture income.
In the Distribution segment, revenues increased 9% from a year ago to $7.8 billion. Earnings before interest, taxes, depreciation and amortization increased as a percent of sales to 9.4% compared to 9.3% of sales a year ago. We expect 2022 Distribution revenues to be up 11% compared to 2021. The increase in revenue is primarily driven by stronger aftermarket demand. EBITDA margins are expected to be approximately 10% compared to 9.4% of sales in 2021, primarily due to higher volumes and increased pricing.
Components segment revenues increased 27% in 2021, while earnings before interest, taxes, depreciation and amortization decreased from 16% of sales to 15.4% as higher material, logistics and compensation expenses more than offset the benefits of stronger volumes. This year, we expect revenues to increase 4%, primarily due to higher industry truck production in North America, offsetting weaker demand in China. EBITDA margin is projected to be approximately 16% compared to 15.4% of sales in 2021, primarily due to stronger volumes, increased pricing and some efficiency gains.
In the Power Systems segment, revenues increased 22% in 2021, and EBITDA increased from 9.4% to 11.2% of sales as the benefits of stronger volumes and better mix more than offset higher compensation expenses and elevated freight costs. In 2022, we expect revenues to be up 5%, primarily due to higher demand for mining engines and power generation equipment globally. EBITDA is projected to be approximately 11% compared to 11.2% of sales in 2021.
In the New Power segment, revenues increased 61% to $116 million in 2021, primarily driven by stronger sales of battery electric systems. Our EBITDA loss was $223 million in 2021 as we continue to invest in the products, infrastructure and capabilities to support strong future growth. In 2022, we anticipate revenues to be approximately $200 million, up 72%. Net expense is projected to be approximately $290 million as we continue to make targeted investments in this space. As Tom mentioned, we are projecting 2022 company revenues to be up 6%. Company EBITDA margins are projected to be approximately 15.5%. EBITDA is projected to increase as a percent of sales versus 2021, primarily due to stronger truck production volumes in North America, increased pricing and easing of supply chain challenges.
We anticipate profitability will be lower in the first half of 2022 than the second half with some of the challenges we saw in 2021 continuing into the first quarter of 2022. We expect earnings from joint ventures to decline 15% to 20% in 2022, primarily due to a decline in demand in China truck and construction markets and the transition of our natural gas engine joint venture in North America to fully consolidate in 2022. We are projecting our effective tax rate to be approximately 21.5% in 2022, excluding any discrete items. We expect that our 2022 capital investments will be in the range of $850 million to $900 million. As we have discussed in prior years, our base case is to return 50% of operating cash flow to shareholders over time. We accelerated cash returns to shareholders in recent years above that 50% base case, given the excess cash generated above our core business needs. We will continue to evaluate the best ways to deploy capital for profitable growth and deliver strong returns to shareholders.
To summarize, demand recovered in nearly all our markets in 2021, and we delivered record sales and higher full year earnings despite facing significant supply constraints. Fourth quarter margins were below our expectations, and we have some actions, including price increases that should see improvements starting in the first quarter of 2022. As we enter 2022, end customer demand remains in many of our core markets, and we are well positioned to deliver a strong year. Our focus remains on investing in the products and technologies that position us to grow profitably for the long run, improve performance cycle over cycle and return excess capital to shareholders.
Thank you for your interest today. Now let me turn it back over to Jack.
Thank you, Chris. Out of consideration to others on the call, I would ask that you limit yourself to one question and related follow-up and if you have an additional question, please rejoin the queue. Operator, we are now ready for our first question.
Thank you. Our first question is from Jerry Revich with Goldman Sachs. Please proceed with your question.
Hi, Jerry. Are you there?
Can you hear me?
Yes, I can now, Jerry. Good morning.
Good morning. Sorry about that. I must be the joys of Bluetooth. Thanks. Tom, the Sinopec agreement really congratulations to the team on getting that done, can you talk about how the pipeline for electrolyzer opportunities looks for you folks in China from here relative to maybe what you laid out at the Analyst Day? It seems like we might be progressing ahead of plan, but maybe you can expand on that?
Yes. And Jerry, we will provide updated figures across the globe at the Analyst Day. So let me just make a couple of brief remarks about that and just I’ll hold the details for then. There is significant pent-up demand in China. Our Sinopec venture is just getting started. We’ve got a lot of work left to do. We do have a project with them, but there is significant pent-up demand. We do believe as soon as we get the operations rolling, we will be able to significantly increase our backlog in China. We do have a project, as I mentioned, working with them, but I think there is a lot more to come where that started. But let me let Amy David update you more fully at the Analyst Day. She’s got a lot more to say about that.
Okay. Terrific. Look forward to it. And then in terms of the margin cadence, Mark, sorry to ask you to jump in, I know you’re not feeling well, but can you just talk about, normally, your margins are flattish sequentially first quarter versus fourth quarter. And I’m wondering what the price increases that you folks spoke about in the prepared remarks. Are we going to see a better first versus fourth quarter than that normal seasonality? So in other words, how back-end loaded is the margin guide? Thanks.
Thanks, Jerry. I’m doing better than I sound. So let me start the year. You’re right, we will expect because Q4 was tough and we’ve taken these pricing actions, we will expect Q1 margins to improve from Q4. But let me start with the years bridge just to kind of give context to the full year guidance. I’ll come back to some of the puts and takes from Q1. So we’ve got 80 basis points of margin, EBITDA margin improvement year-over-year for the full year. That’s 1.9% coming from pricing and surcharges, with 1% from volume, about 30 basis points from positive cost-reduction initiatives that we’ve got. On the downside, we’ve got material cost increases, base increases of about 50 basis points. We’ve got lower joint venture income of 50 basis points, which comes from two areas: one, a weaker full year look in China. We feel like the markets are bottoming right now, so not a change in trajectory from where we were in Q4, but certainly down year-over-year. And then the balance is really the incremental investment in New Power where we’re projecting strong growth again in 2022, and you’ll hear more about subsequent years here shortly and then some additional investment in our core engineering. So that’s the full year bridge. So going back to Q4 to Q1, most of that pricing starts to take effect in the first quarter, so that’s obviously going to be positive for JV moment. There is not going to be much momentum on the JV income line, and we expect the benefits of our cost-reduction work and some of the easing of supply chain really to kick in Q2 and the later quarter. So we won’t get all the way to our average margin guidance in the first quarter, Jerry. But we are expecting a clear improvement from – yes, what was disappointing for us fourth quarter.
And there is no question, Jerry, that we think supply chain cost or supply chain constraints are still terrible. I mean just to call it like it is. I mean Jen and I have been talking about this, that there is labor shortages. Suppliers are struggling. Freight is struggling. I mean, everything – it’s not better in January than it was in December. It’s bad. And we are getting – our plants are getting better at operating in those environments. That doesn’t mean it’s great, but it’s still really terrible, but that – so that’s one thing. And also, we do expect things to just ease across the year, not to get overwhelmingly better in the first months or to be fixed. We are taking a pretty conservative view about that, but what they will start to ease. So as Mark said, our Q1 will have a lot of the benefits and then the costs won’t ease as quickly. And then our Q4 in 2022, we expect more of those costs to ease and still to have those benefits. So that’s just the simple trajectory was built like that.
And then just one small thing, Jerry, just we won’t get a lot more volume in Q1 than Q4. Certainly, year-over-year, we’re expecting that driven heavily by North America truck.
That’s terrific. Thanks.
Our next question is from Jamie Cook with Credit Suisse. Please proceed with your question.
Hi, good morning, everyone. I guess my question specifically is around the revenue guide for engines and components. I would have thought the guide would have been better, in particular with like the pricing actions you’re assuming. So can you just help me understand the revenue guide relative to it sounds like you’ll be below the industry? We have positive pricing. I’m not sure how much of it is red tags that impacts your top line and with the pricing. So the puts and takes around the revenue guide on Engine and Components, just it’s much lower than I would have thought? Thanks.
So I think our guidance for North America truck production, that’s in line with kind of industry averages and some of the independent research firms that are published. So I think we’re in line there. Jamie, certainly, there is a potential to go higher, but it’s really the supply chain constraints that are limiting us. And then I think the big negative year-over-year for those two businesses, particularly the Components business, is China where most of our business is fully consolidated. Again, we saw a significant drop-off in the second half on a full year basis, that’s lower. And then we had – yes, we had very strong growth in on-highway markets. Tom talked about the record demand in China for construction equipment that’s related to the Engine business in particular we expect that. So those are the puts and takes. Most momentum in North America potential to go higher if the industry can build more trucks and get weaker in China as the main offset.
But Jamie, you know the math. The math is simple. We’re taking the market. We expect to be strong or stronger than the market. As you said, we will have the price in there. And then we just – so North America truck and components revenue will follow that exactly. So there is no change in any of that math. So you are right to say that’s a strong – that’s a stronger part of the growth guide. And then some of the other markers are less so. But we can go through those details with the after the call. But the math works, that we are not expecting any negatives there. As Mark said, our view is we picked a spot in the forecast for North America, where there is no question the range could be higher if supply constraints weren’t there, especially in the first half, but I think it’s still a strong market.
Yes. There is no doubt the underlying demand is still very strong. I’ve been out talking to customers. I mean they cannot buy as many trucks as they would like and used truck pricing is really high, which is also benefiting our aftermarket revenue. So it really is a question on the supply base.
But is there any impact from the OEs in North America getting the red tags out the door? I know that a lot of the OEs made progress in Q4. I’m wondering if that goes into Q1 or Q2 and is that impacting the revenue guide specifically?
You’re right, Jamie, that there is a factor in the red tag trucks and on our revenue because in most cases, those red tagged trucks have engines and components on them already. We’ve been able to deliver to our OEM customer needs. And so when they are directing parts to finish out red tagged trucks, they are reducing the order on us. And so we’re seeing some benefit of that as we go into the start of the year as they really did focus in Q4 on clearing the red tagged trucks.
Okay.
Yes. Jamie, I don’t know if you were asking if that’s continuing into 2022. Most of that is cleared in Q4. I mean, there is still some around, but most is gone in Q4. So that’s not impacting our revenue guide for 2022. It did impact our revenue in Q4 though.
Okay. Alright, thank you. I appreciate and look forward to Analyst Day.
Yes. Good to talk to you.
Thanks, Jamie.
Our next question is from Steven Fisher with UBS. Please proceed with you question.
Thanks. Good morning. Wondering if you could talk a little bit more about the natural gas engine development? I noticed the announcement you had, it sounds like you’re delivering some pilot trucks in 2022. I think last quarter you talked about bringing that in, in 2024. So should we take that to mean you’re accelerating that program? And can you remind us how the margin mix would look as that product ramps up?
Yes. Let me just talk a little bit about what we’re doing with the natural gas products. We, of course, have had natural gas products on the market here in North America through our joint venture, which we continue to sell now as Cummins consolidated product in 2022. And we see growing demand from customers as they look at ways to decarbonize and meet our decarbonization goals in a most cost-effective way. And so we have introduced a new heavy-duty natural gas product in China, where there also is demand in the market today for natural gas products, and we plan to bring that product to North America in the ‘24 time frame. And as we develop new engine platforms for the future, one of our approaches is to develop a more fuel flexible platform architecture that will allow us and our customers to be able to evolve from diesel to natural gas to hydrogen as it makes sense as we move up to increasing decarbonization.
And you asked about margin mix and our view across our engine range is that there is unlikely to be sustained differences in margin mix based on fuel. In the past, margin mix was positive for natural gas but they were relatively low volume and higher priced. As we increase the volume of those and are able to drive down cost, I think we will be able to drive competitive pricing and drive up market position with them. And my expectation is margins will level out across different fuel types. But in the past, it has been the margin of natural gas has been higher than diesel. And I think it’s more because of its niche product, if it was a niche product, for a large – to a large degree.
We are looking at some components expansions with the natural gas products. So, we have now done a joint venture in natural gas fueling systems as well as tanks. And so that’s another growth opportunity for us.
Okay. And then if I can just ask about China, your forecast for 2021 was pretty spot on, the first half versus the second half. I am wondering how you feel about the potential range of outcomes for 2022. Do you think it’s kind of similarly banded confidence and maybe how we should think about 2023? Do you think we could exit at all at any point with year-over-year growth, or is it sort of just kind of maybe stabilizing on easier comps in the back half of this year?
Yes. As you said, I mean I think we saw a really strong first half. And as we predicted, we saw inventory buildup happen as the emissions changeover occurred, and that’s been slowly – inventory has been slowly consumed. So, our expectation coming out of the Chinese New Year, we will start to see more demand for the NS VI product. We feel really well positioned with that product and additional components content. So, we will outgrow what the market does, but we don’t expect the market to return to the levels we saw in late 2020 and ‘21. We expect it will be more moderated.
And you asked about 2023, and we don’t – we really haven’t taken a good look at when we think we will return. As Jen said, the market was overproducing, no question about it, in the first half of ‘21. And so there is both the fact that the economy is a little weaker, plus absorbing all this extra inventory to do. Whether that takes 12 months to do or 18 months to do, we are just not sure. But we will continue to report on that and see what we think. There is not – the underlying fundamentals are good. As Jen said, our market position is good. We are getting more content, all that seems fine. We are just trying to understand the market dynamics about when economic growth starts to pick up and absorb the trucks that they put in the inventory ahead of NS VI.
History says, Steve, that in most years, the second half isn’t – there is more buying in the first half than the second half. So, if we – most likely, I would say, if we are seeing momentum build, it will be brought towards the back end of the year.
Perfect. Thanks very much.
Thank you.
Our next question comes from David Raso with Evercore. Please proceed with your question.
Hi, good morning. I think it’s fair to summarize the guide as maybe revenue is a little lower than people thought, the margins definitely stronger than people would have thought, especially on the incrementals. So, I am just trying to add, or not, the credibility to the ‘22 margin guide. And then just sort of think of that as a launch pad for, if those are the margins in ‘22, how do we think about ‘23 in an early look. So, I guess on ‘22 margins, what is in the backlog today that already has a higher price on it, the surcharge? And what percent of your costs have you already sort of locked in, be it maybe you extend it a little further, your purchasing, your hedging? Just a level set on the 15.5% EBITDA margin for ‘22. And then if I can do a quick follow-up on how to think about that 15.5% in ‘22, if that’s possible. In ‘23, again, assuming if China is a little better that helps JV income, but also consolidated sales within the engine business, if supply chain loosens in North America on truck volumes, you might get an acceleration there? So, you would think the margin profile for ‘23 all of a sudden got maybe a little higher than people thought. But the real question about that is, are there other costs in ‘23 or something else we should be thinking about in ‘23 that would retire those margins a little bit. Surcharges rolling off or whatever it may be. Sorry for the long question, but just wanted credibility on ‘22 and how to think about the launching pad for ‘23?
Yes. Thanks, David. I think I have got the handle on that. So, first of all, so we are clear our full potential margins are above 15.5% for the business. Obviously, we are dealing with extreme inflation in a number of key categories and our costs. So, if we think about that bridge year-over-year that I gave, to start with 1.9% improvement in pricing, that’s pretty much locked and loaded. Parts will move in which quarter, maybe some modest variation, but that’s pretty much done, that’s committed. And again, we will need to continue to evaluate how costs move through the year. We cannot yet be certain about the pace and rate of improvement in some of these supply chain efficiency, it’s our expectation. There is things we are working on that are discrete and unique to us. But obviously, we have got the overall market conditions, which we are not in full control of. And it may be if we face more cost escalation, then we may need to revisit that pricing and push it up beyond the 1.9% in the base case. But certainly, we feel confident about the 1.9%. We said we would get 1% from volume. The market demand is there to support the volume. The key is operating in a more efficient way as we scale it, but the demand is there to get that volume. So, I think it’s – the JV income down 50 basis points, that’s where we are operating at. It’s kind of a run rate from the fourth quarter. So, no material changes there. So, what feels to me like the biggest swing factor is the rate and pace of improvement on efficiency gains and easing of that supply chain in the second half of the year. But many – certainly, you can hear confidence about the pricing and some of the other assumptions. And definitely, we think the long-term potential is above the 15.5%.
David, the only other thing I would point you to is, remember, at the same time that we are driving these margins, we are also investing more in our New Power and other engineering categories, primarily in New Power. So, we are building a brand-new business. And I think the opportunity for the company is huge, as you heard me talk about. But if you just look at our core business margins, they are even stronger than you might think just by looking at the overall number. So again, our confidence level is high and our ability to drive margins higher in 2023, assuming we can continue to benefit from the kind of demand we have now. And as Mark said, the reason we have confidence in the 2022 margins is because – we don’t know exactly how supply chain costs are going to go. We have built a reasonably conservative scenario. And if it’s worth, we will raise prices again just that simple.
If I can ask a quick question about that, the investment cost. If you didn’t have those this year, which is imprudent, obviously, you are investing a lot in new technologies. I mean that would be a 16.9% EBITDA margin you would be guiding to. But when I think in the investments for ‘23, ‘24, and I assume we will address this in the next few weeks at the meeting, but do those investments ramp up, like that 140 bp drag this year, should we expect that drag to get greater as we go to the out years or similar or less?
We will talk about that in some depth at the Analyst Day. And we will show kind of what we think the trajectory is where investments sort of peak and returns start to come the other way because, of course, eventually, we would like to see the breakeven and margins start to come the other way in New Power. And we do expect that to happen. So, let us go through that trajectory. But again, there is no question that for the next couple of years, our investments will be increasing and the question is when it turns back the other way. So, let us take you through that. And I think my own view is that you and other investors will recognize that we are creating a significant opportunity at a reasonably affordable investment level relative to our competition.
Thank you very much. I appreciate.
Thank you, David. Appreciate the questions.
Our next question is from Tim Thein with Citigroup. Please proceed with your question.
Thanks. Good morning. Maybe one on distribution, that’s obviously one where Tracy and team have been working hard on all the improvements in North America for the past couple of years. Can you maybe update us there? I mean it’s long been talked about getting to a double-digit margin, maybe this is the year you get there. But what’s kind of underneath the surface? What’s driving – I mean obviously, there is more than one thing, but how much of this is kind of some of that – the benefits being realized from that – from the restructuring versus pretty good top line growth and just the associated kind of volume leverage that comes with that? So, a longer question, but maybe just kind of update us as to distribution and kind of where you are relative to the – some of the goals you have outlined?
Yes. So, if you – if I look at the distribution business, the positive there, we are seeing strong demand for parts and service. And we are seeing the benefits of the work we have done in our North American distribution business to really drive commonality and efficiency and revenue growth into the business. And those are offset currently by the fact that we cannot get enough parts to support all the demand, and we have also experienced labor challenges. And so we have been really focused on increasing parts flow and hiring technicians in that business. And then those logistics costs that we talked about that impact our distribution business as well. And so that was unfavorable for that business in the fourth quarter.
Yes. Tim if I just step back, Tim, obviously, it’s not the perfect time to travel, but it would be worth it in – later when you have a chance to visit some of the distributors. So, Tracy and her North American leader, Jenny Bush, have done an amazing job transforming that business. Just whatever a number of years ago was all independent. We created joint ventures. We bought all the distributors, but they were still independent. Each one was a separate company, its own pricing, its own – it’s now a national distribution organization with business level. So, Power Gen is one organization across North America with sales, service and support linked to customers across the entire North American region. It’s a remarkable transformation. Cost levels and inventories are – levels are lower. As Jen said, the struggle they have had this year to deliver their double-digit margin is we can’t give many parts. They can sell as many parts as we can give them. We just can’t give them enough. And to say that they are disappointed with that would be an understatement. They are screaming about that pretty regularly. And we are – one of the things we are trying to do and part of our 2022 work is to reduce backlog in the parts organization, which of course, helps our customers through service as well, but it also will help our margins. So – but the transformation has just been remarkable. And I think if you get a chance to just see it and to see the operational changes, it is a great, great piece of work. So, we are excited about what we are going to see in terms of margins once we get the parts flowing through the distribution business.
Got it. Thanks. And Tom just your earlier comment about these supply chain issues are not – potentially not getting better or maybe even getting worse in places. The messaging from your peers has kind of been all over the board. And I am curious as to – and again, I am sure it’s impossible to isolate this to a single factor. But do you think that’s – is it just Omicron related that’s disrupted the workforce or is there something more deep-rooted than that? Just what are you seeing on that front that led to that comment?
Yes. I think Omicron is definitely a factor that’s impacting the workforce over the last 1.5 months and contributing to that. And we just continue to be in a very supply-constrained market, so you are building everything you can get parts for. Any minor disruption can create an issue. So, that’s really what’s driving a lot of the uncertainty. And just labor challenges generally, right. So, while Omicron is worsening that, getting workforce and really moving parts through the logistics channel effectively is a broad challenge that continues to plague us.
And Tim, I think the reason you hear different things from different people is because each of us has dealt with our challenges last year differently. You heard Jamie’s question about red-tagged trucks. So, if you are a truck maker and you had a bunch of trucks sitting there, you now have lowered production rates and you are steadying your production more, so your revenue forecast is a little lower. But you are able to stabilize and maybe that feels actually better to you in terms of how your production rates go, not to mention not holding all this extra inventory. And in our case, we of course, did not do that. We were able to ship and keep them running. So, to us, the basic production challenges look the same in January, they looked in December and they did in November. I do agree with what Jen said. She has shown me the data about absenteeism and things, and there is no question Omicron has driven up our own absenteeism as well as that of our suppliers. But if I step back though, chip supply is still a disaster. I mean it just moves around. Lately, my – the biggest thing I am hearing about is anti-lock brakes, which, as you know, don’t affect us. But essentially every one of our customers and car companies are all suffering from analog break chip shortages. So, there just aren’t enough chips. And so that’s why I predict continued challenges. Even if we have a little bit of reprieve from and there isn’t a replacement derivative for Omicron in the next several months that will steady out labor supply. But make no mistake chips will be right behind it. So, I just think we will just continue to work through these challenges and that all of us, our customers, ourselves, our suppliers are all getting a little bit better at dealing with the variability and steadying out our production that’s helping us. Meanwhile, we are dealing with inflation on freight and other costs. So, that’s what we tried to show in that balancing of costs and benefits for our margin next year.
Alright. Thanks for the color.
Thank you, Tim.
Our next question is from Courtney Yakavonis with Morgan Stanley. Please proceed with your question.
Hi. Thanks for the question. If we could just talk about Power Systems, I think that was one of the end markets where you are not seeing that incremental flow through next year and margin guidance is roughly the same on higher sales. So, can you just walk us through maybe why that division is being impacted differently than some of your others?
Yes. I think one of the biggest challenges we have seen is the Power Systems business really start to see the supply chain challenges later in the year than we saw and they were less impacted by some of the chip challenges. But they have been more recently impacted by more labor constraints and more supplier challenges. It’s a very international business. So, the global logistics is an important part of how we get our products to market. So, that has – that did certainly inhibit our margins in the fourth quarter. I think demand again remains strong. It’s really principally a supply constraint on the top line.
And you guys just remember for context that most of the engines used by that division are larger engines, above 19 liters. So, the production supply chain is different than it is for the 15 liter and below. That’s what Mark is talking about. So yes, there are still chips required. There are a different set of chips. And so they just had fewer constraints on and the volumes are lower. But if you look at the freight content of those engines and gen sets is much higher. They are bigger, heavier more. And so as containers got short, shipping rates went up, the impact on that division is much larger than it is on the others as a percentage of cost. And of course, labor shortages affect everybody. But they – for the heavy-duty and mid-range engines, that was just another in the pile after chips and everything else for high horsepower, it’s just really hitting now. So, we do see them improving, by the way. It’s just that everything is pushed back a couple of quarters relative to what we are seeing in our larger volume heavy duty and medium duty. That’s all.
And we have raised prices there as well.
Same – yes, same pricing strategy, just a little bit slower on the cost improvement.
Okay. That’s helpful. And then I think you had been quantifying the total impact of freight logistics and inefficiency costs, and we are expecting another $90 million in the fourth quarter. Can you just true up how that ended up relative to your expectations? And if you can just bucket it for us I think there was – had been a shift between the weighting of some of the freight and logistics versus the inefficiencies versus material costs? If you can just help us pair that up for how it ended for the year.
And you are talking for Q4 versus Q4 there, Courtney?
So, I think you had been – I think it was $295 million year-to-date as of the third quarter. And then you were expecting $90 million year-over-year in the fourth quarter.
Yes. And that, in fact, because of part – well, in large chunk because of the increase in global shipping rates, you are right, we were running at about $100 million a quarter through the first three quarters, that’s a $300 million number between freight, some excess labor costs and inefficiencies, that number bumped up to $150 million in the fourth quarter. So, it was in fact worse than we had anticipated. We don’t expect all of that $150 million to be in the run rate going forward. But yes, to answer your question, those are the numbers.
And Mark said it, while there was a little – some improvement in premium freight it was really that standard freight rate that really grew in the fourth quarter.
Okay. Thank you.
Thank you, Courtney.
Alright. Well, that concludes our teleconference today. As always, thank you to everybody for your continued interest in Cummins. Chris and I will be available for questions after the call. I hope you have a great day.
Thank you.
This concludes today’s conference. You may disconnect your lines at this time and we thank you for your participation.