Cummins Q4 2021 Earnings Call Transcript

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Provided by Quartr
February 2, 2022

Key Takeaways

  • Cummins delivered record full-year 2021 revenues of $24 billion, up 21% year-over-year, returned $2.2 billion to shareholders and authorized an additional $2 billion share repurchase.
  • Persistent supply chain constraints drove elevated freight, labor and material costs in Q4, pushing EBITDA margin down to 12.1%, from 14.4% a year ago.
  • For 2022 the company forecasts revenues to grow 6% and EBITDA margin to improve to approximately 15.5% of sales, underpinned by pricing actions, surcharges and cost-reduction initiatives.
  • The New Power segment achieved 61% revenue growth in 2021 to $116 million and expects about $200 million in 2022 sales while investing for future growth, with a projected $290 million net expense.
  • In China, total revenue is projected to decline 10% in 2022 as medium and heavy-duty truck production and excavator sales each fall about 30% from 2021 levels.
AI Generated. May Contain Errors.
Earnings Conference Call
Cummins Q4 2021
00:00 / 00:00

There are 12 speakers on the call.

Operator

Greetings and welcome to Cummins 4th Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. Please note this conference call is being recorded. I would now like to turn the conference over to your host, Jack Kinsler, Executive Director of Investor Relations, thank you.

Operator

You may begin.

Speaker 1

Thank you. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the Q4 and full year of 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 Colullo. 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.

Speaker 1

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 ks and any subsequently filed quarterly reports on Form Thank you. 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.

Speaker 1

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?

Speaker 2

Thank you, Jack, and good morning, everybody. Before I jump into our results though, I do want to welcome Chris Kullo 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's gained valuable leadership experience in roles across the finance organization.

Speaker 2

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'll 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'm 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.

Speaker 2

Now I'll start with a summary of our Q4 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 Q4 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 costs and resulting in margins below our expectations, particularly in the Q4. We've 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.

Speaker 2

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're a leader in key technologies for 0 tailpipe emissions in commercial and industrial applications and are investing further to strengthen our position. We're also a leader in the transition technologies that will be needed in our industry for many, many years.

Speaker 2

Technologies at lower carbon emissions, while still offering customers economic solutions in 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 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.

Speaker 2

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 0 carbon future, while navigating economic cycles and returning excess cash to shareholders. We're excited to tell you more about our long term strategy during our Analyst Day later this month. Revenues for the Q4 of 2021 were $5,900,000,000 which is flat Compared to the Q4 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 $705,000,000 or 12.1 percent compared to $837,000,000 or 14.4 percent 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.

Speaker 2

For the full year, Cummins sales were $24,000,000,000 up 21% year over year and a record for our company. Our EBITDA margins were $3,500,000,000 or 14.7 percent of sales compared to $3,100,000,000 or 15.7 percent 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'll 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, Well, our unit sales were 94,000, an increase of 21% from 2020.

Speaker 2

We shipped 159,000 engines to Chrysler for use Ram pickups in 2021, an increase of 27% from the previous year. Engine sales to construction Commerce in North America increased by 50% as nonresidential 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 nonresidential construction spending. Our international revenues increased 27% in 2021 with higher demand in all markets.

Speaker 2

Full year revenues in China, including joint ventures, were $7,500,000,000 up 8% compared to 2020. The increased revenue was driven by record demand in the truck construction and data center markets, particularly in the first half of the year. Industry demand for medium and heavy duty trucks in China was 1,600,000 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 2,100,000 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.

Speaker 2

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, health care 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 $2,000,000,000 up 68%.

Speaker 2

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.

Speaker 2

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.

Speaker 2

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. 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.

Speaker 2

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.

Speaker 2

Revenues in global power generation markets are expected to increase 5%, driven by increases in nonresidential construction spending. In New Power, we expect full year sales to be approximately $200,000,000 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.

Speaker 2

We expect supply chain constraints to continue to impact our During the first half of twenty twenty two, 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 twenty twenty two As the industry continues to manage through supply constraints that are limiting production and adding incremental costs. We anticipate these costs will ease throughout the year, driving stronger performance in the second half of the year.

Speaker 2

Now, let me turn it over to Chris, who will discuss our financial results in more detail.

Speaker 3

Thank you, Tom, and good morning, everyone. There are 4 key takeaways from my comments today. Global supply constraints continue to limit growth for our industry in the 4th quarter, Resulted in elevated freight and logistics costs and drove inefficiencies in our operations negatively impacting margins. We've been experiencing supply side challenges all year and saw further escalation in global freight rates in the Q4. On a more positive note, Underlying demand in many of our core markets remains strong, points to another record revenue year in 2022.

Speaker 3

4th 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 $2,200,000,000 to shareholders in 2021 in the form of dividends and share repurchases. Now let me go into more details on the 4th quarter and full year performance. 4th quarter revenues were $5,900,000,000 flat with a year ago. Sales in North America were down 4%, inhibited by supply constraints and international revenues increased 6%.

Speaker 3

Currency movements in aggregate did not have a significant impact on revenue. Earnings before interest and tax, depreciation and amortization were $705,000,000 or 12.1 percent of sales for the quarter, compared to $837,000,000 or 14.4 percent of sales a year ago. EBITDA decreased by $132,000,000 versus the Q4 last year as higher freight, labor and material costs more than offset lower product Coverage costs and the benefits of pricing actions. Gross margin of $1,300,000,000 or 22 point 5% of sales decreased by $44,000,000 or 80 basis points. Lower product coverage expense and the benefits of higher pricing We're more than offset by higher material and logistics costs.

Speaker 3

Selling, administrative and research expenses increased by 86,000,000 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 $1,000,000 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 $31,000,000 increased by $7,000,000 from a year ago. Net earnings for the quarter were $394,000,000 or $2.73 per diluted share compared to $501,000,000 or $3.36 from a year ago. The effective tax rate in the quarter was 22.2%.

Speaker 3

Operating cash flow in the quarter was an inflow of $1,142,000,000 lower than the Q4 last year. Lower earnings and higher working capital contributed to the decline in cash generation. For the full year 2021, revenues were a record $24,000,000,000 an increase of 21% or $4,200,000,000 from a year ago. Sales in North America increased 17% and international revenues increased 27%. Currency movements positively impacted revenues by 2%.

Speaker 3

Earnings before interest and tax, depreciation and amortization were $3,500,000,000 or 14.7 percent of sales for 2021 compared to $3,100,000,000 or 15.7 percent 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 $2,100,000,000 or $14.61 per diluted shares. This compared to $1,800,000,000 or $12.01 per diluted share a year ago. Full year cash from operations was 2,300,000,000 Down from $2,700,000,000 a year ago.

Speaker 3

Higher working capital was the primary driver of the lower cash generation. Capital expenditures in 2021 were $734,000,000 up $206,000,000 from 2020 When we reprioritized and reduced our plans in the face of extreme uncertainty. We returned $2,200,000,000 of cash to shareholders or 98% of operating cash flow in the form of share repurchases and dividends in 2021. In the Q4, our Board of Directors authorized the repurchase of up to $2,000,000,000 in shares of common stock upon completion of the company's 2019 $2,000,000,000 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.

Speaker 3

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 impact 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.

Speaker 3

In the Distribution segment, revenues increased 9% from a year ago to $7,800,000,000 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. Component 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.

Speaker 3

This year, we expect revenues to increase 4%, primarily due to higher industry truck production in North America, offsetting weaker demand in China. EBITDA margins 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.

Speaker 3

In the New Power segment, revenues increased 61 percent to $116,000,000 in 2021, primarily driven by stronger sales of battery electric systems. Our EBITDA loss was $223,000,000 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 $200,000,000 up 72%. Net expense is projected to be approximately $290,000,000 as we continue to make targeted investments in this space. As Tom mentioned, we are projecting 2022 company revenues to be up 6%.

Speaker 3

Company EBITDA margins are projected to At least 15.5 percent. EBITDA is projected to increase as a percent of sales versus 2021, primarily due to stronger truck production volumes in North Increased pricing and easing of supply chain challenges. We anticipate profitability will be lower in the first half 2022 than the second half with some of the challenges we saw in 2021 continuing into the Q1 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 consolidated in 2022. We are projecting our effective tax rate to be approximately 21.5% in 2022, excluding any discrete items.

Speaker 3

We expect that our 2022 capital investments will be in the range of $850,000,000 to $900,000,000 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 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. 4th quarter margins were below our expectations and we have some actions, including price increases that should see improvements starting in the Q1 of 2022.

Speaker 3

As we enter 2022, end customer demand remains in many of our 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.

Speaker 1

Thank you, Chris. Out of consideration to others on the call, I would ask that you limit yourself to one question and a related follow-up. And if you have an additional question, Please rejoin the queue. Operator, we are now ready for our first question.

Operator

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

Speaker 4

Hi, Jerry. Are you there? Can you

Speaker 5

hear me?

Speaker 2

Yes, I can now. I can now, Jerry. Good morning.

Speaker 4

Good morning. Sorry about that. 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.

Speaker 2

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 but I'll hold the details for then. There is significant pent up demand in China. Our Sinopac venture is just getting started.

Speaker 2

We've got a lot of work 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's a lot more to come where that started. But let me let Amy Davis update you more fully at the Analyst Day. She's got a lot more to say about that.

Speaker 4

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 flatter Sequentially, Q1 versus Q4.

Speaker 4

And I'm wondering with the price increases that you folks spoke about in the prepared remarks, Are we going to see a better first versus Q4 than that normal seasonality? So in other words, how back end loaded is the margin guide? Thanks.

Speaker 6

Thanks, Jerry. I'm doing better than I sound. So let me start with 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.

Speaker 6

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 The 1% from volume and 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 2 areas. 1, weaker full year look in China.

Speaker 6

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.

Speaker 6

So going back to Q4 to Q1, most of that pricing starts to take effect in the Q1. So that's obviously going to be positive JV moment. There's 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. We won't get all the way to our average margin guidance in the Q1, Jerry, but we are expecting clear improvement from Yes.

Speaker 6

What was a disappointing for us Q4?

Speaker 2

And there's no question, Jerry, that we think supply chain costs are 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's 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.

Speaker 2

And we are getting our plants are getting better at operating in those environments. That doesn't mean it's great. It's still really terrible. But that's so that's one thing. And also we do expect things to just ease across the year, not to get overwhelmingly better in the 1st months Or to be fixed, we are taking a pretty conservative view about that, but what they will start to ease.

Speaker 2

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.

Speaker 6

And then just one small thing to add, Gerry, 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, Joe.

Speaker 4

Terrific. Thanks.

Operator

Our next question is from Jamie Cook with Credit Suisse. Please proceed with your question.

Speaker 7

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.

Speaker 7

We 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, it's much lower than I would have thought. Thanks.

Speaker 6

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 published. So I think We're in line there. James, certainly there's 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 It's fully consolidated. Again, we saw a significant drop off in the second half on a full year basis.

Speaker 6

That's lower. And then we had very strong growth in on highway markets. You heard Tom talk about the record demand in China for construction equipment. That's a key contributor to the engine business in particular. We expect that.

Speaker 6

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 is

Speaker 2

the main offset. But Jamie, you know the math. The math is simple. We're taking the market. We expect to be Stronger than the market.

Speaker 2

As you said, we'll have the price in there. And then we just so North America truck And components revenue will follow that exactly. So there's no change in any of that, Matt. So you are right to say that's a strong that's the Stronger part of the growth guide and then some of the other markets are less so. But again, we can go through those details with you after the call, but The math works that we aren't expecting any negative there.

Speaker 2

As Mark said, our view is we picked a spot In the forecast for North America, where there's no question the range could be higher if supply constraints They're especially in the first half, but I think it's still a strong market.

Speaker 8

Yes. There's 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 trucks pricing It's really high, which is also benefiting our aftermarket revenue. So it really is a question on the supply base.

Speaker 8

But

Speaker 7

Is there any impact from the OEs in North America getting the red tags out the door? I know that would Yes, a lot of it always made progress in Q4. I'm wondering if that goes into Q1 or Q2 and is that impacting The revenue guide specifically.

Speaker 8

You're right, Jamie, that there is a factor in the Red Tug trucks and on our revenue because In most cases, those Red Tek 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 Tag Trucks, they're reducing 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 tag trucks.

Speaker 2

Yes. So Jamie, I don't know if you were asking if that's continuing into 2022. Yes.

Speaker 3

Most of

Speaker 2

that is cleared in Q4. I mean, there's still some around, but most has gone in Q4. So that's not impacting our revenue guide for 2022. It did impact our revenue in Q4 though.

Speaker 7

Okay. All right. Thank you. I appreciate and look forward to the Analyst Day. Thank you.

Speaker 2

Yes. Good to talk to you.

Speaker 8

Thanks, David.

Operator

Our next question is from Steven Fisher with UBS. Please proceed with your question.

Speaker 9

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.

Speaker 9

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.

Speaker 8

Yes. Let me just talk a little bit about what we're doing with the natural gas products. We, 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 their decarbonization goals in a most cost effective way. 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 2024 timeframe. And as we develop new engine platforms for the future, one of our approaches To develop a more fuel flexible platform architecture that will allow us and our customers to be able to evolve from diesel For gas to hydrogen, as it makes sense as we move, to increasing decarbonization.

Speaker 2

And you asked about margin mix. And our view across our engine range is that there's unlikely to be Staying 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 costs, I think we'll be able to drive Head of pricing and drive up market position with them. And my expectation is margins will level out across different fuel types.

Speaker 2

But in the past, It has been margin the margin of natural gas has been higher than diesel. And I think it's more because of its niche Product, it was a niche product for a large to a large degree.

Speaker 8

We are looking at some components expansions with the natural gas product. So we've Now done a joint venture in natural gas fueling systems as well as tanks. And so that's another outgrowth opportunity for us.

Speaker 9

Okay. And then if I could just ask about China, your forecast for 2021 was pretty spot on With the first half versus the second half, I'm 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 Maybe stabilizing on easier comps in the back half of this year.

Speaker 9

Yes.

Speaker 8

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 The inventory has been slowly consumed, so our expectations coming out of the Chinese New Year is 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 2021. We expect it will be more moderated.

Speaker 2

And you asked about 2023 and we don't we really haven't taken a good look at when we think we'll return. As Jen said, the market was overproducing, no question about it, in the first half of twenty twenty one. And so there's 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're just not sure. But we will continue to report on that and see what we think. There's not the underlying fundamentals are good.

Speaker 2

As Jen said, our market position is good. We're getting more content. All that seems fine. Just we're just trying to understand the market dynamics about When economic growth starts to pick up and absorbs the trucks that they put into inventory ahead of NS VI?

Speaker 6

Yes. History says, Steve, that In most years, the second half isn't there's more buying in the first half than the second half. So if we most likely, I would say if we So in momentum build, it will be brought towards the back end of the year.

Speaker 9

Okay. Thanks very much.

Operator

Our next question comes from David Raso with Evercore. Please proceed with your question.

Speaker 10

Hi, good morning. I think it's fair to summarize the guide as maybe revenue A little lighter than people thought, the margins definitely stronger than people would have thought, especially on the incrementals. So I'm just trying to add Or not, credibility to the 2022 margin guide. And then just sort of think of that as a launch pad for if those are the margins in 2022, How do we think about 2023 in an early look? So I guess on 20 22 margins, what is in the backlog today that already has A higher price on it, the surcharge.

Speaker 10

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 'twenty two. And then if I can do a quick follow-up on how to think about that 15.5% in 2022, if that's possible. In 2023, 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 You might get an acceleration there. So you would think the margin profile for 2023 all of a sudden got maybe a little higher than people thought.

Speaker 10

But the real question about that is, are there other costs in 2023 or something else we should be thinking about in 2023 that would retard those margins a little bit, Surcharges rolling off or whatever may be. So sorry for the long question, but just wanted credibility on 2022 and how to think about the launching pad for 2023?

Speaker 6

Yes. Thanks, David. I think I've got the handle on that. So first of all, I'd say we're clear our full potential margins are above 15.5 Percent for the business, obviously we're dealing with extreme inflation in a number of key categories in our 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.

Speaker 6

That's committed. And again, we'll 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 efficiencies. It's our expectation. There's things we're working on that are Discrete and unique to us, but obviously we've got the overall market conditions, which we're not in full control of.

Speaker 6

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 1.9%, we said we'd 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 up, but the demand is there to get that volume. So I think it's the JV income down 50 basis points.

Speaker 6

That's where we're operating at. It's kind of a run rate from the Q4, 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%.

Speaker 2

David, the only other thing I'd point you to is remember at the same time that we're driving these Margins, we're also investing more in our new power and other engineering categories, again 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're even stronger than you might think just by looking at the overall number. So again, Our confidence level is high in 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.

Speaker 2

We've built a reasonably conservative scenario. And if it's worked, we will raise prices again. Just that simple.

Operator

If I can ask

Speaker 10

a quick question about that, that the investment cost, if you didn't have those this year, which is imprudent, obviously you're investing in a lot of new technologies. I I mean, that would be a 16.9 percent EBITDA margin you'd be guiding to. But when I think in the investments for 2023, 20 24 and I assume we'll address this the next few weeks at the meeting, But do those investments ramp up like that 140 bps drag this year, should we expect that drag to get greater as we go to the out years or similar or less?

Speaker 2

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'd like to see them the breakeven and margins start Come the other way in New Power and we do expect that to happen. So let us go through that trajectory. But again, there's 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.

Speaker 10

Thank you very much. I appreciate it.

Speaker 6

Thank you,

Speaker 2

David. Appreciate the questions. Yes.

Operator

Our next question is from Tim Hynes with Citigroup. Please proceed with your question.

Speaker 5

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, since 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 underneath the surface, What's driving or I mean, obviously, there's 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.

Speaker 5

So A longer question, but maybe just kind of an update us as to distribution and kind of where you are relative to Some of the goals you've outlined.

Speaker 8

Yes. So if you if I look at the distribution business, the positive there, we're seeing strong Demand for parts and service and we are seeing the benefits of the work we've 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've also experienced labor challenges and so we've been really focused on increasing parts flow and Hiring technicians in that business and then those logistics costs that we talked about did impact our distribution business And so that was unfavorable for that business in the Q4.

Speaker 2

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 number of years ago was all independent. We created joint ventures.

Speaker 2

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 PowerGen 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. The cost levels and inventories levels are lower.

Speaker 2

As Jen said, the struggle they've had this year to deliver their double digit margin is we can't get 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.

Speaker 2

And we are one of the things we're Trying to do in 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 To see the operational changes, it is a great piece of work. So we are excited about what we're going to see in terms of margins once we get the parts flowing through the distribution business.

Speaker 5

Got it. Thanks. And Tom, just your earlier comment about the 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'm curious as to and again, I'm sure that 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?

Speaker 5

Is there something more Deep rooted in that? Just what are you seeing on that front that led to that comment?

Speaker 8

Yes. I think Omicron is definitely a factor that's impacting the workforce, over the last month and a half and contributing to that. And as we could just continue to be in a very supply So you're 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?

Speaker 8

So while Omicron is worsening that, getting workforce that really Moving parts through the logistics channel effectively is a broad challenge that continues to plague us.

Speaker 2

And Tim, I think the reason you hear different things Different people is because each of us has dealt with our challenges last year differently. You heard Jamie's question about red tag 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 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 Chip and keep them running.

Speaker 2

So to us, the basic production challenges look the same in January as they looked in December and As they did in November. I do agree with what Jen said. She's shown me the data about absenteeism and things and there's no question has driven up our own absenteeism as well as that of our suppliers. But if I step back though, chip supply is still a Yes. Disaster.

Speaker 2

I mean, it just moves around. Lately, my the biggest thing I'm 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 brake chip shortages. So there just aren't enough chips. And so That's why I predict continued challenges.

Speaker 2

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'll just continue to work through these challenges and that all of us, our customers, 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're dealing with inflation on freight and other costs. So that's what we tried to show in that balancing of costs and benefits

Operator

Our next question is from Courtney Yakavonis with Morgan Stanley. Please proceed with your question.

Speaker 11

Hi, thanks guys for the question. If we could just talk about Power Systems, I think that was one of the end markets where you're 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?

Speaker 6

Yes. I think one of the biggest challenges seen is the Power Systems business really started to see these supply chain challenges Later in the year than we saw and they were less impacted by some of the chip challenges, but they've 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 Q4.

Speaker 6

I think Demand again remains strong. It's really principally a supply constraint on the top line.

Speaker 2

And you guys just remember for context 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 different set of chips and so they just had fewer constraints on them.

Speaker 2

The volumes are lower. But if you look at The freight content of those engines and gensets is much higher. They're 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 costs.

Speaker 2

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're seeing in our larger volume, heavy duty and medium duty, that's all.

Speaker 6

And we've raised prices there as well.

Speaker 2

Same, yes, same pricing strategy, just a little bit Lower on the cost improvement.

Speaker 11

Okay. That's helpful. And then I think you had been quantifying the total impact of Freight, logistics and inefficiency costs, and we're expecting another $90,000,000 in the Q4. Can you just true up how that ended up relative to your expectations. And if you can just bucket it for us, because I think there was this 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.

Speaker 6

And you're talking for Q4 versus Q4 there, Courtney?

Speaker 11

So I think you had been I think it was $295,000,000 year to date as of the 3rd quarter And then you're expecting $90,000,000 year over year in the Q4?

Speaker 6

Yes. And that in fact because of partly well, in large Because of the increase in global shipping rates, you're right, we were running at about $100,000,000 a quarter through the 1st 3 quarters. That's your $300,000,000 number between freight, Some excess labor costs, some inefficiencies, that number bumped up to $150,000,000 in the 4th quarter. So it was in fact Worse than we'd anticipated. We don't expect all of that $150,000,000 to be in the run rate going forward.

Speaker 6

But yes, to answer your question, those are the numbers.

Speaker 8

Then 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 Q4.

Speaker 11

Okay. Thank you.

Speaker 2

Thank you, Courtney.

Speaker 1

All right. Well, that concludes our teleconference 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.

Speaker 6

Thank you.

Operator

This concludes today's conference. You may disconnect your lines at this time and we thank you for your participation.

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