Cummins Inc. Morgan Stanley's 14th Annual Laguna Conference
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All right. Perfect. Thank you everybody for joining us. For those that don't know me, I am Angel Castillo. I am the Head of U.S. Machinery and Construction here at Morgan Stanley. Again, welcome to our 14th Laguna Conference here. With me today, it is my pleasure to have James Hopkins, who was just recently named VP of Financial Planning, Capital Management, and IR. So got a lot on your plate.
Yeah. I love how to abbreviate the title.
It is so long. Exactly.
Also Nick Arens, of course, with investor relations. Before we get started, just a quick disclaimer. For important disclosures, please see Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representative. With that, again, gentlemen, thank you so much for joining us. Obviously, we have been getting a lot of questions about every aspect of your business. Very topical in a lot of ways, but maybe just to start out with the 2027, 2026 dynamic around trucks, right? The North American cycle, there is a lot happening there. Maybe starting at a little bit of a higher level, what are the customers telling you? What are you hearing in terms of what this emissions enforcement changes that has kind of been implemented by the EPA or that they proposed? What does that all mean?
What are you hearing customers tell you about how they are planning to use that?
Yeah. We live in a complicated space right now, I think. First of all, thank you for the invitation. Happy to be here, Angel. A great conference as always, so appreciate that. As many of you know, Cummins participates very strongly in the North America truck market, both in medium duty and heavy duty. It is an area we have had a franchise for over 100 years, and we have some very good long-term trusted partnerships with OEMs. Generally, the market over the last year has been soft. It has been improving, especially over the last six months, and anticipated to continue improving throughout the end of this year. That has really been driven by a couple of different things, as you mentioned. I would say one, we have seen us move to the upside of the general truck cycle.
Fleets are generally making a little bit more money, and as we all know, that tends to drive more purchases of vehicles. On top of that, however, we have had this uncertainty around emissions regulations and product availability in 2027. That has drove, I would say, some externalities that have impacted the ordering patterns of many of the customers. As we sit here today, we are, I would say, privileged to have a little bit more certainty than we did a couple of months ago. The primary reduction in uncertainty has been the EPA providing, let us say, a semi-final rule clarifying what the rules for powertrains will be in 2027. Essentially, what the EPA has stated is that they are providing the industry flexibility to both sell historic powertrains with an NCP or a non-conforming penalty, or to move forward with new powertrains that hit the 35 mg/bhp-hr NOx rule.
That industry flexibility has led, I would say, to a lot of conversation across the industry about what demand patterns will look like in the second half of this year and into next year. As we sit here today, I would say not much has fundamentally changed about those demand patterns because of the general strength of the fleets. Demand remains high in the second half of this year. Also, given the fact that NCPs will kick in on January 1st next year and/or people will have the availability to buy new powertrains, there is going to be a significant increase in cost to the end user in 2027 regardless of what product you buy, which I think supports continued strong demand in the second half of 2026. Maybe that demand could be a little bit less than some people were estimating several months ago.
For those that were really worried about only having the option to buy new powertrains in their trucks, that risk is really off the table now. Fundamentally, I think the industry at this point is already capacity constrained, right? I do not think that is going to be particularly relevant in impacting the second half demand as we see it right now.
And to your point, what are customers telling you about the 2027 demand trajectory? I think the industry expectation is that you're now going to see a step change higher, that continuation of the second half demand into 2027 versus previously, there was maybe an expectation to pre-buy, then you fall off a cliff. What are customers telling you around that, to your point, especially since costs are going up regardless of which engine they're buying ultimately?
Yeah, absolutely. I think the industry appreciates the flexibility that the EPA is providing on product availability, so that likely leads to people purchasing more product than they would have otherwise. This is an industry that really values uptime. People buy trucks to make money. Uptime is key. The industry is generally nervous about the manifestation of potential quality risks with new products. So the availability of current product, which generally across the industry is more reliable than it has ever been, I think will put their minds at ease. They'll probably buy more of those products. Importantly, I think as the industry starts selling some of the new technology into markets, that will also give the industry an option to buy some of that product, get comfortable with the technology. I think it'll let the industry get through any teething problems with the technology.
So when the industry does fully transition to the new technology, the industry will have some experience with it, will be more comfortable with it. So when that does happen, should have less of a cliff event in terms of demand than maybe we've had in prior cycles over the last 20 years or so.
Understood. That makes sense. I do want to remind the audience, I forgot to mention at the beginning, but if you have any questions at any point, raise your hand, we'll get a mic to you. I want to make sure that everybody has a chance as well to get a question if they have one. But, in the meantime, just want to continue down that line. So what is your strategy? What is Cummins' approach to this? I know you've talked about the phasing in of certain engines. Can you just kind of give us an overview of that strategy and also the implications of that on your financials? Because I think as we get all of these changes, there's been concerns that maybe there's now higher costs, but you don't get the price, and therefore more of a headwind to your margins.
If you could talk about kind of the impact on the financials as well as your strategy.
Yeah, absolutely. I'll head off the first item where a lot of people are asking about NCPs and the ability to pass those on. We will fully pass on NCPs through the market. The average selling price of the historical product will go up. We will fully offset that with pricing. Profit dollars will be flat. Percent will be down, just due to the math involved. I'll state that clearly before we move forward. I'd say the strategy of Cummins has always, in this market, been consistent. It's to produce the highest value to the end user through Total Cost of Ownership. That's quality, that's fluid economy, both diesel and DEF, and it's having a product that also provides the best resale value in the market.
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