Cummins Inc (CMI) Q4 2022 Earnings Call Transcript

Cummins Inc (NYSE: CMI) Q4 2022 earnings call dated Feb. 06, 2023

Corporate Participants:

Chris Clulow — Vice President, Investor Relations

Jennifer Rumsey — President and Chief Executive Officer

Mark Smith — Chief Financial Officer

Analysts:

Jerry Revich — Goldman Sachs — Analyst

Jamie Cook — Credit Suisse — Analyst

Stephen Volkmann — Jefferies — Analyst

David Raso — Evercore ISI — Analyst

Robert Wertheimer — Melius Research — Analyst

Nicole DeBlase — Deutsche Bank — Analyst

Matthew Elkott — Cowen — Analyst

Noah Kaye — Oppenheimer — Analyst

Tami Zakaria — J.P. Morgan — Analyst

Avi Jaroslawicz — UBS — Analyst

Michael Feniger — Bank of America — Analyst

Presentation:

Operator

Greetings and welcome to the Cummins Inc Fourth Quarter 2022 Earnings Conference. [Operator Instructions] A brief question-and-answer session will follow the formal presentation. [Operator Instructions]

It is now my pleasure to introduce your host, Chris Clulow, Vice President of Investor Relations. Thank you. Please go ahead.

Chris Clulow — Vice President, Investor Relations

Thank you very much. Good morning, everyone, and welcome to our teleconference today to discuss Cummins’ results for the fourth quarter of 2022, as well as the full year performance. Participating with me today are Jennifer Rumsey, our President and Chief Executive Officer; and Mark Smith, our Chief Financial Officer. We will all be available to answer 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 and Exchange Act of 1934. Such statements express our forecasts, expectations, hopes, beliefs, and intentions on strategies regarding the future. Our actual future results could differ materially from those projected in such forward-looking statements because of a number of risks and uncertainties. More information regarding such risks and uncertainties is available in the forward-looking disclosure statement in the slide deck and our filings with the Security 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’ll be discussing certain non-GAAP financial measures and we will 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 within the Investor Relations section at cummins.com.

With that out of the way, I’ll turn you over to our President and CEO, Jennifer Rumsey to kick us off.

Jennifer Rumsey — President and Chief Executive Officer

Thank you, Chris. Good morning. I’ll start with a summary of 2022, discuss our fourth quarter and full year results, and finish with a discussion of our outlook for 2023. Mark will then take you through more details of our fourth quarter and full year financial performance and our forecast for this year. Last year was an incredibly exciting one for Cummins and our stakeholders. We made significant strides in our inorganic growth strategy, most notably through the acquisitions of Jacobs Vehicle Systems, Meritor and the Siemens Commercial Vehicles business. We also navigated complex global supply chain challenges, advanced our preparations for the separation of our filtration business, and transitioned from Tom to me as the CEO. We accomplished all of this and delivered record revenues, EBITDA and earnings per share in 2022.

We did so with a focus on the exciting opportunity in front of us, to lead the industry to a broader, clean economy and do so in a way that is best for our stakeholders and the planet. Decarbonization is a growth opportunity for Cummins, uniting our business and climate goals. In 2022, we launched our long-term decarbonization growth strategy, Destination Zero, which includes making meaningful reductions in carbon emissions through advanced internal combustion technologies, widely accepted by the market today, while continuing to invest in and advance zero emission technologies ahead of widespread market adoption. As part of our organic growth strategy, we unveiled the industry’s first unified fuel-agnostic internal combustion powertrain platforms. And we continue to see momentum in our electrolyzer technology and green hydrogen production opportunities.

Demand for our products remained strong across all of our key markets and regions with a notable exception of China, resulting in strong revenues in the fourth quarter. Fourth quarter revenues totaled $7.8 billion. Excluding the Meritor business, revenues for the fourth quarter of 2022 were $6.6 billion, an increase of 13% from the fourth quarter of 2021, primarily driven by increased demand in many of our North American markets. To provide clarity on the fourth quarter and 2022 full year operational performance of our business and allow comparison to our prior guidance, I’m excluding the Meritor operating results and associated acquisition and integration costs. The costs related to the separation of the filtration business and the costs associated with the indefinite suspension of our operations in Russia. Mark will provide more detail on the reported results in his comments.

With these exclusions considered, EBITDA was $1.1 billion, or 16.1% of sales in Q4, above our guidance of 15.5% and stronger than the $705 million, or 12.1% reported a year ago. EBITDA and EBITDA percentage improved due to an increase in gross margins with positive pricing, higher volumes, lower product coverage costs, and some improvement and logistics costs all of which offset increases in material costs. Gross margin improvement is key to meeting our long-term goals of increasing the returns in our core business while transitioning our New Power business to break even EBITDA by 2027.

In the fourth quarter, Meritor operating performance and financial results showed improvement, and we continue to accelerate value-capture opportunities across the business. Our employees have done an excellent job in integrating the Meritor operations and people within Cummins, and continue to make strides in identifying cost-reduction opportunities. We remain confident in our ability to achieve the $130 million in pre-tax synergies we referenced upon completion of the acquisition. And in addition, we expect to deliver incremental tax synergies as we integrate the business.

Excluding Meritor, 2022 revenues were a record $26.2 billion, 9% higher than 2021. Also excluding Meritor, the costs related to the planned separation of the Filtration business and the impact of the indefinite suspension of our Russian operations, full year EBITDA was $4 billion, or 15.1% of sales compared to $3.5 billion, or 14.7% of sales in 2021. Improved volumes, better price realization and an improved supply chain environment more than offset higher compensation expenses, increased material costs and lower joint venture income for the year.

EBITDA percent improved year-over-year in Engine, Power Systems, Distribution, and Components segments. Leading the way with the Components segment, which delivered 150 basis points of EBITDA margin expansion. The Power Systems business finished 2022 with another solid quarter and delivered full year EBITDA of 12.2%, up from 11.2% last year. The improvement in performance in this segment over the past six months is encouraging, and you will see from our guidance that we expect further margin gains this year. EBITDA margins in the distribution business increased by 110 basis points. Our reported full year 2022 results include five months of operational performance for Meritor, or $1.9 billion of revenue and $26 million of EBITDA, including $115 million of acquisition, integration, and purchase accounting related costs.

Now let me provide our overall outlook for 2023, and then comment on individual regions and end markets. Our 2023 guidance includes our expected results of the Meritor business and excludes the costs or benefits associated with the separation of the Filtration business. We are forecasting total company revenues for 2023 to increase 12% to 17% compared to 2022, and EBITDA to be 14.5% to 15.2% of sales driven by the inclusion of a full year of sales from Meritor, continued strength in the North American truck market, improved demand in power generation markets, overall pricing improvement and slow improvement in the China on-highway market.

Industry production for heavy-duty trucks in North America is projected to be 260,000 to 280,000 units in 2023, a range of a 5% decline to 2% improvement year-over-year. In medium duty-truck, we expect the market size to be 125,000 to 140,000 units, flat to up 10% from 2022. We expect our deliveries in North America to continue to outpace the market as the engine partnerships we announced in 2021 continue to phase in. Our engine shipments for pickup trucks in North America are expected to be 140,000 to 150,000 units in 2023, volume levels consistent with 2022. In China, we project total revenue, including joint ventures to increase 7% in 2023. We project a 15% to 25% improvement in heavy and medium-duty truck demand, and 10% to 20% improvement and demand in the light-duty truck market, coming off the low market levels in 2022.

Industry sales of excavators in China are expected to decline 25% to 35% in 2023, as the market adjusts to new emissions regulations and adjust the inventory on hand. We are watching the situation in China closely with ensuring the safety and well-being of our people as our first priority. The change in the country’s COVID lockdown policy could positively impact our operations in the coming months. The current events make it difficult to gauge. The markets within China are at a low point as we close out 2022 and our guidance assumes a slow recovery in 2023.

In India, we project total revenue including joint ventures to be up 1% in 2023. We expect the industry demand for trucks to be flat to up 5% for the year. We project our major global high horsepower markets to remain strong in 2023. Sales of mining engines are expected to be down 5% to up 5% dependent upon the trajectory of commodity prices and supply chain improvements. Demand for new oil and gas engines is expected to increase by 15% to 25% in 2023, primarily driven by increased demand in North America. Revenues in global power generation markets are expected to increase 10% to 15%, driven by increases in non-residential construction and improvements in the data center market.

In New Power, we expect full year sales to be $350 million to $400 million, more than doubling our 2022 revenues. We have a growing pipeline of electrolyzer orders, which we expect to convert to backlog and to be delivered over the course of the next 12 months to 18 months. At the end of the first quarter of 2022, we shared that we had reached the milestone of $100 million in electrolyzer backlog. This tripled to $300 million at the end of 2022, demonstrating the strong momentum in this market. With demand continuing to rise, we are focused on adding capacity for electrolyzer production. During 2022, we announced several capacity expansion investments and expect to have more than two gigawatts of scalable capacity in the 2024 to 2025 timeframe across Europe, North America, and China. Additionally, we will continue to deliver battery electric and fuel cell systems, along with electric powertrain technologies as adoption continues in the transportation markets.

As mentioned, Meritor results are included in our overall guidance for 2023. We are continuing to drive improvement in our margins post acquisition and expect Meritor to be accretive to earnings per share in 2023. We will continue to provide updates on the progress of our value capture initiatives, which will be focused on the portion of the business within our Components segment. Within Components, we expect Meritor to add $4.5 billion to $4.7 billion in revenue in 2023, with EBITDA margins in the range of 10.3% to 11%, an improvement from the comparable 2022 EBITDA margin of 7.2%. The electric powertrain portion of the Meritor business has been integrated within the New Power portfolio with projected 2023 EBITDA losses of $55 million included in the overall guidance for that segment.

In 2023, we anticipate that demand will remain strong in most of our key regions and markets, especially in the first half of the year. While some macroeconomic indicators have weakened in recent months, we have not seen a significant change in customer orders at this time. In summary, we expect full year sales growth of 12% to 17%, and EBITDA to be 14.5% to 15.2% of sales. We have taken a number of actions to improve our EBITDA in 2023 and expect to generate very strong incremental margins within our core business and improve the margins of the Meritor business, while continuing to invest in our New Power business. Having effectively managed through the challenges of the past couple of years, we expect improved performance in 2023 and are well-positioned to invest in future growth while continuing to return cash to shareholders.

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

Mark Smith — Chief Financial Officer

Thank you, Jen, and good morning, everyone. There are four key takeaways from my comments today. First, we delivered strong results in the fourth quarter of 2022, exceeding our own projections for revenue and EBITDA from three months ago, and we delivered stronger margins in engines, components, distribution and power systems compared to a year ago. Second, we continue to make good progress on the integration of Meritor. We remain on track to deliver $130 million of pre-tax synergies by the end of year three. We returned $1.2 billion to shareholders in 2022 in the form of dividends and share repurchases. Finally, demand for our products remain strong, supporting increased revenues in our core business and New Power and growth in EBITDA and earnings per share in 2023.

Now let me go into more details on the fourth quarter. Fourth quarter reported revenues were $7.8 billion and EBITDA of $1.1 billion, or 14.2%. For the full year, revenues were $28.1 billion and EBITDA $3.8 billion, or 13.5% of sales. Also in the fourth quarter, Meritor generated $1.2 billion of revenue, $60 million of EBITDA, after incurring $27 million of acquisition and integration-related costs. Our fourth quarter results also included $19 million of costs related to the planned separation of the Filtration business.

Full year 2022 results included five months of operational performance for Meritor, yielding $1.9 billion of revenue, $26 million of EBITDA, reflecting $115 million of acquisition, integration and purchase accounting-related costs. We’ll all look forward to a cleaner set of numbers in 2023. Our full year 2022 results also included $81 million of costs related to the planned separation of the Filtration business and $111 million of costs related to the indefinite suspension of our operations in Russia.

To provide clarity on the fourth quarter and 2022 full year operational performance of our business and allow comparison to our prior guidance, I am excluding the Meritor results and the separation of Filtration and the indefinite suspension of Russia in my following comments. But hopefully, you’re clear after my earlier remarks about the magnitude of those — each of those items.

Fourth quarter revenues were $6.6 billion, an increase of 13% from a year ago. Sales in North America were up 25%, driven by continued strong demand in truck markets. International revenues decreased 1% with strong demand for power generation and mining equipment in most markets offset by declines in China, and of course, the impact of our suspension of our operations in Russia. Currency movements negatively impacted sales by 4% due to a stronger US dollar. EBITDA was $1.1 billion, or 16.1% compared to $705 million, or 12.1% a year ago. EBITDA increased by $359 million due mainly to improved pricing, higher volumes, lower product coverage expenses, all of which contributed to stronger gross margin performance and more than offset higher material costs.

Now let’s go into our income statement in a little more detailed by line item. Gross margin of $1.7 billion, or 26.3% of sales increased by $420 million or 380 [Phonetic] basis points from a year ago. Selling, admin and research expenses increased by $52 million, up 6% due to higher compensation and research costs as we continue to invest in new products and capabilities to support future profitable growth particularly in the Engine and New Power segments. Joint venture income decreased $28 million due to lower demand for trucks and construction equipment in China. Other income was $44 million, an increase of $13 million from a year ago, primarily due to higher pension income.

Interest expense increased $58 million, largely driven by the financing costs associated with the acquisition of Meritor. The all-in effective tax rate in the fourth quarter was 17.2%, including $52 million, or $0.36 per diluted share [Technical Issues] favorable discrete items. All-in net earnings for the quarter was $631 million, or $4.43 per diluted share, up from $394 million, or $2.73 a year ago. Operating cash flow in the quarter was an inflow of $817 million, including Meritor and $85 million higher than the fourth quarter last year, driven primarily by higher earnings. For the full year ’22, revenues were a record $26.2 billion, or up 9% from a year ago, with sales in North America, up 18% and international revenues down 2%. Currency movements negatively impacted revenues for the full year by 2%. EBITDA was $4 billion, or 15.1% for 2022 compared to $3.5 billion, or 14.7% of sales a year ago.

Improvements in components, distribution, power systems and engine margins were partially offset by increased investment in new power and more than $100 million of mark-to-market losses on investments that underpin some of our non-qualified benefit plans, all of that run through our operating EBITDA. All-in net earnings were $2.2 billion, or $15.12 per diluted share compared to $2.1 billion, or $14.61 per diluted share a year ago. Full year cash from operations was $2 billion, down from $2.3 billion, primarily due to higher inventory levels. Capital expenditures in 2022 were $916 million, an increase of $182 million from 2021 as we continuing [Phonetic] to invest in new products and capacity expansion critical for future growth. We returned $1.2 billion of cash to shareholders, or 63% of operating cash flow in the form of share repurchases and dividends last year.

Now moving on to our guidance for 2023, which includes Meritor, and thankfully, reduces the number of exclusions we’ll have to explain each quarter, and I appreciate your patience as we work through that in 2022. We are excluding any separation costs associated with Filtration, and for now, we’re assuming that the operating results of Filtration are in our guidance for the full year 2023, as the timing of that separation is not yet determined. We expect Meritor to add $4.5 billion to $4.7 billion of revenue in 2023. We currently project 2023 company revenues, including Meritor to be up 12% to 17% and company-wide EBITDA margins expected to be in the range of 14.5% to 15.2%.

In ’23, we expect revenues for the engine business will be flat to up 5%, driven by continued strength in North American truck market and a modest recovery in China. 2023 EBITDA is projected to be in the range of 13.8% to 14.5% compared to 14.4% in 2022. We expect distribution revenues this year to be up 2% to 7% and EBITDA margins to be in the range of 10.3% to 11% compared to 10.5% in 2022. Including Meritor, we expect 2023 components revenues to increase 28% to 33% and EBITDA margins in the range of 14.1% to 14.8% compared to 15.0% in 2022. In ’23, we also expect Power Systems revenues to be up 5% to 10%, due to higher demand for oil and gas engines and power generation equipment globally. EBITDA there is projected to be between 13% and 13.7%, up from 12.2% of sales last year. And also this year, we expect New Power revenues to increase to the range of $350 million to $400 million.

We expect New Power net losses to be in the range of $370 million to $390 million, as we continue to make targeted investments in capacity, technology to support growing customer demand. Our goal remains to achieve breakeven EBITDA in 2027. Our effective tax rate this year is expected to be approximately 22%, excluding any discrete items. Capital investments will be in the range of $1.2 billion to $1.3 billion this year. We remain committed to our long-term goal of returning 50% of operating cash flow to shareholders over time and have accelerated cash returns to shareholders in recent years above that 50% goal when we have generated more cash than required to support our strategy. In 2023, we will prioritize cash towards dividends and debt reduction following the acquisition of Meritor, while continuing to invest to deliver future profitable growth.

Having a strong balance sheet is an important asset as we navigate through economic cycles and sustain our investments in new products for existing and new markets. To summarize, we delivered record sales, strong full year earnings in 2022, while managing through supply chain challenges and a very weak demand environment in China. As we move through 2023, demand for our products remains strong in most of our core markets with good visibility into the first half of the year. We’ll continue to focus on raising margins in our core business, driving improvements in the performance of Meritor, generating strong cash flow and investing in the products and technologies that position us to lead in the adoption of new technologies and penetrate new markets through our new power business.

Thank you for your interest today. Now let me turn it over to Chris.

Chris Clulow — Vice President, Investor Relations

Thank you, Mark. Out of consideration to others on the call, I would ask that you limit yourself to one question and a related follow-up. If you have an additional question, please rejoin the queue. Operator, we’re ready for our first question.

Questions and Answers:

Operator

Thank you. The floor is now open for questions. [Operator Instructions] The first question today is coming from Jerry Revich of Goldman Sachs. Please go ahead.

Jerry Revich — Goldman Sachs — Analyst

Hi. Good morning, everyone.

Jennifer Rumsey — President and Chief Executive Officer

Good morning, Jerry.

Mark Smith — Chief Financial Officer

Good morning, Jerry.

Jerry Revich — Goldman Sachs — Analyst

I know it’s early post the acquisition of the Siemens propulsion systems and Meritor, but I was wondering if you could just comment on what the acceptance has been of the products in the marketplace? Post Cummins ownership, what’s the pipeline from the developments look like? How is that cross-selling working out versus what you folks had expected before acquiring the assets? Thanks.

Jennifer Rumsey — President and Chief Executive Officer

Yeah. Thanks, Jerry, for the question. Yeah, we are right now are really focused on integrating the Meritor business, the Siemens commercial vehicle business, and the investments that we were already making within New Power and having a number of conversations with our customers on how we bring that together to deliver those electric powertrains and components to meet their needs. So it brings some strong products, employees, as well as customer relationships, and we’re seeing growing opportunities as we have relationships at a senior more strategic level with these customers to grow our business going forward. It’s really early days at this point. So we’ll continue to talk about that as we bring those businesses together.

Jerry Revich — Goldman Sachs — Analyst

Sounds good. Jennifer, thanks. And Mark, can I ask in terms of the pricing that you’re expecting in ’23 within the outlook? And if you could just touch on the logistics costs embedded in the guide as well? You folks have been running pretty hot to hit deliveries in ’22, I’m wondering to what extent does that — a tailwind within the guidance?

Mark Smith — Chief Financial Officer

Yeah. We’ve got about 2% of price cost benefit embedded in the guidance, Jerry. That’s the biggest single driver of margin improvement.

Jerry Revich — Goldman Sachs — Analyst

Yeah. Great, thanks.

Operator

Thank you. The next question is coming from Jamie Cook of Credit Suisse. Please go ahead.

Jamie Cook — Credit Suisse — Analyst

Hi, good morning. I guess, two questions. Just given the concern on the macro out there, can you guys speak to by business line, where you see the most visibility or where demand trends do you see sort of weakening? And then I guess, on the engine margin guidance, I guess, I would have thought margins would have been a little better in implied guide just given maybe price cost going away, China improving. So if you can just help me bridge 2023 to 2022 engine margins, what’s implied? Thank you.

Jennifer Rumsey — President and Chief Executive Officer

Great. Thanks, Jamie. Let me speak first to what we’re seeing in the market. And we, of course, are paying attention to some of these macroeconomic trends. If you take just the North America truck market as a starting point, while there has been some decrease in spot rates, we still continue to see healthy freight activity and strong backlogs out through the first half, which gives us confidence that the market is going to remain strong, certainly through the first half of the year. And it’s important to note, it’s just not been a typical cycle for us, because for the last two years, we’ve been undersupplying to the market demand. They’ve been using that equipment. We’re seeing that reflected in very high aftermarket demand, which continues, and these new trucks provide efficiency benefits to the fleet. So we continue to expect strong North America truck market.

In the Power Systems business, again, we have a healthy backlog of products and strong demand across many of our markets. Mining, we’re forecasting to remain around flat, but growth in power generation, growth in the oil and gas business. So we’re feeling pretty confident about that as well. The biggest uncertainty is really around China. And as I said in my comments, we do project some slow recovery throughout 2023. With the lift of the stringent lockdowns that they had in the last couple of years in December, we expect that, that may result in economic strengthening and certainly, less operational disruption, but we’re still monitoring what happens with the COVID waves there. Is there any government stimulus into the economy? We feel really well positioned there. We’ve launched our NS VI products, which we think will enable Cummins to grow our position in the market. We’ve launched the automated manual transmission there. We’ve got a new natural gas platform. So we’re really well positioned as China continues to strengthen and just uncertainty on exactly what the shape of that will look like.

I’ll let Mark talk about the margin question.

Mark Smith — Chief Financial Officer

Yeah. I think the main thing on the engine business margins is that we haven’t got building a very strong recovery in China. And then the other piece that you didn’t mention, Jamie, is that we’ve got fairly sustained investments ahead of us over the next couple of years because we’re updating several of our platforms. We’ve won a lot of external business and we’ve got to meet future emissions regulations. So that’s the only other element that’s running through the engine business that may not be obvious from the outside, but otherwise, we’ll expect them to do well, if markets continue to be strong.

Jamie Cook — Credit Suisse — Analyst

Okay. Thank you, Jennifer. Thanks, Mark.

Mark Smith — Chief Financial Officer

Thank you.

Operator

Thank you. The next question is coming from Stephen Volkmann of Jefferies. Please go ahead.

Stephen Volkmann — Jefferies — Analyst

Hi. Good morning, everybody. Maybe just following on, on the engine margin question, Mark. Given what you just described around, increased spending, R&D, et cetera, should we think about sort of flattish incremental margins over the next few years, or can it still be better than that if we have some volume?

Mark Smith — Chief Financial Officer

I think it can definitely be better than that. We’re still battling some inefficiencies here, Steve. We’re still expecting to have aftermarket growth over time. So no, we’re not locked into these margins. I was just trying to be clear on what the underlying factors. I’ve seen a few comments around engine business margins, but no, I think they can go higher. Getting China, which is the world’s biggest truck market, I know the earnings come through JV, we have the lowest market in a decade. And we think we still got more share to gain there. We’ve got more content in the components business. So, if I sit here today and say what could be the one thing that could move, that could change our guidance most clearly, I would agree with Jen, it would be China, right now. We don’t have visibility. People are more enthusiastic, but the activity hasn’t yet materially picked up. So that, that would be one important factor.

Stephen Volkmann — Jefferies — Analyst

Great. Understood. And then my follow on maybe a bigger, broader question. But as we start very early days, but we start to think about the 2027 emissions, regulations. Do you guys feel like you have a line of sight to what you need to do technically to get there? We’re starting to hear that this is going to be sort of the biggest emission hurdle ever, and that some people may have trouble getting there, or it maybe have some massive costs associated with it, which has some implications for prebuys and maybe whether people do it themselves or outsource it to you. Just your big picture thinking on 2027, and how that kind of plays through?

Jennifer Rumsey — President and Chief Executive Officer

Yeah. We are focused on continuing to meet more stringent regulatory requirements and do so with products that will provide benefits to the environment and exceed our customer needs. We now have clarity on the EPA 2027 NOx regulations that happened late last year, and they finalized that standard at a 0.035 gram NOx, and our intention is to offer a full product lineup with our new fuel-agnostic engine platforms to meet that regulation, and we’re finalizing our product plans right now with our customers on those. But we really feel well positioned to invest in really as a part of our Destination Zero strategy, reduce CO2 and NOx impact to the environment and offer products — market leading products to our customers with that regulation.

Stephen Volkmann — Jefferies — Analyst

All right. Thank you, guys.

Mark Smith — Chief Financial Officer

Thank you.

Operator

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

David Raso — Evercore ISI — Analyst

Hi, thank you. The China guide, the up 7%, I assume that includes consolidated and JV revenue, sort of how you usually kind of speak to it.

Mark Smith — Chief Financial Officer

Yes.

David Raso — Evercore ISI — Analyst

Even — maybe can you update us on the mix of your end markets? It feels like the consolidated off-highway, the construction exposure you have that shows up in the P&L more so than JV, and the JV is more of the on-highway. I’m surprised with the mix, because that construction business at this stage must be pretty small after the declines we’ve seen. So to have truck up double-digit for China, for heavy and light, even though the excavators down a lot, the mix would suggest, you’d be up more than 7%, if truck is up double digit and at now relatively small construction business is down. Are there other businesses keeping it only at 7%? Is there a share comment there? Just trying to understand why only up 7% with that China end market guide.

Mark Smith — Chief Financial Officer

I don’t think there’s anything significant in there, David. I mean, obviously, whether it’s consolidated or unconsolidated truck is probably 70% [Phonetic] plus when you add up all of our markets. So if truck does better, we’ll be up more than 7%. If it doesn’t, we won’t. I think for components, that’s all consolidated revenue. That’s almost entirely on-highway. It’s really the engine business that has the off-highway business of any size. And then, yeah, I think Power Systems has been pretty strong last year in China. It has probably been the exception to what we’ve seen in every other market, but there’s no big change in dynamics.

Jennifer Rumsey — President and Chief Executive Officer

Just on your share, we expect to continue to grow our share in the China market with the launch of the NS VI product. So that’s assumed in our guidance.

David Raso — Evercore ISI — Analyst

I even think with some of the transmissions as well. So I’m just trying to understand like Photon is struggling more than I would have thought. It’s still barely making money now for two quarters in a row. Is there something about that dynamic we should be more sensitive to on the margin recovery in China in the JV because of Photon?

Mark Smith — Chief Financial Officer

No, we did get some sizable tech fees and other things from the early part of last year, which kind of helped — that’s the wrong word. We were entitled to those based on product launches, but no, I don’t think there’s anything significant.

David Raso — Evercore ISI — Analyst

And I’ll hop off, just one kind of modeling question. If you take the interest expense in the fourth quarter and annualize it, it’s $348 million. You mentioned there’s debt reduction, but your guide is $380 million. I mean what are we assuming for interest rates from the fourth quarter on to have up interest expense, but you’re targeting debt reduction?

Mark Smith — Chief Financial Officer

Right. So I think the answer to that is, we’ll need to keep working that down. I think we’ve got some floating rate exposure. It’s not all fixed. And probably, the debt reduction will come in the second half of the year, but let me come back to you on that, David.

David Raso — Evercore ISI — Analyst

All right. Thank you very much. I appreciate it.

Operator

Thank you. The next question is coming from Rob Wertheimer of Melius Research. Please go ahead.

Robert Wertheimer — Melius Research — Analyst

Hi. I know it’s still early days, but you’re starting to see some ramp in electrolyzers. And I guess there’s obviously a lot of uncertainty as to what the ultimate margin structure is going to be, New Power or clean energy generally. So I wonder if you have any thoughts on when you see clarity? Any thoughts on where gross margins might trend? Maybe you’re still heavily investing, but the gross margins are improving. Or just your thoughts on how the curve of profitability is shaping up in clean tech?

Jennifer Rumsey — President and Chief Executive Officer

Yeah. The electrolyzer business is really going to drive the majority of our progress towards breakeven in ’27 for New Power and the growth aspirations that we shared for 2030. And so, we expect during that time frame to scale up the product, the supply chain, and manufacturing and continue to see growing backlog and conversion of orders into revenue. And so through that time period, you’ll see margins going positive and improving. The exact margin structure of that business is still unclear. There’s not a lot of suppliers in the market, and we expect demand to be quite strong through that time period. So I’m optimistic on what margin structure for the business will look like. So obviously we’ll share more as we get towards that breakeven point and go margin positive.

Mark Smith — Chief Financial Officer

Yeah. Rob, one thing I’ll add is, for the gross margin on a project basis, we’re at gross margin positive last year, which is a good early indicator. We have other costs that are going into for capacity expansion and other things that obviously offsets that, but it’s a good indicator that we’re on the right path for profitability as we move forward with more volume.

Robert Wertheimer — Melius Research — Analyst

Okay. That’s helpful. Thank you. And obviously there’s just still a lot of build-out in manufacturing and supply chain. So do you have a sense as to how you stack up competitively on either design cost, or I guess you have a lot of advantages in manufacturing as you build out and off the top there?

Jennifer Rumsey — President and Chief Executive Officer

I mean one of the advantages we have here is, we’re able to leverage our existing footprint and capability that we have as a part of the broader comment. So you saw us announce recently. We plan to use our Fridley [Phonetic] manufacturing facility for electrolyzer production in North America. So we are tapping into that strength we have in our footprint and supply chain capability to help build out profitable both product as well as supply chain. And that’s an advantage that I think Cummins has here.

Robert Wertheimer — Melius Research — Analyst

Thank you.

Operator

Thank you. The next question is coming from Nicole DeBlase of Deutsche Bank. Please go ahead.

Nicole DeBlase — Deutsche Bank — Analyst

Yeah, thanks. Good morning, guys.

Mark Smith — Chief Financial Officer

Nicole.

Nicole DeBlase — Deutsche Bank — Analyst

Maybe just on the distribution margins. It looks like you guys aren’t expecting margin expansion there, even though sales were up 2% to 7%. I guess what is the reason for that?

Mark Smith — Chief Financial Officer

I think there’s a little bit of improvement baked into the guidance, but we’ve got a pretty track record of improving. There’s no structural impediments to growing margins over time. It’s a range. So under the different revenue scenarios there’s some variation, Nicole. But over the time, we expect the margins to keep going up.

Nicole DeBlase — Deutsche Bank — Analyst

Okay. Understood. Thanks. And then I guess Power Systems stood out to me. On the other side, it’s just the margins look really impressive year-on-year in 2023. Is price/cost the biggest driver of that, or is there any other big drivers of the margin expansion that you guys are expecting?

Mark Smith — Chief Financial Officer

I think, certainly, that’s been a big factor, and then we’ve got pretty healthy demand locked in now. So there’s been a lot of focus on that business. We’ve been pleased with the solid results, particularly in the second half of this year, and we just — we’ve got a very, very strong focus on continuing to drive [Speech Overlap]

Jennifer Rumsey — President and Chief Executive Officer

For that — for that business, it’s important to keep in mind, you see a very long — we have a very long lead time on orders. So as costs accelerated, it took a while for us to pass on some of the price increases to offset that, and that is in part what drove the strong margin improvement from ’21 to ’22.

Nicole DeBlase — Deutsche Bank — Analyst

Makes sense. Thank you. I’ll pass it on.

Mark Smith — Chief Financial Officer

Thanks, Nicole.

Operator

Thank you. The next question is coming from Matt Elkott of Cowen. Please go ahead.

Matthew Elkott — Cowen — Analyst

Good morning. Thank you. If you can give us a sense of how much of a growth moderation can we expect in the second half? I’m assuming that will be the case directionally, because you’ll have the Meritor comps. And also it sounds like you guys are more cautious on the second half. So how much of a growth moderation are we expecting?

Mark Smith — Chief Financial Officer

You can roughly split our revenues 52% to 53% in the first half versus the second half, Matt.

Matthew Elkott — Cowen — Analyst

Got it. That’s very helpful. And then just one follow-up on the New Power front. It’s been about a year since you guys announced the fuel-agnostic engine. So any update on that and the receptiveness from customers in your conversations? And also I think back in August, PACCAR announced that they’re using your new natural gas engine. So is there anything new on that front as well?

Jennifer Rumsey — President and Chief Executive Officer

Yeah. So the fuel-agnostic platform, just to clarify that’s being developed as a part of our engine business. And as I mentioned earlier, we’ll launch a full lineup in North America of that product as a part of the 27 EPA regulation. As you’ve seen, PACCAR is integrating and plans to introduce the natural gas version, and we have customers that are very interested in that product, including with renewable natural gas, and we announced partnerships around that. We also announced a memorandum of understanding with Tata late last year on the hydrogen version of that platform. And so really, we see a lot of interest in those platforms, both as a way to improve efficiency of diesel engines and then create flexibility to move to other fuels such as natural gas or hydrogen with the platform and really minimizing the integration pair up that’s required for customers as they move between those platforms. So we’ll begin to launch those with the natural gas version here in North America in late ’23, early ’24 and then accelerate introduction in the coming years after that.

Matthew Elkott — Cowen — Analyst

Perfect. Thank you very much.

Operator

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

Noah Kaye — Oppenheimer — Analyst

Good morning. Thanks for taking the questions. Can you characterize the current mix of investment spending in New Power? Just kind of give us a sense of the key buckets where you’re spending. Maybe you can even give us some guidelines on how much of the capex for this year would be attributed to New Power? And then I think the higher question here is, are you ready to call 2023 kind of the peak of net investment spending for the segment?

Jennifer Rumsey — President and Chief Executive Officer

So at a high level, the different categories of investment in New Power. Of course, there’s big investments happening in electrolyzers, and we talked about the growth and capacity investments that we’re making there. The other buckets include investments in batteries, other electrified components in the electric powertrain, and then in fuel cells. So we’re investing in both the prime mover as well as some of the key components to position ourselves as our current markets start to move to electrified powertrains to be both the powertrain provider as well as provide key components similar to the model we have today with engine business and components. Do you want to talk about allocation [Speech Overlap]

Mark Smith — Chief Financial Officer

Yes. So capex, probably in the $100 million to $125 million range, so just under 10% of the total for the company in the New Power segment, and most — more of that’s weighted towards electrolyzers where, of course, we’re ramping up production, albeit, using existing Cummins sites, where possible and appropriate. And then, yes, I’d love to call the peak in New Power losses. They’re going to have to peak soon, because we’re aiming towards breakeven in 2027 at the EBITDA level. The only caveat is, if there’s a significant change, should we invest in some new capabilities that aren’t part of our current portfolio? That’s not part of our plan today now, but that would be the only variation.

Noah Kaye — Oppenheimer — Analyst

That’s helpful. And then just to give us some expectations around the cadence of earnings this year. Obviously, you’re guiding to EBITDA, not EPS. But thinking about China JV modestly improving, getting better synergies, capture on Meritor throughout the year, but then maybe some offset from potential deterioration in some end markets. So just any guideposts you would give us on first half versus second half, the EBITDA or even EPS?

Mark Smith — Chief Financial Officer

No. I mean, by and large, it will go along with the revenue. Unfortunately, we had a tough Q3 in 2022. So that probably gives us the easiest comp, just kind of going through by quarter, and then we started the year much stronger. So ex-JV, I think we’ll have a good first half of the year. The JV will be the biggest single swing factor. When you look at our P&L, I would think — in the first half of the year, maybe that helps in the second. Q3 gross margins were disappointing. We’ve rebounded well in here in Q4. So yeah, I modestly expect first half to be stronger all in, unless revenues in the second half change direction significantly from what we’ve guided.

Noah Kaye — Oppenheimer — Analyst

Very helpful. Thank you.

Mark Smith — Chief Financial Officer

Welcome.

Chris Clulow — Vice President, Investor Relations

Thanks, Noah.

Operator

Thank you. The next question is coming from Tami Zakaria of JPMorgan. Please go ahead.

Tami Zakaria — J.P. Morgan — Analyst

Hi, good morning. Thanks for taking my question. So my first question is, are you expecting any synergy savings from the Meritor acquisition this year? I believe you were expecting $130 million in total by year three. So anything this year?

Mark Smith — Chief Financial Officer

Absolutely. Yeah, we’re working very hard on that. Me personally along with many members of the Meritor, Cummins team. So yes, and we’ll talk about those as we go along. But yes, we’re feeling confident about that progress towards that $130 million.

Tami Zakaria — J.P. Morgan — Analyst

And some of that is embedded in guidance, I’m assuming would that be incremental?

Mark Smith — Chief Financial Officer

We’ll try and get as much as we can because that both helps the long-term interest of that business and improve the cost structure. So yeah, we expect the results clearly to improve, especially in the components segment. We’re assuming that’s all in for now. If we get more then, we’ll be happy to report. We won’t get more than $130 million, want just to be clear. That’s a year three number, but we’re making good progress.

Tami Zakaria — J.P. Morgan — Analyst

Got it. And so, I’m sorry if I missed it, but can you give some color on the embedded Meritor margin expansion cadence for the year? Should it be in the guided 10% to 11%, or does it ramp towards the back?

Jennifer Rumsey — President and Chief Executive Officer

Yeah. So let me just reiterate the guidance that we had. Within the components business we have $4.5 billion to $4.7 billion in revenue and EBITDA margins for the Meritor business, 10.3% to 11% compared to — in 2022, that was 7.2%. And some of that is progress on price/cost in that business, operating efficiency as well as synergy cost savings.

Tami Zakaria — J.P. Morgan — Analyst

Got it. Thank you.

Mark Smith — Chief Financial Officer

I think you should just expect sequential improvement through the first half of the year from the Q4 levels.

Tami Zakaria — J.P. Morgan — Analyst

Perfect. Thank you so much.

Chris Clulow — Vice President, Investor Relations

Thanks, Tami.

Operator

Thank you. The next question is coming from Avi Jaroslawicz of UBS. Please go ahead.

Avi Jaroslawicz — UBS — Analyst

Hey, guys. Thanks for taking our questions. On for Steve Fisher. Just in terms of the power generation market, can you talk a little bit more about what’s driving that market to be so robust this year? We might have expected data centers weakening a little bit. It sounds like you’re expecting that to be up still again this year. But if you could just talk about some of the drivers in that market?

Jennifer Rumsey — President and Chief Executive Officer

Yeah. The power generation market, really non-residential construction as well as data centers, and despite some of the announcements that you’ve seen from our data center customers regarding staffing levels, they continue to show interest in investing in data centers, and have demand and drive backup power — demand on our products in that market. So we are still quite bullish about the opportunities there for 2023.

Mark Smith — Chief Financial Officer

I think it’s fair to say, it’s pretty broad-based across multiple markets, broad parts of the economy. Yes, the data center gets a lot of attention. It is a significant individual segment, but we’re seeing robust underlying demand for power generation across multiple segments.

Avi Jaroslawicz — UBS — Analyst

Okay. Appreciate that. Thank you. And then just in terms of the New Power business, have you seen an acceleration in recent months following the IRA in terms of customer interest there? And does that possible acceleration in the market change your view on when we could see breakeven in that business?

Jennifer Rumsey — President and Chief Executive Officer

Yeah. Well, how I would describe it is, the inflation reduction act and the investments around that are really going to be key to enable the adoption rate that we anticipate is going to drive an acceleration in hydrogen investment. The details around that investment are being clarified right now. So it’s going to take several years before you really see that translate into actual projects and business. Definitely, it’s going to drive growth in the hydrogen market in the US between now and 2030 as that — as those incentives come into place to both put the hydrogen production in place as well as drive adoption of some of these technologies, which today, frankly, just cost more. So you need those incentives in order to start to drive customer adoption and bring down the costs and make them more viable in the market.

Mark Smith — Chief Financial Officer

I mean in the short run, we’re investing more because we’re building up capacity as are others in the industry. So the faster we go in the short run could consume more cash. But obviously, we want the market to move and we expect to deliver good gross margins once we get up this kind of investment phase. So it could go faster. It’s quite a long incubation period, so very different from, say, our on-highway engine business, why we take an order. And then typically, we’re shipping in a few weeks. It’s not been that typical in the last 12 months versus sometimes more than a year between headline announcements to actually putting equipment into place and sometimes even more than a year. But we are encouraged, strong adoption for our technology, and yeah, business — doing well on the business development side in New Power.

Avi Jaroslawicz — UBS — Analyst

Understood. I appreciate the time. Thank you.

Chris Clulow — Vice President, Investor Relations

Thanks.

Operator

Thank you. We’re showing time for one final question today. The final question is coming from Michael Feniger of Bank of America. Please go ahead.

Michael Feniger — Bank of America — Analyst

Thanks, everyone, for squeezing me in. When we look at China revenue, the consolidated plus JV in 2022, it’s basically the lowest it’s been over three years, four years. I think slightly below 2019. I’m just curious, in those three years, how profitability looks maybe post some restructuring optimization? If units in China recover, are you more profitable in each of those units than maybe you were in the past?

Mark Smith — Chief Financial Officer

Well, what’s happening over time is that the content is going up, right? So one thing that’s been a big positive for our business is China consistently adopting more advanced emission standards. So the amount of revenue that we’re selling is going up per vehicle quite significantly over time. And certainly, cycle over cycle, it’s billions of dollars of extra revenue growth a year. We’re just at the lowest market in a decade. So we agree that, that growth rate is modest. We don’t have any signs yet of a rapid adoption. We’ll be looking at the same data you’re looking at. And obviously, taking on board the feedback from our customers, but we are profitable in our operations. We don’t disclose profitability by region, but for sure, when China volumes improve, our profits will go up.

Michael Feniger — Bank of America — Analyst

Thank you. And we’ve seen quite a few emerging suppliers in the EV, e-mobility space, really struggled in the last 12 months with deliveries or profitability. Do you see some of the dynamics driving OEM conversations back to you and traditional suppliers as we start looking ahead to some of these key dates and trying to adopt more of this altered powertrain? Thanks.

Jennifer Rumsey — President and Chief Executive Officer

Yeah. We talked about this in our Analyst Day about a year ago. We expect that this transition is going to take a long time for our industry, and that positions incumbents like Cummins well, because you need to invest for the long term. Regardless of what our customers are adopting, we’ve got the solution in our portfolio. And so for sure, you see the benefit of a company like us that has a portfolio of options to meet their needs, it’s going to be around for the long term and continuing to invest in some of these new technologies. Be able to do that and support the product is an advantage, and it’s playing out to be more of an advantage as time goes on compared to some of the new entrants. We continue to pay attention to those new entrants though and how they advance the technology and work to enter the market. So we wouldn’t discount them, but certainly, this long investment period makes it more challenging for them to stay in and be successful.

Mark Smith — Chief Financial Officer

And I think also our footprint, our reputation for dependability, wherever our customers operate is leading us to be approached in new segments by global large industrial players. So it’s not just in the market that we operate in today, we’ve been approached to expand into different market applications. That’s particularly exciting.

Michael Feniger — Bank of America — Analyst

Thank you.

Chris Clulow — Vice President, Investor Relations

Thanks, Mike.

Operator

Thank you. At this time, I’d like to turn the floor back over to Mr. Clulow for closing comments.

Chris Clulow — Vice President, Investor Relations

Thank you all for your participation today. That concludes our teleconference. I really appreciate the interest. And as always, the Investor Relations team will be available for questions after the call this afternoon. Take care.

Operator

[Operator Closing Remarks]