Caterpillar Inc. (NYSE:CAT ) Bernstein 38th Annual Strategic Decisions Conference Call June 1, 2022 11:00 AM ET

Ryan Fiedler - Director of Investor Relations

Jim Umpleby - Chairman & Chief Executive Officer

Hi, good morning everyone. My name is Chad Dillard. I'm the lead analyst here at Bernstein for the U.S. machinery sector. And I'm really pleased to have Caterpillar here. And joining me from Caterpillar is Ryan Fiedler, the Director of Investor Relations; and Jim Umpleby, Chairman and CEO. So we're going to start off with Ryan reading off some disclosures and then we'll move into a quick presentation by Jim and then we'll dive right into a full-on Q&A session.

So without further ado, let me pass it up to Ryan.

Thanks, Chad and I really appreciate everyone being here today, both in person and watching virtually. I'm Ryan Fiedler, our Head of Investor Relations at Caterpillar. I'm just going to hit a couple of key items before we get started here today. So first, we may make forward-looking statements and they are subject to risks and uncertainties. For a full list of risks and uncertainties that could cause our actual results to vary materially from any forward-looking statements we make today, please refer to our most recent SEC filings, our 10-K for 2021 and our most recent 10-Q for the first quarter.

Second, we'll be posting the slides on at investors.caterpillar.com. With that, I'll turn it back over to Chad and Jim, our Chairman and CEO of Caterpillar.

Well, good morning, everyone. Thank you for joining us. Certainly I appreciate your interest. I'm going to run through very quickly a few slides just at this stage and then we'll open it up to the Q&A. We introduced a strategy for profitable growth back in 2017 based on three main elements. One is operational excellence which includes safety, quality, lean and a competitive and flexible cost structure. So we know we can't control market dynamics but we certainly can control the way we perform at those various sales levels.

Expanded offerings includes our ability to develop and introduce machines that will allow us to meet various customer price point expectations. Previously -- Caterpillar traditionally has been known for having the highest quality, most productive piece of equipment. And we still have the highest quality but now we've introduced a line of products that allows us to capture customers that we call life cycle value customers who are more interested in first cost than productivity. And then last is services which is a great opportunity for us to profitably grow our company which I'll talk more about later. And of course, it's all towards the idea of profitably growing our company.

Just a word about that services target. In 2019, we put out a target to double services from $14 billion to $28 billion in 2026. And we've been told our investors at our recent Investor Day that we're increasingly confident in our ability to meet that target for a whole variety of reasons that I can talk -- I'm sure I'll talk about during our discussion here.

At our Investor Day a couple of weeks ago, one of the things we did is we added sustainability as one of our core focus areas because we do believe that represents an outstanding opportunity for us to profitably grow our company. I hope the energy transition is expanding Caterpillar's total addressable market, that and growing global energy demand as well. Stop and think about electric vehicles, a number of autos that are being put on the road and the other ways that our economies are being electrified, that represents a great opportunity for our mining business. A typical EV takes 6x the minerals as a conventional automobile. And again, we make the mining equipment that allows our customers to produce those commodities that are required for the energy transition.

That growing global energy demand also represents an opportunity for us including things like the increased interest in liquefied natural gas or LNG because Caterpillar plays across a wide portion of that natural gas value chain. As more renewables are added to the grid, that creates some grid reliability issues, that represents an opportunity for us to sell more gas turbine generator sets and reciprocating engine generator sets to help provide that grid stability. And our gas turbines and recip engines have the ability to burn a wide variety of fuels, natural gas, biofuels, 100% hydrogen. So that's also an opportunity.

And also infrastructure, you stop and think about the investments that need to be made either as a result of the energy transition or just the infrastructure bill, that represents an opportunity for CAT as well and it's lots of expanding service opportunities that I'm sure we'll talk about. Again, I won't read this whole chart to you but we do believe that our total addressable market is increasing for the reasons I've explained, primarily the energy transition and growing global energy demand and it provides an opportunity for us to grow original equipment and services across our portfolio.

And with that, we'll open it up to questions.

Sounds good. So Jim, I want to start off just with some near-term questions and then we'll go into more of like the longer-term strategic questions. But over the last several weeks, there's been a growing concern about potential slowdown, recession has been throwing around. So I just want to ask you directly, I mean, are you seeing any indications of activity in your core markets starting to slow or anything signaling a recession ahead?

We haven't seen that. I mean our demand still remains quite strong. Last year, we -- in 2021, we increased our sales by more than 20%. And we told our investors that our sales would have been even higher if not for supply chain constraints. And in the first quarter of this year, our sales were up double digit and again, we told investors that our sales would have been even higher if not for those supply chain constraints. So we haven't seen signs of slowdown in our markets. The vast majority of the markets we serve are still quite strong and our challenge at the moment, quite frankly, is supply chain, our ability to supply enough equipment to meet all the demand that's out there. We haven't seen that slowdown.

The one area where we had -- we have talked about with our investors is in China. We had two extraordinarily strong years in 2020 and 2021. And in China, that market for Caterpillar is primarily hydraulic excavators, 10-ton and above and we've told our investors that we believe that the market this year will be slightly less than it was in 2019. So again but we've known that for a while. That's not that new. But in the other markets that we serve, demand continues to be quite strong and we have not seen a slowdown in demand.

Okay. And so let's just hypothesize here. So if we do go into a recession, are there any structural changes that you've made in your business that would -- that you potentially call out that could actually make a cyclical amplitude lesser or even like the trough earnings level higher?

So we introduced some Investor Day targets back in 2017 and then we upped the ante in 2019. And we know, again, we can't control the market but what we have said in our 2017 -- excuse me, 2019 Investor Day is that we would achieve adjusted operating profit margins 300 to 600 basis points above what we did in -- between 2010 and 2016 at similar levels of sales. And quite frankly, there was a bit of skepticism when we rolled those out, people said, okay, well, you've demonstrated it on the way up but can you really do it on the way down in 2020? Unfortunately, we had a COVID-induced downturn where our top line fell 20% in one year. Despite that 20% decline in sales, we still met our operating margin target.

So, we -- I believe we have structurally changed our company. And over the last five years, since we introduced our new strategy, we have met our Investor Day targets for improved adjusted operating profit margin every year -- including a year when we had a 20% downturn. So we do believe we have the ability to perform better during the downturn.

Okay. So at the Analyst Day a few weeks ago, you gave a guidance that implied incremental margins like the 30% to 40% range. Do you think you're going to be able to capture enough pricing this year to get you back to -- back on track to hitting your targets as we go into 2023?

And the way we look at this is, we really don't talk about incremental margins quarter-to-quarter or year-to-year. Again, what we talk about is those adjusted operating profit margin targets, 300 to 600 basis points based on that reference period of 2010 to 2016. So what we believe we will meet those targets this year and we fully intend to meet them moving forward. Having said that, we also, again, we see that our total addressable market is increasing. We know we have to make increased investments in some products but we believe, based on everything we see, again our intent is to invest more. Our total addressable market is increasing, we'll maintain our margins, meet those margin targets which should -- which will increase -- should increase our free cash flow [indiscernible] to the top line.

So during the Analyst Day, you talked a lot about how CAT will operate in the energy transition. And so my question is more about what is the correct revenue growth algorithm? Because if you look back to the early 2000s to like the 2010s, Caterpillar grew at a kind of like high single-digit levels. It's a little bit more towards like mid-singles most recently. But as we embark on this transition, how should we think about your revenue growth potential going forward?

Yes. So I'll refrain from making an absolute top line prediction here that wouldn't be a wise thing to do. But I will talk about some of the dynamics that are driving what we believe again is this increase in our total addressable market. So we talked about the energy transition already, how the fact that we have our customers need to help the world produce more commodities as the world electrifies more minerals for EVs, again average auto EV takes 6x as many minerals as a conventional car. Think about all the other elements of the energy transition, what's going on with LNG infrastructure.

So we do believe there is a significant opportunity for our market to grow and we're certainly committed to continue to invest to ensure that we remain competitive through that. So I'm reluctant to give you a number. But again, regardless of exactly how the energy transition plays out, we believe we're in a very good position to benefit. If you look at the IEA sustainable scenario, the stated policy scenario, total energy demand is expected to grow 16% between now and 2040. Oil and -- oil has continued -- is expected to increase. Natural gas is expected to increase even more than that. And renewables are expected to more than double. So we can all have our own opinions as to exactly how that will play out. Will renewables even faster? Will they be a bit slower? Will natural gas be a bit lower than anticipated, will it be higher.

The good news is that regardless of how that plays out, Caterpillar is well positioned to benefit from those changes that will take place. Again, our mining business and our recip engines and gas turbines benefit from more renewables and more EVs. If, in fact, again, the increased interest in LNG drives more natural gas production and transmission -- we're very well positioned for that because we do play across a wide portion of that natural gas value chain. Our engines are used for natural gas drilling. And now we have the ability, as opposed to flaring, we have the ability to burn field gas and use batteries to reduce our oil and gas customers' carbon footprint. We have well service solution now that goes from the trailer to the wellhead because of the acquisitions we've made and the internal investments we've made as well and we're helping our customers, again, reduce their carbon footprint there as well.

Our solar gas turbines drive large natural gas compressors to compress gas on the pipeline. So again, we play across a wide portion of that value chain. Again, more renewables, that's good for us as well. So we feel we're very well positioned regardless of one's opinion as to exactly what the percentages that will be here and how quickly this will play out, we believe we're well positioned to benefit.

Actually, I should have mentioned this at the beginning. But if you have any questions, please feel free to log in the pigeonhole, ask your question and then I'll be more than happy to ask Jim. So just carrying on, so within resource industries, the energy transition is actually somewhat of a double-edged sword. So on one hand, you've got coal demand which will likely sunset. While mineral demand will probably increase driven by EVs as you pointed out. So, can you talk about how CAT plans to navigate this transition? And to what extent will it be like a net positive for CAT?

Yes. And some of that I have talked about, again, regardless of how the energy transition plays out, we're well positioned to benefit. Coal represents 3% to 5% or 3% to 6% of our total sales, 3% to 5% of our total sales. So it's relatively minor in the bigger scheme of things and again we're well positioned to benefit from increased electrification, renewables, all the things that have to be -- the minerals that have to be bind but also we're well positioned to help our oil and gas customers reduce their oil and gas footprint -- excuse me, their carbon footprint as they produce more oil and gas.

Okay. Okay. So as your mining customers decarbonize, how does this change the energy demand profile at the mine site? And then like to what extent does this transition expand your E&T business opportunity in mining? And maybe you can talk a little bit about like how CAT's products are differentiated to support that.

Yes. There's been a number of announcements by our major mining customers as to how we are working with them to help them meet their sustainability objectives. And so -- we are investing in new technologies. We're investing in batteries. We're investing in hydrogen. We're doing a whole variety of things to help our customers achieve those objectives. At the same time, we believe we're uniquely positioned among our mining equipment competitors because of our energy and transportation portfolio. We have, again, gas turbines, we have recip generator sets. We have distributed power capabilities when we're working with our customers to figure out how, as an example, for electrification, how the mine site gets electrified.

One of the things that I think a lot of people don't have a good sense of is, how different an electrified piece of construction or mining equipment is from, let's say, a car, an automobile. With a big mining truck you fill the tank with diesel fuel and that mining truck will run 24 hours a day before we have to fill it again. With a battery-powered machine, it will run about two hours. So one of the things that has to be put into our mining customer's planning process as they electrify their mine sites is figuring out how their mining trucks will get recharged. If it's hydrogen, how that will work. So it's quite complex.

And we do believe, again, because of our power management, our power distribution, the fact that we have micro grids, the fact that we have reciprocating engines, we have gas turbines that we are uniquely positioned to help our mining customers electrify their sites. Maybe just another word kind of about electrification, the other thing to think about is as we work with our customers and we are investing, we will have battery-powered machines, we already have a battery-powered underground loader that is being operated by a customer. So again, we're already starting to introduce these products. But stop and think about a hydraulic excavator that's in the middle of nowhere regardless of where it is, it's building a highway, there's no grid, there's no infrastructure, it's very isolated and it's got a battery in it. How does that work?

So when the battery goes dead at 2:00 in the afternoon, what is the solution? There's no grid. So do you fire up a diesel-power genset to fast charge it which probably reduces the whole -- it eliminates the benefit of having a battery-powered machine? Do you have an extra excavator? Do you try to change the batteries? What is it you do? So there's a lot of complication that goes into this. And I believe that the adoption of alternative drivetrains in construction and mine equipment will vary by application and it will vary by geography. So one can very readily see a situation, relatively quickly, within a decade, let's say in the island of Manhattan that for construction equipment, paving equipment that digs up the street, they will all be battery powered. That's easy to visualize and easy to understand technically how that would occur.

More challenging, again, to build that highway in the middle of nowhere, where there's nothing, there's no infrastructure. How does that work? So again, we'll have to, I believe, the -- and also what happens in Manhattan and what happens in the middle of a very remote place in Africa or Australia or even in the United States, I think it will vary. So again, we're committed to working with our customers to figure this out. We're investing in the technologies. But a lot of times, people will make a one-to-one analogy between automobiles and construction equipment. It is quite different and we'll have to work our way through that.

For the smaller machines, much easier and much easier to envision how it would work. For very large pieces of equipment that operate in remote locations, it will be more complicated.

So you spent some time talking about grid modernization at the Analyst Day. I was hoping you could maybe expand on that. How does good modernization expand your addressable market?

Yes. So as more renewables get added to the grid, it has created stability issues and more in some geographic areas than others. And we're already starting to see that play its way out. And if one looks at the aspirations by governments to add even more renewables, arguably that will increase the opportunity for us because we do build, again, as I mentioned earlier, we have reciprocating engine-powered generator sets and gas turbine power generator sets that can be installed in the grid to provide that grid stability. And those engines have the ability to burn a whole variety of fuels. They can burn natural gas, they can burn biofuels. We've demonstrated both in our gas turbines and our reciprocated engines, the ability to burn 100% hydrogen. So as this energy transition occurs, we have the ability to provide these generator sets, both gas turbines and recip engines that will help provide that grid stability.

So that's what we really see is when we talk about grid modernization and grid stability, that's what we really mean. We've had the ability to burn hydrogen in our gas turbines. We started in the '80s as an example. Maybe just one sustainability example there in China. We've sold a number of gas turbines that burn coke-oven gas. So traditionally, coke-oven gas is a natural byproduct of steelmaking. And traditionally, coke-oven gas was vented to the atmosphere and has a very detrimental greenhouse gas effect. So we were able to modify our gas turbines to burn that coke-oven gas to produce electricity.

So it has a double environmental benefit. It prevents the coke-oven gas from being vented into the atmosphere but it also negates the ability -- the need for that electricity to be generated in another way because we burn our gas turbine and produce electricity. So this is an example of one of the many sustainability examples that we have, given that energy and transportation portfolio and we're quite excited about the opportunities moving forward.

So just moving over to China. So with the lockdowns we're seeing in the country, how much visibility do you have into your large excavator market? And maybe you can just remind us about just like the revenue exposure that you have there?

So again, I mentioned that we expect China this year to be slightly less than 2019 levels. And again, 2020 and 2021 were extraordinarily strong. So we do believe we're well positioned in China. It's certainly still an important market to us but it is softening a bit and it's for a whole variety of reasons. It is not all just lockdown. It's I think part of it is the economic cycle. Part of it's how much equipment was bought over the last two years and there's kind of a natural flow there as to how that works. Now it remains to be seen, of course, much of what happens in China is driven by, of course, government policy. We see some stimulus coming. But again, we don't see -- our view currently is that, that market will be slightly below 2019 levels.

So at the Analyst Day, CAT talked about scaling its autonomous mining capabilities going from offering kind of like a 25 haul truck down to 12 haul trucks. By how much does this expand your market? And how does this improve like the range of applications that can use this sort of technology?

Thanks, Chad. Well, just maybe as a level set for everyone. And we've been on the autonomy journey for quite some time. We've been investing in this technology for more than 20 years and our autonomous mining trucks have driven 100 million miles, it is pretty incredible, much more than any car manufacturer by a long shot. And so one of the things that had limited the adoption of autonomous mining trucks in the past was the mine had to be a certain size for it to make sense. Just given the capital investment required and the infrastructure and the mine site to have that pencil-out. And so what we've been able to do in working with our customers and continuing to invest, we've been able to bring down from about 25 trucks to now we're saying 10 to 15 trucks. If a mine has 10 to 15 trucks, it can make sense to have an autonomous investment to have those products run autonomously. And we've had customers publicly say that they achieve a 30% productivity increase versus their best manned sites. You say, well, why is that?

Well, one of the things is that autonomous mining truck doesn't make a mistake. Autonomous mining truck, it never gets tired, it doesn't need a break, you don't have to fly someone to remote mine site, you don't have to put them up, you don't have to feed them. It's always repeatable. And one of the things we've also been able to do is take that autonomous technology and put it into other products at the mine site as well. So as an example, we have one of our large mining customers, the first autonomous water truck is operating. We have drills. We have dozers. And we have semiautonomous products as well. So a lot of that is starting to come in to other products across our portfolio, just an example of semiautonomous now and also remote control.

We have the ability now, we've demonstrated this, we're an operator. Chad, you could sit here in your chair in New York and control machines anywhere in the world and you have the ability to control autonomous dozers, you can control up to five dozers because they are in a semiautonomous mode in different parts in the world. Think of what a game changer that is for our customers is particularly today with the labor shortages that we have, the ability to have one operator operating in one place and remotely operating multiple machines. So we're very excited about this opportunity and what it's going to do to increase the productivity of our customers and how much more flexibility it gives them over time.

Okay. So just sticking with autonomy. The overarching question for me is just how does this have the potential to change the business model for CAT. So I'm thinking about just like the replacement demand cadence, parts intensity, service opportunity and is there anything else you would call out which could structurally change kind of how CAT goes to market?

Well, firstly, we believe we feel pretty strongly that we have the best mousetrap in the industry. We feel very good about our autonomous capabilities. And I believe that our customers are voting with their dollars just in terms of how many projects that we're capturing. An autonomy is not only for new trucks but it's also for retrofit as well. So we've gone into existing sites and put an autonomous capability as a retrofit. In terms of other things that go around that. Typically, when we sell an autonomous truck, there's a hardware element, there's a software element, there's a recurring license element. But one of the things that it really allows us to do is to work more closely with our customers. When we sell an autonomous solution, Caterpillar employees are typically at the mine site, working with the customer. And that allows us to become much more of a partner with our customers to make them successful.

So they have them embedded sitting there. And if we do our jobs right, we provide that incremental value. We make our customers more successful. That positions us very well for the next time a purchasing decision is made for new trucks. It positions us very well for service opportunities as well. Because our employees are there, again, helping our customers avoid unplanned downtime, being proactive about repairs that can help utilize our AI tools to help them as well. So again, a lot of opportunity here that we're quite excited about. It really truly is a game changer.

So, I'm actually going to take some questions from online. And just a reminder, if you'd like to have your question asked, please log on to pigeonhole and back it out [ph]. So are you seeing improvement stability or degradation in the supply chain? And what actions are you taking to reorient the supply chain to alleviate any of those challenges.

Yes, it's a very, very good and topical question. So we haven't seen a degradation nor have we seen an improvement in our supply chain situation. Semiconductors continue to be a challenge. With other components, we'll resolve one issue, then one will pop up some other place. So again, it hasn't gotten worse -- hasn't gotten materially worse, hasn't gotten materially better. Having said that, certainly, we're working to put more resilience in our supply chain, everything from dual sourcing to thinking about where we source. We're a global manufacturing company. So we manufacture in many different parts of the world. We're working to ensure that we have multiple sources in various places, hopefully close to where we build the end product. But again, I think this lesson over the last few years has taught us the importance of resiliency. Cost is still important but resiliency is there as well. Geopolitical tensions, just distance, port issues, issues with transportation. I think it's all led all manufacturing companies just step back and think about how they want to do this.

And certainly, this is not a situation where you flip a switch and it changes overnight. We've already started to make some changes but this will be something that will evolve for some time as we think about, again, resiliency as being a very important part of the equation.

So next question for you. So China -- as China slowly reopens, how do you expect the cadence of reopening to play out? And are you starting to see any evidence of this flowing through your results, such as your order book?

Yes. Again -- there's a lot of dynamics here. So again, when you think about our business, we just don't think about shutdowns. We also have to think about the market dynamics over the last few years and the fact that our demand was extraordinarily strong in 2020 and 2021. So again, what we see is that total industry 10-ton hydraulic excavators and above being slightly below 2019 levels. And, we still expect that to be the case. So again, not a change from where we see it as a result of what's happening with COVID.

Okay. And then can you talk about just CAT's approach to succession planning?

Sure. That's a loaded question. So the CAT's Board of Directors takes their succession planning responsibility very seriously, it is something the Board is continually focused on. The Board, again -- at every Board meeting has a conversation, both with the CEO and without the CEO. We look at talent within all levels of the organization. We believe that we have a strong bench strength of executives. We are working to continually enhance the capabilities and experience of those executives and looking one level down and two levels below that. So it isn't just for the next CEO succession but it's for the one after that and one after that, looking at talent in all levels of the organization. Obviously, a big focus on diversity as well as we work to advance our diversity objectives. But again, something the board is very focused on and it's a big part of their job.

So, can you talk about CAT's role in lowering carbon footprint of oil and gas extraction? And one thing I'm curious about -- the customers that you serve in that industry -- is it -- like would you characterize it more as a push or more as a pull?

Yes, it's really become a pull. It's transitioning from push to pull. Our oil and gas customers are very focused on reducing their carbon footprint because their customers are really focused on that issue as well. So it's flowing its way to the supply chain. And as I mentioned earlier, we've made a number of both organic investments in our capabilities as well as investments which has allowed us to help lower our customers' oil and gas carbon footprint. Many examples. I mean [indiscernible], one of our divisions has a methane abatement system which they can sell to customers. We have -- we've introduced what we call a DGB or dynamic gas blending engine which allows the customer to substitute up to 85% of their diesel fuel with natural gas and then convert it into field gas which reduces their carbon front print and also reduces the cost for that customer of diesel truck with that diesel fuel.

And in the Dynamic Gas Blending engine now, we've demonstrated to introduce of the 10% hydrogen which can further reduce our customers' carbon footprint. We bought a company called CarbonPoint Technologies which allows us to help our customers with capture and sequestration as well CO2. We have e-frac. So what many customers are starting to do is either using field gas to run a gas-powered reciprocation generator set or a gas-powered gas turbine and then they -- that drives an electric motor which drives a frac pump. And we, through the purchase of Weir SPM that we made a few years ago, it is a very good timing for that acquisition. That has given us an electric motor-driven pump which facilitates that electric drive solution. So we've done a whole variety of things to help reduce carbon -- customers' carbon footprint. And one of the things we've also done is we've developed control capabilities that allow our customers at well service sites to run much more efficiently.

It used to be that many operators would operate -- operate their engines. It's kind of like having a Ferrari and driving it to work in first gear. Now with the controls algorithms and the systems that we put in place, we help our customers run at the right speed which allows them to be more efficient which burns less fuel and puts less emissions into the year. So we've done a whole -- I could talk for an hour about because we have battery-powered solutions as well. So one of the things that we have with -- certain solutions we have in oil and gas is we'll combine, let's say, a gas-powered gen set with a battery solution as well that also helps reduce customers' carbon footprint because it -- it just gives them much more operational flexibility. So there's a whole variety of things that we're doing and I think we're just scratching the service. But clearly, we've seen this go from a push to a pull. There's a lot of interest by many of our customers in these technologies, we're very excited.

Very excited. So I want to ask you a little bit about your electrification strategy. And like most directly, how do you think about what you need to own versus outsourced? And why?

So as it is the case with all products, we look at each situation on an individual basis. And as is always the case with our traditional product line, there are certain things that we do ourselves. There are certain things that we use suppliers for. There are certain things that we use partners for and electrification will be no different than that. I doubt that we'll make the battery cells themselves. I think we'll take advantage of other scale and technical capability as chemistry changes there. But in terms of between the battery cells and a battery pack and a machine, we'll play in that -- at the right place in that value chain. And we're still working some of that out. But one of the things that Caterpillar has demonstrated the ability to do quite well is to be a good integrator. One of the reasons that makes -- that we're more competitive in a variety of our products is our ability to integrate across the system. So that's something we're very focused on.

So again, don't expect that we'll build those battery cells. But again, we'll be involved in the integration and the packaging of those cells. And we'll figure out exactly where we're going to play in that value chain and we're starting to do some things there but don't -- I don't want to release anything too soon here.

Sounds good. So just last question on the electrification theme. What's the road map? Maybe you can kind of like lay out in terms of like your product, role and expectations, how do you think about sequencing, what goes first? What comes a little bit later? What's the timing?

So -- well, we already -- as I mentioned earlier, we already have an electric underground loader that's operating in underground mining applications and that's -- that's a fantastic application for an electric drive machine. You just have to think about underground. If you have a diesel engine in a machine, then you have to worry about ventilation in the mine. If it's electric power, all those problems go away. So that product has already been introduced and is already in operation. And we're very pleased at that. We are working with our mining customers, again, because they have very ambitious objectives and we're committed to help them succeed. One of the orders that we received that's been in public is from a company called Nouveau Monde Graphite in Canada where their license to operate is based upon their ability to have an all-electric mine operating, I believe, the year is 2027, it's close to that, where they need to have an all-electric mine and there's hydropower in Canada. There's hydro power available in the area. So that really truly will be very renewable and they're making graphite that will go into EVs, right? So it's a fantastic application.

So again, we'll have mining equipment for them and for our other mining customers as well. We -- smaller equipment is, again, I think it will probably be -- there'll be more customer pull for that first but we have variety of products where we've identified, we'll have battery-powered machines and we have dates and we're driving towards those. So again, it will vary by -- it's a combination of kind of what makes sense from a technical perspective to do first but also customer pull. And so, when we see that customer pull. We are -- we will have the products ready when the customers need them. And I believe the adoption rate, again, of those various drivetrain technologies will vary by application and by geographic area. And in certain areas, I suspect -- we'll continue to sell diesel engines for quite some time, certain applications, certain geographic areas.

In certain geographic areas, one can see in, again an urban environment, place in Western Europe, certain places in the U.S., Australia, pretty quickly governments are going to regulate that all machines will probably be battery powered in the early stages. And again, we're working on hydrogen as well. My sense is that's a bit farther out, hydrogen a bit further out than batteries at least in the near term.

Okay. So just moving on to the service part of the conversation. So back in 2019, you guys announced a target, I believe it's $26 billion by 2026. And when we reconvene for the Analyst Day, it sounds like you're even more confident that you'd be able to reach those goals. So what gives you that confidence?

And again, if you can maybe like lay out some data points that support that prediction.

Certainly. And so when we establish that goal to double services between 2016 and 2026, we did say that it would not be linear, that it would not -- it would be a bit back-end loaded because we knew we needed to make investments to make that occur. What are some of those investments? Well, we've invested heavily in our digital capabilities. We hired a new leader of our digital team that came from outside of the industry and he brought in a whole new leadership team and we built that up. We made those investments.

There are other investments we've made as well. But to answer your question, what's given us increased confidence in our ability to meet that target is things like e-commerce, how we're increasing e-commerce and how much of that is increasing and the rate at which it's increasing and that's allowed us to increase part sales which is part of services. We've -- we're pleased with the adoption of what we call CVAs which are customer value agreements which are more long-term agreements. And so now 50% of everything we sell has a CVA attached to it and that helps services as well. The way where we've developed and we're starting to utilize AI to help our dealers and our customers be more successful. So preventing downtime, unplanned downtime, given our -- we have what's called prioritized service events which is really based on AI which gives our dealers a lead to contact a customer to sell a product or service before it's required to be proactive.

There's a whole variety of things that we're doing just based on the progress we're making and a variety of those elements gives us the increased confidence of our ability to make that services goal.

Okay. So I just want to spend some time on remanufacturing. And my question is just why is it such a big growth opportunity? And why does it not take away demand for new equipment?

So remanufacturing is very positive from a sustainability perspective because remanufacturing a part takes less power, less material than a new part but it also is at a lower cost point. And so we've proven this for many, many years in our gas turbine business where we've remanufactured components for gas turbines, where it is a great customer benefit to it because, again, it reduces -- it's a lower cost. So it reduces their cost of ownership, it reduces our cost as well. So it's a benefit for both of us.

I do believe that making our customers successful over the long term is the best thing for us. So again, we've demonstrated time and time again that by having to remanufacture products, it is a net positive, both for our customers and for us. We could say, well, we don't want to do it because we want to have just new parts. Again, remanufactured parts make us more competitive. They make our customers more successful. So it's a good thing for us. Increases our volume.

Got it. Okay. So I'm going to take one more question from online. So what is the constraint to pursuing all the opportunities in service, autonomous, et cetera. Is the dealer network equipped to deliver these?

So what are some of the constraints? Certainly, all of us are competing for digital talent in all of our -- I think that's the case in every industry. So certainly, ensuring that we have enough digital talent certainly is something we're very focused on. I do believe our dealers are very well equipped. They're great partners with us and they work with us. And one of the things that we've started to do as part of this services journey is we have -- we've identified a certain percentage of our dealers that represent a big part of the services opportunity. So we've sat down with them. We've identified what the service opportunity is we've identified what we both need to do, both the dealers and Caterpillar to achieve that opportunity. And then with a very rigorous governance process work to monitor how we're doing internally in terms of achieving our objectives to achieve that services goal and also what the dealers need to do and how they're doing as well. So we do believe that our dealers are equipped to capture this.

The good news is that our economic incentives are very much aligned, sometimes with manufacturers and distribution channels. The manufacturer wants to do something which may not be in the economic interest of their distribution chain and that can cause problems. That is not the case here. Our economic interest are very well aligned. If we sell -- we and our dealers sell more services, it's economically beneficial to them and it's economically beneficial to us. So, it really comes down to agreeing on the things that we need to do collectively to capture that opportunity and we're certainly doing things like investing heavily, as I mentioned earlier in our digital capabilities.

We're investing in AI, we're investing to connect assets, 1.2 million connected assets and we're asking our dealers to do certain things as well. But again, our economic interests are aligned. So I do believe that we'll make this happen.

So just shifting over to construction. There's obviously a pretty significant infrastructure cycle that's starting to ramp up. And so my question is, what sort of productivity-enhancing technology can CAT offer that wasn't present in any prior infrastructure cycle? And are you starting to see like any real uptake or incremental adoption here?

So maybe to answer the last part of your question first. So we are very pleased with the Infrastructure Bill passed. Our expectation is that, that will manifest itself into actual business for us, probably late this year, more likely in 2023. And one of the things it does for our customers is that they know -- if a construction customer is trying to make a decision as to whether or not they should buy a piece of equipment. Do I make that capital investment now? If they're confident there's a blend of work behind it, they're much more likely to go ahead and make that capital investment and buy that piece of equipment because they know it will be utilized for quite some time moving forward.

To answer the first part of your question, we talked earlier about autonomy and the way that we're -- again, in semiautonomous equipment as well. We're adopting technologies that kind of started in our mining space into construction as well. So we believe that, that will help our customers. We talked about remote control, line of sight. An operator no longer -- for many of our machines -- doesn't need to be in the machine. They can do it remotely, they can do it from a location that may be line of sight that's just safer or they can do it from a completely remote location where they're in a different place. And those technologies, to answer your question, didn't exist 10 years ago. So that's a way that we're helping our customers be more efficient.

And again, we believe that's something that gives us a competitive advantage as well and we're committed to continue to invest in technology to keep that competitive edge.

Okay. And sticking with infrastructure, what sort of opportunities do you see with the ability to automate roadbuilding?

Well, I believe that there will be opportunities there again. We talked about autonomous and semiautonomous. I suspect we talked at a trade show a while back about an autonomous soil compactor. So I think we will have that in the future. Again, we're working on a whole variety of things there. But it's an exciting time for the industry. It's changing pretty rapidly.

And then what share of your revenues do subscriptions represent today? And where do you think that could go in the next like 5 years, 10 years? And maybe you can lay out like what are some of the key drivers that elevate you there?

Yes. So we don't break out publicly disclosed subscription revenues. Again, it's all part of -- as we think about it, we put together a total package. And what are we trying to accomplish? We're trying to always add value to our customers. We want our dealers to be more successful and we want to profitably grow Caterpillar. So when we develop our offerings, regardless of how those offerings are structured, we keep that in mind. And we don't -- frankly, we don't disclose what those revenues are.

We are disclosing once a year as you know.

So as we enter the energy transition, like what gaps do you think could be filled through M&A?

We continually charge our leaders to look at M&A as opportunities to help us in a whole variety of ways. We talked about the Weir acquisition that we made, SPM acquisition we made when oil went negative, it was a good time to make that acquisition. That acquisition brought certain technologies like an electric-driven pump and it did some other things that we didn't have. We bought CarbonPoint Technology which is CO2 sequestration and capture. We bought a company called Marble Robotics which helps us -- helped us advance autonomy in construction equipment. So we're -- we've made a number of acquisitions like that, that brought us technology to help us move more quickly along both the autonomy journey, the sustainability journey and the services journey. And I suspect we'll continue to make those kinds of acquisitions.

I'm often asked, I was asked this morning in one of the breakouts, okay, what about large acquisitions. We have a very strong balance sheet and we have the capability of the make large acquisitions. We're not out elephant hunting. I'm not saying we won't do it. But again, that's not our primary focus. Our primary focus is on acquisitions that help us advance the three areas I mentioned: Services, sustainability and technology as well.

Okay. Maybe on the flip side, divestitures. Can you talk about how your strategy, how your approach has changed? And is there anything that we should be thinking about in the near-term horizon?

One of the things we did when we introduced our operating and execution model, our O&E model a few years ago is we get much more granular understanding by product by application, where we're creating shareholder value and where we're not. And is often -- Caterpillar is often the case, I think, with many large manufacturing companies, we had a division, let's say that had a dozen products. And that division was exceptionally profitable. We tended not to get involved in the details and to leave them alone and allow them to invest to keep going. But then when we really got into the granular detail. We often understood that, let's say, six or seven of those products are creating shareholder value and five were not and hadn't been for a long time and the ones that were creating value were more than offsetting the ones that weren't. So now we look by product by application. We've gotten very granular understanding where we're creating shareholder value and where we're not.

And those areas that aren't acceptably -- aren't providing an acceptable return on the capital they've invested, we've challenged the leaders to improve the profitability of those businesses. And in many cases, that has occurred. To answer your question and there are certain select cases, we've made a decision either based on market dynamics that you know what, if you look at the competitors in this space, no one does very well or in one case, I can think of our competitive position was such that we decided what we are better off investing our resources, our capital, our expense and our management time in areas that represent a better opportunity for future profitable growth.

So we have made some divestments. We got other specialty forestry products. We made some divestments in mining of some of the pieces that came with the Bucyrus acquisition. More recently, we've announced that we will only stay in the service and parts and of our big MaK engines that are built in Germany and we'll get out of the OE. So we continue to look at our portfolio. And again, I suspect surgically, we'll make changes over time. I don't anticipate anything major there but we'll continue to do that. So that is all part of what we do. And it really comes down to, again, investing our resources in those areas that represent the best opportunity and future profitable growth and that's why we're driving services; that's what we're driving sustainability.

And our measure for profitable growth internally is what we call OPAC which is operating profit after capital charge. So we charge our groups capital charge and then we expect them to produce a positive return after that capital charge. And what we drive is absolute OPAC dollar growth, again, operating profit after capital charge and we believe that, that absolute OPAC dollar growth aligns well with TSR over time. So that is our goal. So as we think about always the trade-off between margin percent and growth. Again, if we grow that absolute OPAC dollars, we believe that's very positive for our investors.

Okay. One more question for you online. To what extent do you hedge metals prices?

We do a certain amount of that. We do a certain amount of hedging in steel and other things. Again, those only last for a certain period of time and we're not immune from some of the changes that have happened. What we have said though publicly this year is that we do expect price to more than offset manufacturing costs, labor and material cost increases. So we said that for the total company for the year.

So I guess in our last 30 seconds, what's the 30-second elevator pitch for why to buy CAT today?

Well, again, I mean you just have to think about our creditability. We've met our margin targets each year for the last five years. In the last three years despite COVID, we've produced $14 billion of free cash flow. A lot of people wouldn't have thought possible. So as investors look increasingly to companies that return capital to shareholders through dividends or share repurchases or a dividend aristocrat, we've returned over the last three years, 101% of our free cash flow to shareholders. We've done what we said we're going to do and we believe our total addressable market is increasing. So we're very excited about the future. And in my 42 years with the company, I've never been more excited about our future as I am right now.

I think that's a good place to stop.

All right. Thanks for your time. Appreciate it.

End of Q&A