Cummins (CMI) is one of the world's largest producers of diesel and natural gas engines for vehicles. The company was established in 1919 and has strong relationships with top truck manufacturers like Volvo, Ford (F) etc. The company generated over $18 billion in revenues in 2011 and serves customers in over 190 countries. CMI is divided into four segments: Engines, Power Generation, Components and Distribution. Over 50% of its revenues comes from the Engines segment while the other segments contribute more or less equally to the rest 50%. Cummins sells its engines to the transportation, mining, marine, oil and gas as well as the agricultural sectors.
The company reduced its revenue guidance in the last quarter, due to economic slowdown in key markets like India, China and the US. Despite this warning, the stock has run up by 30% in the last three months. We think that at ~$112, the stock seems fully priced in for now and cannot go up much further in the short term.
- Natural Gas Engines- Cummins has a joint venture with the biggest manufacturer of NG engines for trucks. The Westport (WPRT) - Cummins JV is developing a new generation of natural gas engines for the truck market. The first models will be introduced in the market in 2013. NG has got a 40% cost advantage over diesel. Clean Energy Fuels (CLNE) has already completed a significant part of its LNG fuel stations network. This will provide a ready-made NG infrastructure for the natural gas engine trucks powered by Cummins-Westport engines. Cummins has an option to buyout Westport in this JV in the future.
- Buybacks and Dividends - One of the biggest reasons to buy big companies with global franchises, is because of the large and stable cash flows that they generate. Cummins has announced a new $1 billion buyback program in December 2012, after finishing their previous $1 billion buyback program in 22 months. This is on top of the 1.6% dividend yield that the company yields. We don't think that Cummins is an attractive company from the yield perspective, as there are many companies that give a much higher yield with equally stable and growing businesses. However, investors should note that Cummins has been growing their dividends at a rapid pace over the last 6 years, increasing their dividends almost fourfold from 33c in 2006, to 133c in 2011. The problem is that Cummins does not grow its dividends regularly. Being exposed to cyclical industries, the company was forced to halt dividend increases in some years (e.g.. 2000, 2005).
- Exposure to BRIC Markets - Cummins has a solid presence in emerging markets and generates almost 20% of its revenues in China. The company has a wide distribution in China and partnerships with leading Chinese companies.
- Low Debt - The company's debt received an upgrade from Fitch ratings in October 2012, due to the company's low leverage and strong operating profile with stable cash flows. Cummins has got just $800 million in total debt, compared to total cash of ~$1.3 billion. The company's total cash and debt has remained more or less at the same level in the past 5 years.
- Growing Margins - The company's gross margins have increased steadily over the last decade, from ~18% in 2002 to ~25% in 2011. Its operating and net margins have also increased at the same rate, as the company has managed to cut costs almost every year.
a) Global Economic Slowdown - Cummins has been negatively affected by the global economic slowdown, with annual revenues falling by almost 5% in 2012, to $17 billion. Other companies like Caterpillar (CAT) have also lowered their revenue guidance. The company faces declining sales from the key mining and oil/gas sectors which have slowed down considerably. Key markets like India and China are showing declining sales as well. In China, the company's total revenues declined by 26% year-over-year in the third quarter. Production at its key Tata-Cummins JV in India, also showed a decline of 33% in 3Q12. The company announced 1500 job cuts in order to reduce costs.
b) Valuation - CMI valuation is more or less in line with the industry average, which supports our view that the stock does not have a lot of upside. The P/B and P/S for the company is 3.3x and 1.2x, compared to the industry average at 2.6x and 1.6x respectively. The forward P/E at 10.4x, also fairly values the company's growth prospects in our view.
c) Stock Performance - The stock is currently trading at $112, which is just 15% below its all time peak of ~$128. Cummins has heavily outperformed the rest of the industrial goods sector in the last 5 years, giving a return of ~126%. Even in the last one year, the company has returned ~15% compared to the 7% decline in the CAT stock. We think the stock is not discounting the risks to the global economy.
Cummins is a well managed company with a long history and has a leading market share in the engines business. However, the company is suffering from the global economic slowdown leading to a decline in overall revenues. The company also does not have a sufficiently high dividend yield to attract dividend and value investors. The company is trading at just 15% below its 52 week high and we think that it cannot rise much in the near future. After a 30% rally from its October lows, we think that Cummins is not discounting the risks of a global slowdown.