For the long-term minded investor, the market's short-term minded reaction to two existing conditions affecting Cummins (CMI) has created an exciting opportunity. First, a slew of new emissions standards in the US are causing would-be customers to adopt a wait-and-see approach before purchasing machinery that might later prove unnecessary. Second, is a global slowdown from the mining, and the oil and gas sectors.
In case you're not familiar with the company, Cummins has four main business units. The engine segment produces engines and parts for busses and trucks of all sizes. Visit any construction site, mine, farm, railyard, shipyard, or military base and you'll probably find an engine from Cummins. The Company's components segment sells filtration products, aftertreatment systems, turbochargers and fuel systems. The power generation segment sells just about anything that spins around and makes a loud noise to produce electricity. Finally, the distribution segment has boots on the ground to distribute, service, and repair all of the above.
Long-term opportunities for growth
A tightening of emissions standards are playing right into this company's hands. Cummins has a wide portfolio of high-tech, low-emissions engines for light to heavy-duty applications. Also should the long awaited shift from diesel to natural gas materialize in North America's trucking industry, Cummins is well positioned to capture that potentially enormous market.
Its joint venture with Westport Innovations (WPRT) is producing medium to heavy-duty engines that are already popular, and capable of running on liquefied natural gas [LNG]. These engines are identical to the diesel versions with the exception of Westport's High Pressure Direct Injection (HPDI) technology -- which is also sparkless -- and LNG tank mounts.
Rising demand for Cummins-Westport engines is now more of a "when" than an "if." Clean Energy Fuels (CLNE) has already completed construction of over 70 LNG filling stations along the interstate routes of many long haul truckers. Although I have nagging doubts about Westport's execution, Cummins is certainly capable of profiting from the impending surge of natural gas as a transportation fuel.
Fellow contributor Robert Rhodes has written up extensive studies concerning the future of natural gas as a transportation fuel in North America, particularly as it relates to both Clean Energy and Westport. If you have any interest in the topic, I strongly recommend his exhaustive analysis.
Using company guidance to conservatively estimate 2013 EPS
Cummins posted first quarter revenues of $3.9 billion. Based on the company's full year guidance, Cummins expects revenues to be flat to down 5% and EBIT to be in the range of 13% to 14% of sales. At the low end, annualized revenues minus 5% is $14.82 billion. 13% of sales brings us to pre-tax earnings of $1.927 billion. Item 5 in the the footnotes of the company's Q1 2013 10-Q filing states, "Our effective tax rate for the year is expected to approximate 29.5 percent, excluding any one-time items that may arise." This brings us to a net income of $1.389 billion.
The Cummins Board of Directors approved a share repurchase plan of $1 billion in February 2011. Of that plan, $226 million remained at the end of Q1 2013. An additional $1 billion in share repurchases has also been approved upon the completion of the 2011 plan. I'm going to assume that the average number of shares to compute diluted EPS for 2013 will be 188 million, down from 189.67 million in 2012. That brings us to a conservative EPS estimate of $7.39 for 2013. At the recent price of $110, that's a forward PE of about 14.89.
Any way you slice it, Cummins is experiencing tremendous growth
Using existing EPS figures from years 2003 and 2012 the compound annual growth rate -- CAGR -- is 39.20%. Sometimes even annualized data and long term time frames give skewed results. Using my conservative 2013 EPS estimate of $7.39 and the 2004 EPS figure of $1.848 I arrived at an impressive EPS CAGR of 14.87%, which is still exciting.
Assuming that dividends remain at $0.50 per quarter throughout 2013, during the 2004-2013 period distributions rose a CAGR of 20.89%.
Although growth at Cummins isn't as consistent as an earnings stalwart like General Mills, (GIS) its past decade hasn't been overly erratic either. The company's balance sheet is as solid as the engines it produces. Cummins is unlikely to require debt or share dilution to weather a prolonged slowdown.
Projecting the 2004-2013 period forward another decade, results in a 2023 EPS of $29.55. At a market average PE of 16.5 that's a price of about $487.61 per share. Assuming accumulated dividend distributions of $65.59 are neither taxed or reinvested, you can reasonably expect a future value of $553.19 per share in 2023. This estimate is fairly conservative and assumes that competition doesn't eat away at the company's margins.
Cummins's competitors are also feeling the pressure of slow recoveries and commodity price weakness. In the first quarter of 2013, Volvo's North American retail market for heavy-duty trucks decreased 14%, and industrial operations are also down 26% compared to the first quarter of 2012. Also in the first quarter of 2013, Caterpillar's (CAT) construction, resource, and power segments all suffered year on year declines of 17%, 23%, and 12% respectively.
Although the opportunity for significant long-term gains exists at the company's recent share price of about $110, I'm reasonably confident that upon reporting second quarter earnings the market might price the company even lower. Since my personal portfolio is almost fully extended, I'm going to wait for a perfect pitch, which is why you won't see me holding shares of Cummins in the disclosure statement.