The rising manufacturing index of The Institute of Supply Management, an increasing farm income and demand for logistics and supply chain are strengthening the claim of economic recovery. However, the slow economic growth forecast for China and most of the developing East Asian countries is a big concern for the companies operating in the diversified machinery industry. Cummins Inc. (CMI) is among the well-known companies operating in the diversified machinery industry. I am aiming to study the impact of macroeconomic as well as microeconomic factors on the performance of the company. Moreover, I have conducted a detailed analysis of operating segments of the company and tried to figure out any investment opportunity by analyzing the growth prospects of the company.
Engines paving way
As shown in the following pie chart, the company has five segments that are Engine, Components, Power Generation, Distribution and Intersegment Eliminations.
Source: Company's financials
The Engine segment is further subdivided into three markets:
- Heavy-Duty Truck Market
- Medium-Duty Truck & Bus Market
- Light-Duty Auto & RV Market
Cummins recently announced its third quarter results. The Engine segment is making the largest contribution in the total revenues of the company. Cummins generated 58.42% of the total revenue from its Engine segment. Sales of this segment declined by 1.38% in the third quarter of the fiscal year 2013 relative to the same period last year. Decline in the sales of Engine segment was primarily attributable to a reduced demand in the on-highway light-duty automotive and medium-duty bus.
Medium-duty truck is expected to see a decent growth, in the near term, in North America. However, the company is expected to face a challenge in the Engine segment globally. The demand for engines utilized for mining application is expected to deteriorate globally over the short run. Therefore, the lower sales volume of Engine segment will eventually have a negative impact on the earnings of the company over the short term.
However, the company is on its way to introduce a wide range of on-highway and off-highway heavy-duty engines that are in accordance with the latest emissions requirements. Thus, I believe that the improved technology will help Cummins to post decent results over long term.
A peek at other segments
- Component segment contributed 25% of the total sales in the most recent quarter of the fiscal year 2013. Quarterly sales for this segment increased 14.29% YoY. The short-term outlook of Component segment improved as the company's market share increased in North America. Therefore, I believe this segment will have a positive impact on the earnings of the company.
- Distribution segment contributed 22.13% of total revenues in the third quarter of the fiscal year 2013. Sales of this segment grew at a CAGR of 26.17% over the last three years. I believe that this segment is more stable than the others as it is less cyclical relative to the other segments of the company. I believe this segment will be a key to Cummins' positive growth prospects in the future.
- Power generation segment produced about 17% of the total revenues. Sales of this segment decreased 12.53% YoY in the 3Q13. The short-term outlook of this segment is a bit shaky as the company is expecting a weak demand for its power generation segment in the international markets. Therefore, I believe that the company will see a further decline in the revenues of this segment in the near term.
Although the company does not have a direct exposure to the European sovereign debt, the company generated 8% of the total sales from Euro zone countries in the first 9 months of FY13. However, due to an economic uncertainty, the company is expected to witness a sluggish demand in the European market. Therefore, I believe it is highly unlikely that the company will be able to produce high sales from European market.
Toyota Motor Corporation (TM) and Nissan are already relying on Cummins' ability to manufacture engines for their Tundra and Titan models, respectively. Similarly, Navistar International Corporation (NAV) is also considering the installation of Cummins' engines in their medium duty trucks and buses. Navistar plans to add the Cummins 6.7 liter engine to its international Dura Star medium-duty trucks and CE series school buses. The production is scheduled to start at the end of this year or by the start of next year. Therefore, I believe that Cummins will be able to post decent margins over the future owing to its recent accord with Navistar.
Cummins holds a large market share in the U.S. and Canada due to a wide range of engines installed in Navistar's vehicles. The addition of newer engines will help Cummins in improving its revenue that will eventually boost the earnings over the long run.
The short-term outlook of the Engine and Power Generation segments is not quite promising. I believe that the company will not be able to produce a decent revenue stream from these two segments in the near future given a weak demand for its products. As the Engine segment contributes more than 50% of the total revenue, I believe that the total revenues of the company will decline in the near term owing to waning demand for Engine for the mining applications.
However, the infrastructure needs in emerging markets and the tightening emission standards will help the company to boost its sales of Engine segments in the long term.
However, Components and Distribution segments will somewhat help the company in reducing the impact of lower sales volume of engines for the mining applications and the power generation segments.
Although, the short-term outlook of the company is not promising, I believe that the company will be able to boost its earnings over the long term.