Cummins - Time To Take Profits After A Solid Run And Shareholder Payday

Jul.14.14 | About: Cummins Inc. (CMI)


Cummins reshuffles management and increases payouts to investors.

Despite the good news, shares lost some ground over the past week due to Goldman turning more cautious.

I don't see a compelling risk-return opportunity here, with Cummins trading at similar multiples to the wider market, despite being a cyclical player.

Cummins (NYSE:CMI) announced a payday for investors after the company announced a sizable share buyback and dividend hike. Still investors lost a bit of ground after analysts at Goldman Sachs turned more cautious on the prospects for the stock.

I share Goldman's more reserved stance amidst a valuation for this cyclical player which is equivalent to that of the wider market. This is despite increased payouts and a solid financial footing.

Goldman Sachs Believes Cummins Is No Longer A Conviction Buy

Analyst Jerry Revich has removed Cummins from the conviction buy list, yet he leaves shares rated as a "regular" buy. The share price target of $175 remains unchanged and represents about 15% potential upside from Friday's closing levels.

Revich has previously placed Cummins on his conviction buy list on the hope of a $2 billion new product cycle and structurally improved returns.

Revich now believes that the market has priced in the share gains in the high margin US truck and emissions components market. This is as the company still has to deliver on share gains in the Chinese truck business and on new content within European Trucks.

The bearish call came one day after Cummins reported certain leadership changes as well as increased its payouts to investors.

Cummins Expands Leadership And Increases Shareholder Payout

Last week, Cummins announced that it has expanded its leadership team in order to drive growth. Part of these changes result from the greater global presence and an increase in complexity of the industry.

Rich Freeland has been named the COO of the business after previously leading the engine business. Dave Crompton will succeed Freeland to run the engine business.

At the same time, Cummins hiked its quarterly dividend by 24.8% to $0.78 per share which provides investors with an annual dividend yield of 2.0%. The board of the company furthermore authorized a new one billion share repurchase program, following completion of its past repurchase program.

Valuing The Business

At the end of April, Cummins opened the books for its first quarter of this year. The company ended the quarter with $2.3 billion in cash, cash equivalents and short-term investments. Cummins has about $1.7 billion in debt outstanding, resulting in a comfortable net cash position of about $600 million.

On a trailing basis, Cummins has now posted sales of $17.8 billion on which it net earned a little over $1.5 billion. Trading around $152 per share, Cummins is valued at $28 billion which values operating assets at a little less given the modest net cash holdings.

This values operating assets at 1.5 times sales and roughly 18 times earnings.

Look At The Past, What Does The Future Hold?

Over the past decade, Cummins has roughly doubled its annual revenues from $8.5 billion in 2014 to nearly $18 billion at the moment. Note that sales have been stagnant between 2011 and 2013, yet real growth is anticipated this year.

More important are the structural gains in margins which resulted in very impressive net profit margins, coming in at a healthy 8%. Note that the total share base has been roughly flat over time despite recent share repurchases.

For 2014, Cummins sees 6-10% sales growth and EBIT of 12.75-13.25%. This followed a very strong first quarter in which sales jumped by 12%, accompanied by margin gains.

Following the outlook, Cummins sees full year sales of around $18.5 billion on which operating earnings are forecast around $2.4 billion. Given the capital structure and tax situation, this should result in net earnings of about $1.6 billion.

Growth is driven by the engine, components business, and distribution business in particular. Power generation sales are seen roughly flat, holding back anticipated full year revenue growth. While there is quite some diversification in the business operations, Cummins still generates half of its revenues from engines. The company furthermore still relies on the US and Canada for the slight majority of sales.

Final Takeaway

While Cummins operates in a rather cyclical industry, the increased globalization and diversification across business lines creates a little less volatility in its results. This is of course aided by the solid financial position of the firm which results in fewer worries during harsh times.

Shares did display a lot of volatility surrounding the economic recession with shares falling from levels around $70 before the recession to lows of $20 per share within the time period of a year. Shares quickly rose to a high of $100 by the end of 2010 and have steadily moved upwards to highs of $160 earlier this year.

This makes it that shares are not trading at very appealing levels at 18 times earnings, despite the lack of strong revenue growth in recent times. While the company is showing growth for 2014, the company remains inherently cyclical. As such, I find little appeal as shares trade at a multiple which is equivalent to the general market. This is as the company remains cyclical, while the financial position remains very strong.

Following a 30% run-up over the past year, I understand Goldman's cautiousness. I fail to see drivers creating further appeal which would improve the risk-return thesis at the moment. The market multiple and cyclical nature make it easy for me to pass on this one.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.