Investors were not impressed with engine maker Cummins' (NYSE:CMI) second-quarter results. Even though the company reported robust growth in both top and bottom lines, and also raised its revenue forecast for the full year, the fact that it didn't raise the earnings guidance didn't go down well with investors. As a result, Cummins shares traded lower after the results were released.
But, the positive side is that investors can consider this an as opportunity to buy more shares of Cummins on the drop, as the company has decent long-term prospects. It is on track to benefit from increasing auto sales and its partnership with Westport Innovations (NASDAQ:WPRT) to tap the natural gas vehicle market.
Growth across the board
Cummins is seeing broad-based strength across its business. As far as margins are concerned, the company seems to be delivering strongly on this count as well. For example, in the components business, Cummins delivered record revenue and EBIT growth. Revenue increased 15% year-over-year, while EBIT percent improved by 230 basis points to 14.5%. Higher volumes, lower warranty costs, and stronger cost controls led to an improvement in the EBIT margin, and the trend is expected to continue.
In fact, Cummins expects EBIT in the components business to increase 25 basis points to the range of 13% to 14% this year. Components is the second-largest and the second-fastest growing segment of Cummins, so a positive forecast in this business indicates better times going ahead.
Factors driving growth
Moreover, Cummins new products are performing well, and product failure rates have dropped to very low levels. As a result, warranty costs per engine on EPA 2013 engines are much below the cost of EPA 2010 engines. Looking ahead, the company is confident about reducing these costs further in 2015.
Cummins' engine business, its largest segment, is also delivering robust operational performance, particularly due to strength in its manufacturing operations. Gross margins in this business, before product coverage costs, stayed strong despite weakness in certain end markets. Moreover, Cummins has completed three acquisitions in North America so far this year, and expects to complete four more by the end of the year. These acquisitions will further increase Cummins' footprint in engines, and allow it to tap solid demand in on-highway markets.
In fact, shipments to the North American heavy-duty truck market increased 11% from the second quarter of 2013, exceeding 23,000 units. In the medium-duty truck market segment, Cummins delivered approximately 20,000 engines in the second quarter, an increase of 28% as compared to a year ago. Clearly, Cummins is seeing great traction in the engine business, and there are more improvement in the cards due to the expected growth in the trucking segment.
Also, Cummins' National Standard 4 product is doing well. Demand has been robust as compared to last year, owing to end users buying ahead of the new NS4 emission regulations. The transition to NS4 products is expected to continue in 2015 as well, and about 50% to 60% of industry production of heavy and medium-duty trucks in the fourth quarter of this year is expected to be NS4 compliant, above the previous estimates.
End-market prospects are strong
According to Alix Partners, the heavy-duty truck market is expected to grow at a CAGR of 5.4% through 2016. In fact, emerging markets such as China and India might clock growth rates of up to 7.2%. As such, Cummins should see a sustained strength in sales of its engines going forward. In addition, the company's tie-up with Westport Innovations could be another driver, allowing it to tap the natural gas trucking market.
According to Navigant Research, the total number of natural gas vehicles across the globe will hit nearly 1.9 million trucks and 1.8 million buses by 2022. Cummins is in a joint venture with Westport, and the two have developed a cutting-edge engine. As mentioned in my previous article:
"Westport's joint venture with Cummins is another important catalyst to note. Recently, the two companies announced a 12-liter natural gas engine with a power output of 400 horsepower and 1450 ft-lb of torque."
Hence, Cummins should see solid growth in its engine segment going forward, driven by innovation and the expansion of the end market.
All in all, Cummins seems well-positioned for growth going forward. The company is sitting on a lot of opportunity due to secular growth in the market.
At the same time, investors should also take a look at Cummins' valuation. Its trailing P/E is 17.60 and forward P/E is 13.18. Also, it is better than the industry's P/E average of 22. Finally, Cummins' prospects should lead to strong bottom line growth, and analysts expect the same. Its earnings are expected to grow at an impressive CAGR of 14.07% for the next 5 years, marginally above the industry's average of 13.70%. Hence, investors should definitely consider Cummins for their portfolio as the stock can deliver solid upside in the long run.
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.