Domestic Market Strength And Strategic Moves Should Help Cummins Get Better

Sep. 4.14 | About: Cummins Inc. (CMI)

Summary

Positive trends in the trucking market in the U.S. and Canada will drive Cummins' performance.

Cummins' new product introductions and increasing distributor base are catalysts to consider.

Cummins is facing headwinds in international markets such as China, but it expects improvements going forward.

Cummins is trading at a cheap valuation when compared to the industry average.

Cummins (NYSE:CMI) reported robust numbers for the second quarter, thanks to strong demand from the domestic market. Its performance was driven by traction in the U.S. and Canada, which reported growth on a year-over-year basis. However, the same cannot be said about the international market, with Cummins seeing sluggishness in Mexico and Brazil. But, Cummins' overall performance was on the positive side.

Its revenue during the quarter increased to $4.84 billion from $4.53 billion last year, and was in line with analysts' expectations of $4.83 billion. Its net income rose 7.7% year over year to $446 million, resulting in EPS of $2.43 per share. In comparison, analysts were expecting earnings of $2.38 per share. Going forward, Cummins increased its outlook for the full year. It now expects its full year revenue to be in the range of $18.7 billion to $19.2 billion, an increase of 8%-11% for the year from the earlier expectation of 6%-10% growth.

Strong demand will drive results

Considering strong demand from the U.S. and Canada for Cummins' products, which include engines and other vehicle components, an upbeat outlook is not surprising. Truck demand in both nations is strong as the economy is improving. According to a NTEA report:

"If the upward trend that began back in 2009 continues at pace, average monthly sales should be about 33,000 by the fourth quarter of 2014. That's 3,000 units more moving through upfitters each month than the fourth quarter of 2013. Given current capacity, and the number of upfitters, the increase will probably not require new capital expenditures for structures or equipment beyond what depreciates to zero in 2014."

As a result, it is not surprising to see that Cummins' engine and component business is gaining good traction. For instance, in the previous quarter, the component business turned in an outstanding performance with 15% growth in revenue year over year, along with a 230 basis point improvement in its margins.

New products and distributor acquisitions are more catalysts

Looking ahead, the company is looking to launch new products in order to continue benefiting from increased trucking demand. Moreover, the products that it has launched are already performing well. But, a point of concern are the higher warranty costs because of the complexities in its engines. However, management is confident of reducing this in the coming months, which will strengthen its margins further.

For instance, last year, Cummins launched a new engine platform, known as the G Series, for manufacturers across the globe. According to Equipment World:

"The new G Series platform is an in-line six cylinder engine, and will be available in 10.5- and 11.8-liter displacements. The engines were designed here in the U.S., but will be sold in markets around the world. The first on-highway engines will be the ISG11 and ISG12 will be available in 2014 and will offer a power range from 290 horsepower to 512 hp.

Cummins says the engines have an "adaptive architecture" allowing the company to specifically target markets and regions with an engine that meets their "unique performance and cost-of-ownership expectations." In order to increase the power-to-weight ratio, a key design element was making the platform as light as possible through use of a sculptured block and an oil pan made of a composite material. In the end, the engine weighs just 1,900 pounds."

Driven by such product innovations, Cummins should be able to sustain its momentum going forward. In addition, Cummins' distribution business is also doing well, mainly driven by its acquisitions in North America. The company has acquired three firms so far in 2014, and expects to complete four more by the end of the year. These new distributors have been smoothly incorporated into Cummins' structure, and consequently, it anticipates its financial performance to improve in the coming months.

A look at the challenges

However, Cummins also has to face certain challenges in some of the international markets, such as India, Mexico, and Brazil, where it is experiencing a slowdown. Management has scaled back its revenue forecast for Brazil on the backdrop of plunging demand for commercial trucks in the region. Even in China, which was a strong market for Cummins last quarter with 10% rise in sales, it does not seem to be optimistic. In fact, Cummins reduced its yearly sales growth forecast in China to 10% from 15% earlier.

During the previous quarter, industry-wide truck sales in China declined 10% due to deteriorating end markets. In addition, weakness in infrastructure will lead to a drop of 14% in sales of construction excavators this year. According to Chairman and CEO Tom Linebarger, "Demand in the construction market has softened from already weak levels. The pace of investment in infrastructure has not rebounded in China."

But, even in the midst of this sluggishness, Cummins is optimistic about the light duty market in China even as emission regulators tighten their hold on the market. It is looking forward to grow its partnership with Foton, a commercial vehicle manufacturer in China. Together, both companies have already launched new products, such as the Foton Daimler Auman GTL "Super Power" truck, which is powered by Cummins' ISG engine. Moreover, with the transition to NS4 (National Standard 4 Products) in the heavy and medium duty market, Cummins is optimistic of generating better results.

Conclusion

Although Cummins is facing headwinds in the international market, but its domestic performance has helped it overcome the challenges. Moreover, driven by its partnership in China, new product introductions, and an increase in the number of distributors, Cummins should get better.

In addition, Cummins is cheap. Currently, it has a trailing P/E of 17.57, which is lower than the industry P/E of 21.22. Its forward P/E of 13.17 is even more promising as it signifies earnings growth. Moreover, management has authorized a buyback of shares worth $1 billion that will benefit shareholders going forward, while a dividend yield of 2.20% is another attraction. Therefore, in light of all the above facts, investors can consider adding Cummins to their portfolio.

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.