Cummins Has Rising Dividends And Some Torque In Its Future

Feb.21.12 | About: Cummins Inc. (CMI)

By Mark Bern, CPA, CFA

Cummins Inc. (NYSE:CMI) designs, builds and services diesel engines for the truck, bus, auto, industrial and electric power generation industries. The company services its customers through approximately 5,000 distributors in 160 countries worldwide and derived about 64% of revenue from outside the U.S. In other words, the company is well-positioned to take advantage of global growth no matter where it emerges. But right now one of the growth engines that is running on all cylinders is the North American market. Three press releases from Americas Commercial Transportation Research (ACT Research) provide some of my reasoning for being bullish on CMI for 2012.

The first (pdf) of the releases reported that December was the best order month in six years for Class 8 Heavy Duty Commercial Trucks at 30,293 units ordered continuing a strong trend that began in August 2011.

The second (pdf) of the releases reported that January orders were in line with expectations, continuing the strong trend.

The third (pdf) release reported that "Demand for heavy trucks and trailers is running stronger than demand for medium-duty vehicles because of strong freight markets and healthy trucker profitability."

According to the Cass Freight Index which tracks shipments and volumes in North America for all forms of transportation reported in its January Report that total shipments increased by 3.6% in January 2012 compared to January 2011 while total expenditures for freight increased by 22.1%. The Cass Truckload Linehaul Index January Report noted that, "Truckload linehaul rates leveled off a bit during January. Up just slightly from December, however, they hit their highest point since the 2005 date that our Index data begins."

I mention these reports from different sources in order to provide corroborating evidence of the strength of the trucking industry. All of that points to continued sales of new heavy-duty, commercial trucks that use Cummins engines. This is a very cyclical industry that does best when in the middle stages and late stages of an economic recovery. From what I can determine, we are still in the middle stages and should have another couple of years to go, as long as Europe doesn't spoil our fun (I know, that's a big "if").

I do believe that there will be a recession in Europe and that it will slow the growth in emerging markets. I just don't know how deep the recession will be, or if it will create significant collateral damage to the U.S. market. So, I am proceeding on the basis that we will continue to muddle through with below-normal levels of recovery, but sustained none the less. Obviously, the industry dipped in 2009 and the recovery didn't get fully underway until early in 2011. From that perspective, then, I sense that the recovery is still at the beginning of the middle stage for this industry. Even though 2010 say improvement over 2009, the industry trend was still not consistently upward.

That being the case, I like what I see in the CMI numbers. I am starting a new report card system that measures basically the same ratios for each company that I review. The report card is based primarily on the measures I used in the original article in my series on "My Long-Term, Enhanced Income-Investing Strategy." Let's take a look at the report card for CMI.



Industry Ave.


Ave. Annual 5-Yr Earnings Growth




Net Profit Margin




Debt to Total Capital




Return on Capital




Dividend Yield








Click to enlarge

One other measure I like to see in dividend-paying stocks is at least five consecutive years of dividend increases with an average annual increase of 5% or more. CMI has increased its annual dividend for eight consecutive years by an average of 32% per year. That gets a pass from me as well. With a strong industry trend to support continued growth I believe CMI presents a good investment for at least the next two years. At the current price (as of the close of markets on February 17, 2012) of $122.07 and a trailing 12-month P/E of 12.78 the stock still looks appealing. But the price has appreciated 53% since early October 2011 and looks like it needs a break along with the rest of the market.

I recommend being patient and setting a buy target of $107. That represents a 12% discount from today's price and, in my opinion, a good entry point for an investor with a 2-year or more time horizon. The stock is fairly volatile with a beta of 1.45 so it may be possible to get it below $100 if the S&P 500 corrects by 10% or more. I don't know if we will see that much of a pull back before spring, but there is also a possibility of a summer correction being stronger again this year similar to what we experienced in 2011. Either way, I think investors will be in good shape by year end.

Another way to approach a planned purchase of this stock for those who don't want their money sitting around collecting dust earning next to nothing, is to sell cash secured put contract(s) (1 contract for each 100 shares you intend to purchase). My favorite at this time is to sell/write the June expiration (June 15, 2012) put with a strike price of $110 and paying a premium of $5.40 (bid) and $5.60 (ask). Assuming an investor gets filled at the bid premium of $5.40, he/she would collect $540 per contract up front to give another investor the right to sell us the stock at $110 (strike price) between now and June 15. Our cost basis for tax purposes, should we be put the stock would be $104.60 ($110 - $5.40) providing a discount of 14.3% from the current price.

If the stock doesn't get down that low or stay there through the June expiration, we could allow the option to expire worthless, keeping the $540 (less commission) for a return of about 4.8%, depending on your commission schedule and how many contracts you sell (it could be more if you pay less than $9 on the first contract or sell multiple contracts). That's not a bad return on your cash while you wait for all of four months, and works out to about 14.4% on an annual basis.

One last thing that I must stress to readers is that when you sell a put you should never do so on a stock unless you really want to own the stock. It might happen. So, only sell puts on stocks that you really want to own. With that, I bid you farewell and a prosperous investing future.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.