Cummins: Down 2015, Down 2016, But Still A Buy

| About: Cummins Inc. (CMI)

Summary

Cummins had a down 2015 as the overall global market deteriorated.

They are forecasting a lower 2016 as well but are taking steps to mitigate these issues.

There is plenty to look forward to still, including the great yield that management remains committed to grow in 2016.

I still remain bullish on the company and will add to my position once the market digests the earnings and the stock pulls back slightly.

Cummins (NYSE:CMI) released their final quarterly earnings for the year and the numbers for their entire 2015 and they weren't that bad all things considered. The entire industrial sector is battening down their hatches to weather the rough economic seas across the globe and Cummins is no different. Taking a look at how Cummins performed in 2015 we can start to see how healthy the business really is, and how undervalued they are right now.

Cummins brought in $19.1B in sales this year which was a slight drop from the 2014 figure of $19.2B, not bad considering the drop off in HD truck sales that were very good for 2014. The company earned $8.93 per share for a drop of $.20 compared to the previous year. Their aggressive buybacks helped to offset the drop in EPS and will continue into this year as management feels these prices present a great value overall. The BOD increased the dividend by 25% as well and they paid $3.51 for the year which is just below 40% of the EPS. The management has done a great job in the tough year to remain efficient and turned in a 19% return on equity, down just 1% from 2014. All things considered I'm inclined to consider this a good year in light of the challenges and headwinds.

The engine segment is Cummins' largest by a large margin and accounts for 43% of overall revenues. For the year we see engines provided $10.4B in sales which is down from $10.9B in 2014. It may be surprising that the drop in sales didn't come from HD and MD engines but was the results of LD auto, industrial and stationary power falling. In North America the HD truck market hit a wall and stumbled backward hard but Cummins managed to produce more sales than last year. There to take up any additional slack in the engines segment was the MD trucks and bus market also increasing sales figures. There is something else to cheer about in the engine segment and that is Chinese JV sales of engines. Across the globe Cummins JV engine sales were up almost $200M and came in at $3.4B. China was the lion's share of the JV space and accounted for 62% of revenues. The Beijing Foton Cummins JV was the champion and produced $62M in sales more than offsetting drops from the other two Chinese JVs. The 2016 guidance is calling for a drop of 5%-9% in engine sales and will probably come in just over $10B much like 2013. Most notable in this space is their Light Duty Diesel engine, or LDD. A slowdown in demand and failure to secure another ongoing customer besides Nissan led to Cummins writing down $211M before taxes with $202M coming from engines and $9M coming from components. They are not exiting the space and will continue to honor the agreement with Nissan but they realize the market for LDD just isn't there right now and it makes no sense to allocate precious capital to this area.

The distribution segment was great for 2015 and they increased sales by almost a billion dollars to $6.2B. This is kind of a double edged sword for Cummins. One reason the segment did so well is because sales of new engines did so poorly. As more companies choose to refresh and refurbish they have no choice but to service their Cummins engines with Cummins parts. The vast network of distributors enables this and is a huge draw for companies to choose Cummins over many other manufacturers when purchasing engines. The smartest thing Cummins is doing when it comes to the distribution is acquiring all of their North American distribution JVs. This is immediately accretive to the bottom line and helps to streamline their distributor network. Due to an overall slowdown expected for 2016 Cummins expects distribution sales to be flat to down 4%, not a bad figure considering the drops in their other segments they're forecasting.

Looking at components Cummins had a slightly up year with $50M more in sales to arrive at $5.1B. Filling this space is turbochargers, fuel systems, filtration and the very popular emissions. What I like most about the components segment is that the products contained here are used by just about every engine manufacturer and are not exclusive to Cummins. Emissions solutions are also a great business to be in as worldwide regulations concerning greenhouse gas emissions are being pushed making it mandatory for many companies to achieve a certain level of efficiency. The JV sales in this space have been steadily increasing as well showing that Cummins has been growing this profitable segment very well especially in their international markets. To be expected Cummins is forecasting a drop of 6%-10% in sales for 2016.

The darkest mark in the year for Cummins is easily in the power generations segment. With just $2.7B in sales the slide for the segment continues year after year. There really isn't much good to say about the segment, it has been dropping for years now and that doesn't seem likely to change. The international market has promise as developing nations who do not have widely established power grids will require power and establishing a stand-alone generator will be the only option in many cases. Unfortunately this impacts all other segments inside the company, as generator sales fall so does the demand for engines, parts, and services. Cummins estimates a 3%-7% drop in sales for 2016, no surprise as that's been the trend for years.

I'm encouraged by the numbers for China and India as well. In 2015 CMI did $1.5B worth of business in India, a $200M increase over the year and they're even forecasting that to remain flat for 2016. India is an important market for Cummins as the nation is now the fastest growing per GDP in the world eclipsing China. Their growth is spurring large increases in infrastructure spending and the demand for manufacturing is rising giving Cummins a great tailwind in the nation going further into the future. Just as important is China where Cummins' sales came in flat in 2015 at $3.3B and are expected to stay at this level for 2016. With Chinese growth slowing this is actually great; one would imagine sales would drop in the rapidly growing nation as they transition to a more consumer based economy. A catalyst for growth here is tightening emissions regulations as China works to make the air breathable and meet international climate agreement benchmarks. If Cummins can maintain sales in these two countries as the global economy slows through 2016 there could be a huge breakout in 2017 and 2018. I'm most excited about this aspect of the business.

Overall Cummins had a pretty decent year. In the industrials sector of the economy, defense companies excluded, it is difficult to find a growing business. This coming year will continue to be a challenge for the space but Cummins is very quick to react to market forces. For the full year 2016 they're estimating an overall drop of 5%-9% in revenues with EPS to drop in line. The CEO Tom Linebarger was adamant about Cummins' intent to return 75% of operating cash flow to shareholders in the form of dividends and share repurchases. I remain bullish on the company and see it as incredibly undervalued from a long-term perspective. With the market reaction to the earnings report incredibly positive it seems shareholders are more confident in the company now and that the huge drop in share price from their highs was mostly overdone. It is hard to say where Cummins will hold, but $90 has always been a pretty good area for the share price in the last couple weeks although $100 seems to be where it intends to go. The stock remains very vulnerable to any bad news, but with what seems like a bottom in the oil market at least within sight Cummins could greatly benefit from a rise in oil prices in the latter half of 2016. I'm going to wait a few days for the earnings report to soak into the market and will probably witness a drop back to the lower $90s where I may add to my position. I thank you all for reading and look forward to the discussion in the comments. As always best of luck to you all!

Disclosure: I am/we are long CMI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.