It is always hard to interpret corporate executives' comments during earnings season. While many companies offer clear guidance based on what these companies think the business environment will be over coming quarters, seasoned corporate executives often attempt to manage expectations as well.
While the S&P 500 and its tracking exchange traded fund, SPY (SPY), has rallied over 20% from the lows of last year, and stocks such as Apple (AAPL) are up over 30% this year, many leading cyclicals, such as Caterpillar (CAT), GE (GE), and Citigroup (C), have sold-off hard since mid-April.
Cyclicals have consistently underperformed the S&P 500 and most of the broader indexes over the last year. Also, while cyclicals such as Boeing (BA) and GE on longer-term contracts have rallied nicely over the past month, cyclical companies on shorter-term cycles such as Caterpillar and engine maker Cummins (CMI) have remained weak.
Cummins has been one of the hardest hit stocks in the market over the last several months, and the stock has traded down from around $130 a share in early March to nearly to $82 a share last week, after management took its recent first quarter guidance down from 10% sales growth to 0 several weeks ago. The company will report its second quarter earnings this Tuesday.
Cummins is a nearly $18 billion dollar company headquartered in Columbus, Indiana, that gets nearly 70% of its revenues abroad today. The company's core products are engines, and Cummins is the largest maker of Diesel engines over 200 horse power in the world.
Cummins's stock is always volatile during uncertain times because this company's business is extremely cyclical and the trucking markets have been up and down.
This is why I think management's recent decision to take guidance now so severely just a couple months after the company issued fairly strong full-year guidance after the first-quarter earnings report was so interesting. Cummins' management team is known for being conservative, and the company has consistently been negative about its outlook for Europe and most emerging markets for some time. While Cummins' recent earnings revision included continually negative commentary about Europe and emerging markets management also included negative comments about the company's North American markets, which is where this leading engine maker has seen most of its recent growth.
Cummins is a very well run company, and the leading engine makers' strong product mix and ability to offer significant fuel efficiencies has enabled the company's earnings to hold up well over the last couple years. Cummins also has a five-year growth target of 14%-15% a year, and plans to hire over 7,000 engineers over the next decade. The company was one of the first to form joint ventures in emerging markets such as India, ahead of even strongly positioned companies in many emerging market economies such as Caterpillar.
This is why I question whether management was too quick to aggressively lower guidance by nearly 10% just two months after the company's first-quarter conference call. Obviously, the recent economic data in the U.S., Europe, and most emerging markets, has been poor. Still, energy prices remain high, interest rates are at historically low rates, and the spring is often a seasonally weak period for economic growth.
I also think Eaton's (ETN) recent earnings report was very important. While this Midwestern company's businesses are more diversified than Cummins, Eaton is also heavily tied to the trucking and hydraulic markets in North America and abroad, and the company recently reported very strong earnings after previously raising guidance just a couple months ago. Eaton did discuss weakness in the trucking market. Still, the company also suggested its margin in the trucking industry would likely remain strong, and the company saw a small rebound in demand for its products and services in Asia.
To conclude, Cummins' revised outlook calling for minimal to no growth in 2012 has severely lowered expectations for the company's second-quarter earnings. Still, with companies such as Navistar increasingly having difficulty building their own engines, and fuel prices still high, Cummins' earnings should continue to hold up fairly well. With the stock now trading at around 8x an average estimate of this year's recently lowered earnings estimates, the company is likely moderately to significantly undervalued if the growth outlook in Europe and most emerging markets improves even modestly throughout the year.