Further Regulation A Positive For Cummins

| About: Cummins Inc. (CMI)
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With the Obama administration's recent crackdown on coal-fired power generation, it will only be a matter of time until diesel trucks come into view of the Obama administration's cross-hairs. The Obama administration already has the trucking industry in its sights with changes in regulations with regards to capping the average work-week for a truck driver at 70 hours down from the previous maximum of 82. It's not too much of a stretch to see the Obama administration further regulate diesel truck engines to the point of extinction - I can just see the dancing on Rudolf Diesel's grave (inventor of the diesel engine). With further regulation of the diesel engine on the horizon, investors should take a closer look at Cummins (NYSE:CMI).

Cummins designs, manufacturers, sells and services engine related products. In particular, Cummins has a joint venture with Westport Innovations (NASDAQ:WPRT) for designing, developing and marketing natural gas engines. With the recent advances in extraction of natural gas, North America is drowning in natural gas which has caused the price of natural gas to drop significantly and has made the implementation of natural gas engines more attractive.

In Cummins' Q1 2013 reported results conference call, the company had $3.9 billion in revenue which represented a decline of 12% year-over-year, which doesn't sound too attractive, but Patrick J. Ward, CFO and Vice President, expects Q1 to be a trough in sales and profitability for 2013, so it appears Cummins is currently near the bottom performance-wise. N. Thomas Linebarger, Chairman, CEO and Chairman of the Executive Committee, further noted he expects strength in the on-highway and construction markets in North America to pull the company out of the trough.

In the company's conference call, Mr. Linebarger highlighted the company's new Cummins Westport ISX12 G natural gas engine that is now in limited production which is generating a lot of interest among end-users. Mr. Linebarger further noted Cummins advantageous positioning as the company is pretty much the only independent engine company for developed markets and presents a nice value proposition for partner company's wishing to deliver increased value to customers. As a side note, Cummins also markets power generation products for data centers which are very lucrative as the growth of computing, communication and Internet market segments has been exponential.

In spite of Cummins recent lull in revenue, the company's stock price has appreciated over the last year as shown below:

As shown in the chart above, Cummins' stock price has pulled back and is currently near its previous support level in the $105 range.

Cummins' Price-to-Sales (P/S) ratio of 1.2 places the company's stock price in the value realm, and its Price-to-Earnings (P/E) ratio of 14 is reasonable based on a comparison with its competitor Caterpillar (NYSE:CAT) which has a P/E ratio of 11.

With increased diesel truck engine regulation sure-to-come, Cummins' sweet positioning in the natural gas engine market, the positive environment for natural gas and the recent pull-back in Cummins stock price this could be a good point for considering investing in Cummins. However, a protected position is considered as the situation with regard to regulation, commodity pricing, etc. can change on a dime. A protected position to consider is the married put as it provides for unlimited upside with limited downside. The married put position is entered by purchasing a put option against the stock in order to provide downside protection. The put option is typically selected several months out in the future in order to reduce the per-day cost of the put option "insurance."

Using PowerOptions, a number of married put positions were found for option expiration in December of 2013 as shown below:

The married put position using the 2013 Dec 110 put option looks attractive with a maximum potential loss of 7.5%, prior to consideration of expected dividends. When taking expected dividend payments during the holding time into consideration, the maximum loss is reduced to 6.7%, so even if the price of the stock drops to zero - the maximum loss which can be sustained is 6.7%. The specific details for entering the married put position for Cummins are shown below:

Cummins Married Put Position:

  • Buy CMI stock (exiting or purchased)
  • Buy CMI 2013 DEC 110 put at $10.00

A profit/loss graph for one contract of the Cummins married put position is shown below:

As shown above, for an increasing stock price, the value of the married put position also increases. For a decreasing stock price, the loss for the married put position is limited. And if the price of the stock increases to above the $110 strike price of the put option, then income methods as taught by RadioActiveTrading.com can be applied in order to receive income and reduce risk.

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