Is Cummins A Good Stock To Buy?

| About: Cummins Inc. (CMI)

Summary

The favorable business environment will drive potential growth for Cummins business.

The company’s penetration in on-highway markets and expansion of its distribution business will allow it to post record profits.

Cummins is a good buy on the dip.

Cummins Inc. (NYSE:CMI) has been continually losing its share price over the past three months. The stock lost around 11.6% of its value during that time. This sell-off started with the overall correction in the market that started in mid July. Still, Cummins fails to underpin investor confidence in its share price which results in a continuous decline in its share price. This happens, though it has posted very strong results in the second quarter of this year on 28th July along with the announcement of a 25% increase in its quarterly dividends. Most of the analysts say that the stock was overvalued as a result of the significant surge it made in between March to the start of July. During that time, the stock surged from $123/share to $161/share.

However, after a big sell-off, its stock now presents an attractive opportunity to initiate a position in the company. I believe, its share price will stabilize in the coming few days because it is trading below the lowest price target estimate of around $145/share. In addition to that, its current price valuations show that the stock is undervalued and is trading well below the industry averages. Cummins stock is trading at 16 times to earnings and 1.4 times to sales as compared to the industry average of 20 and 1.8. Furthermore, I believe the company has a strong outlook and it is well set to post significant growth in sales and earnings in the coming quarters. This will happen on the back of the stabilizing of the economic situation in North America and Canada along with the stabilization in the developing markets.

Cummins is operating in the four business segments: engine, components, power generation and distribution. Apart from its power generating business segment, which is falling due to the lower spending from the U.S. military and lower power generating in the international markets, Cummins other three segments have generated very strong growth in the past two quarters. It's other three segments account for more than 85% of overall revenue and all these segments have been generating double digit growth rates in sales and earnings. Therefore, the impact of slower growth in its power generation segment can be offset by the others.

In the most recent quarter, Cummins has posted consolidated sales growth of 7% as compared to the past year's quarter and a 13% growth in its earnings. The company is working on a smart business strategy which is driving potential growth. Its strategy is to lower the cost of production through economies of scales, global presence & partnerships and with innovative technologies alongside enhancing operational efficiencies. Cummins has been seeking to expand its market share in related markets so as to establish a competitive advantage. With the recovery of the economy and increased business activities in commercial, manufacturing, industrial and construction industries, the demand for its engine and component business is enlarging. In the distribution segment, the company is expanding its market share with the acquisition of North American distributors.

Overall, the long-term fundamentals of Cummins business look strong. With the stabilization of the economy and the expansion in its distribution business, along with increased demand in on-highway markets, the company is set to generate high single digit growth rates in consolidated revenues and high double digit growth rates in earnings for this year. Furthermore, based on IMF reports, the global economy will grow at a higher rate in 2015 as compared to 2014 and I am expecting similar growth in the next year. On the risk side, the company seems to be at the lower end of the ladder because its business has gained momentum and the economic environment is favorable. The company is in a sound cash position because its operating cash flows are covering the capital requirements and dividend payments. This is evident with the recent increase of 25% in its dividends.

In Conclusion

 

CMI

Industry Average

Price/Earnings TTM

16.3

19.6

Price/Book

3.3

2.8

Price/Sales TTM

1.4

1.8

Rev Growth (3 Yr Avg)%

9.4

4.4

Net Income Growth (3 Yr Avg)%

12.6

7.9

ROE TTM

21.7

14.7

Source: Morningstar.com

I firmly believe that Cummins is offering an attractive entry point at this level. In addition to that, its share price has a strong upside potential and will regain its lost value in the coming months. It is trading at attractive valuations and its return on equity is very high. The company is always looking to return 50% of its cash flows to investors and it has potential to sustain that momentum as it is well set to generate big profits.

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.

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