Cummins 2016: An Urgent And Flexible Operator In This Environment

| About: Cummins Inc. (CMI)
This article is now exclusive for PRO subscribers.


Despite decreasing sales, Cummins' management is doing a good job of maintaining margins by cutting costs and streamlining operations.

Although 2016 will present another challenging year for the company, Cummins is well positioned to weather the cyclical downturn.

Management intends to return 75% of cash flows to shareholders in 2016 via buybacks and dividends and has ample cash on hand.

The decrease in share price has been related to the global economic downturn rather than with Cummins products or operations. Cummins is a solid company.

Cummins, Inc. (NYSE:CMI) is a manufacturer, distributor, and servicer of diesel and natural gas engines and electrical power generation systems, with over 7200 dealer locations in 190 countries worldwide. Founded in 1919, CMI is based in Columbus, Indiana and employs approximately 55,000 people globally. Market capitalization on 2/4/2016 is approximately $17.25 billion with approximately 176 million outstanding shares of common stock. The closing per share price on 2/4/2016 is $97.57 and CMI pays an annual dividend per share of $3.90, which equates to a 4.00% yield. The 52-week high is $146.13 on March 3, 2015, and the 52-week low is $79.88 on January 20, 2016.

The company operates in four segments: Engines; Components; Distribution; and Power Generation, with its key end markets for reporting purposes currently consisting of North America and the emerging markets of Brazil, China, and India.

CMI provides engines and components for original equipment manufacturers (OEMs) in the following industries:

"On-Highway": Trucks (heavy-, medium- and light-duty), bus, recreational vehicles (RVs), and emergency vehicles.

"Off-Highway": Construction, agriculture, mining, rail, defense, oil and gas, and material handling.

The price of Cummins, Inc. stock has taken a pretty significant beating since the summer of 2014, when it reached all-time highs close to $160/share, to January 2016, when the price dropped to the low $80s, a price the stock hadn't seen since 2012. In fact, after a price dip to the high $120s in October 2014, during a sharp correction that hit virtually every corner of the market, CMI managed to rebound nicely to about $150/share by December 2014 before beginning a long, slow decline to the lows of just a couple of weeks ago.

Cummins' high-quality engines reliably provide the raw ingredients of movement that growing industrial economies need: TORQUE and HORSEPOWER. When these economies are growing, Cummins' business is booming. When these economies slow down, however, the company has to adjust its operations accordingly. Looking at the CMI chart in retrospect, it seems pretty easy to peg the price decline to the overall slowdown in the global economy. The current industrial malaise that has hit everything from commodities to construction globally has resulted in decreased demand for the engines and power production that Cummins is famous for.

Fortunately, this is not CMI's first time around the block when it comes to cyclical downturns. In the past year-plus, management has taken decisive steps in the face of lower revenue to cut costs and increase manufacturing and supply chain efficiency, while actually INCREASING returns to shareholders, without damaging the overall balance sheet.

On February 4, 2016, CMI management presented 4Q and full year 2015 earnings, as well as guidance for FY 2016. While the drop in the price of CMI stock has been a truckload of ugly for those forced to ride it out, the company is not in any immediate danger and management has even indicated they intend to return a large percentage of operating cash flow to investors again in 2016. As Cummins CEO N. Thomas Linebarger said on the 4Q15 earnings call, "You know, we've been (here) before. We're an urgent and flexible operator in this environment, so I wish it wasn't this, but I think we'll do relatively well because we will react quickly."

FY 2015 Full Year Results

In 2015, CMI generated sales of $19.1 billion, which was down only 1% year-over-year (YoY)- an impressive feat given the overall market climate. Even more impressive, gross margins actually improved YoY, from 25.4% in 2014 to 25.9% in 2015.

While the Component segment (which produces individual components for OEMs rather than completed engines) and Distribution segment (which provides supply chain and sales services) performed well in 2015 and were two sources of increased cost efficiency, the Engine segment and the Power Generation business faced significant headwinds and reduced overall demand.

Total 2015 North American revenue improved 7% over 2014, though results were somewhat mixed. The Power Generation segment saw an overall decline of 9% in North America in 2015, and a full 3% of the 7% total North American growth is attributed to acquisitions of other (non-Cummins) distributors by the Distribution segment. Overall North American heavy duty truck demand was up 9% YoY to 290,000 units, but Cummins share of this market dropped from 35% to 33%, while the market for medium duty trucks was steady at around 124,000 units and Cummins was able to increase its market share from 72% to 78%.

2015 International revenues were DOWN 11% overall, with Brazil showing the largest percentage revenue drop (down 48% YoY) as that country fell into a full blown recession (just in time for the Olympics this summer, of course). China and India were somewhat better, with revenue from China holding steady from 2014 at $3.3 billion and India showing a nice 15% increase to $1.5 billion. Interestingly, while overall demand for trucks and components dropped in China, Cummins was actually able to GAIN overall market share, which is a positive sign for the future, when demand inevitably picks up again. The decline in Chinese infrastructure spending was felt in the Power Generation segment, which dropped 10% from 2014. In India, overall truck production increased 28% over 2014, and Cummins was able to maintain market share at around 41%.

2016 Guidance

There is some bad news to start off with, as management expects total company revenue to decline by 5% to 9% for 2016, "driven by a decline in heavy duty truck production in North America, continued weakness in global off-highway and Power Generation markets, and further strengthening of the U.S. dollar against a number of currencies."

In North America, total heavy duty truck orders are expected to decrease by 25%, to about 220,000 units and Cummins expects its market share to drop to between 30-33%. Medium duty truck demand is expected to remain steady from 2015 at around 124,000 units, with Cummins market share dropping slightly YoY to 72-75%.

In China, Cummins expects overall demand for heavy and light pickup trucks to decrease, but also expects to increase overall market share as it did in 2015. Cummins expects overall demand for most end markets in China to be down 10%, but also expects revenue to remain flat (due to market share gains). Power Generation is expected to face another challenging year in China as well.

In India, things look somewhat better, with demand for trucks expected to grow 8% in 2016. In addition, the Indian government is strongly promoting investment in infrastructure, which would be a positive for the Power Generation segment, though achieving full project approval and moving forward to actual construction can be a very slow and uncertain process in India. However, the overall Indian economy is showing signs of continued improvement and CMI is in a good position to capitalize on growth opportunities in this market.

Finally, Brazil looks to face another year of recession and truck demand is expected to drop another 20% in 2016. At this point, there is no telling when or how the Brazilian economy is going to find its feet again and Cummins expects across the board declines in revenue from this market in 2016.

The company anticipates ferreting out additional inefficiencies from supply chains, reducing the cost of production materials, and improved manufacturing quality (thus reducing warranty expenses) among other cost saving initiatives in 2016 and hopes to maintain, or even improve on current margins.

While I applaud the nimbleness and responsiveness management has demonstrated and I understand that hard decisions have to be made in order to maintain the overall viability of a global business over the decades, it bears pointing out that "cost saving initiatives" in a corporate setting unfortunately means cutting the workforce to some degree. In 2015, Cummins "reduced our worldwide workforce by approximately 1900 employees,… including 370 employees accepting voluntary retirement packages, with the remainder of the reductions being involuntary." While I'm sure the company is "leaner" and more efficient, and while ALL of us face job cuts in the "new economy" for many of the same reasons Cummins has pared its workforce, I do not want to seem cavalier about the fact that Cummins has chosen dividend payments and share buybacks over retaining a certain portion of its workforce. Again, that's the game we are all involved with these days and I'm not calling Cummins management out for making a decision that I'm sure wasn't easy for them, but I think it's worth at least pointing out that for some folks there is some real pain in this process.

In summary, despite the setbacks, Cummins has done a remarkable job of cutting costs and maintaining overall margins on decreasing revenues in a relatively short timeframe- the hallmarks of a company used to operating (and thriving) in cyclical industries and markets.

Shareholder Value

In 2014, before the downturn that has resulted in the downsizing and efficiency initiatives, Cummins made dividend payments to common shareholders of $512 million and spent $670 million on share repurchases, for a total of $1.182 billion returned to shareholders (at a time when the price per share was significantly higher). At year-end 2013, Cummins had $2.699 billion cash and cash equivalents on hand and at year-end 2014, Cummins had $2.301 billion in cash and cash equivalents on hand, a decrease of $398 million.

In 2015, Cummins made dividend payments to common shareholders of $622 million (increasing the dividend by 25%) and spent $900 million on share repurchases (a total 7.2 million shares), for a total of $1.522 billion returned to shareholders, which represented close to 75% of operating cash flow. At year-end 2014, Cummins had $2.301 billion cash and cash equivalents on hand and at year end 2015, Cummins had $1.711 billion cash and cash equivalents on hand, a decrease of $590 million.

Patrick J. Ward, Cummins CFO on 4Q15 earnings call:

"For the full year, we generated $2.1 billion in cash from operating activities, the third straight year above $2 billion. We continue to use our cash to reinvest back into the company and to return value to our shareholders. We returned 74% of the cash generated from operations to our shareholders in 2015. We increased our dividend by 25%, and we repurchased 7.2 million shares for a combined total of $1.5 billion, up 29% over the amount returned in 2014…

"… we will continue to repurchase shares and as we indicated at our Analyst Day last November, we plan to return 75% of operating cash flow to our shareholders through dividends and stock repurchases in 2016."

While Cummins doesn't have an unlimited amount of cash on hand, the fact that CMI still has $1.7 billion in excess cash on hand above cash flows means it has sufficient cash to continue shareholder distributions through the next couple of years comfortably, with the expectation that the global market will eventually improve and allow them to replenish their on-hand cash supply in anticipation of the NEXT down-cycle. In the meantime, Cummins still has ample cash for capital improvements and strategic acquisitions as opportunities arise.


Eventually, the market for the types of products Cummins makes (and for CUMMINS products specifically) should improve. The decrease in sales and revenue is driven by economic conditions rather than a deterioration in the fundamentals of the company or problems with the quality of its products. In the meantime, the company is doing a good job of managing through the down-cycle by cutting costs, downsizing operations to meet demand, finding ways to gain market share, even in markets where overall demand is down, and using the "rainy day fund" to make strategic acquisitions and return value to shareholders. The share price of CMI may remain under pressure for the next few quarters (then again, it was showing some real signs of life today, jumping 7.5%) and investors who bought in at $120 or $130 (or higher) may have to wait a while to return to those levels, but the robust dividend is not in any danger and, if an investor has some patience, they can DRIP, DRIP, DRIP their way to some nice long term profits with this stock.

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.

Additional disclosure: The author is not a professional or licensed investment or financial advisor and the preceding article is intended for informational purposes only. It is not to be taken as ”buy, sell, hold”, or other specific investment or financial advice of any type. Before making any investment/financial decisions, investors are advised to conduct their own research to their own satisfaction and are solely responsible for the decisions and actions they take- the author bears no responsibility for any gains or losses of any investment decision made of any type based on this or any other article written by the author.