Is Cummins A Good Dividend Stock Portfolio Choice?

Summary

• Cummins' business will experience major change over the coming decade, as electrification will lead to fewer diesel engines being used.
• In the near term, the growth outlook is compelling, as Cummins should benefit from economic growth.
• What investors should consider regarding Cummins' dividend yield and valuation.
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Photo by Maksim Safaniuk/iStock Editorial via Getty Images

Article Thesis

Cummins, Inc. (NYSE:CMI) is an industrial company with a strong dividend track record. The company's engine business will experience both threats and opportunities going forward as the industry changes and natural gas powered and electric engines will gain market share versus diesel engines. Overall, Cummins is a quality pick with a solid outlook, but its valuation isn't especially advantageous right now and investors don't get an overly generous dividend yield at current prices.

Cummins' Business: Opportunities And Threats

Cummins, which primarily sells diesel and natural gas engines today, will experience meaningful change for its business model over the coming years and especially decades. Today, most large commercial vehicles such as trucks and excavators can't be powered by electricity yet and are mostly powered by diesel, but it has to be expected that this will change in the future, at least to some degree. This is why Cummins has established a New Power segment which seeks to electrify all types of commercial vehicles, including school busses, trucks, and more. So far, this segment is only generating about $100 million a year in revenue for the company, and the New Power business unit is also not profitable. For the time being, Cummins' investments into its electrified engines business is thus not driving bottom line growth -- quite the contrary. The company seeks to expand this business over the years, however, and with growing scale it seems reasonable to assume that Cummins will eventually start generating profits with its electric engines as well.

Source: Ward'sAuto.com

On the other hand, Cummins' diesel engines - where Cummins is the market leader, as seen in the above chart - will likely see some sales headwinds eventually, as more customers will switch to electrified vehicles. One could thus say that the change that the industry will likely experience over the coming decade could turn out well or bad for Cummins. Depending on how well the company manages to transition towards a more electrified product lineup, Cummins may either lose market share or further fortify its position as a key engine supplier for many commercial vehicle manufacturers.

In the very near term, however, electrification will not play a major role, and Cummins' business outlook is more dependent on economic growth and truck sales. For 2021, as the global economy is poised to bounce back from 2020's downturn, Cummins' outlook is very solid. The company seeks to generate revenue growth of 20%-24% this year, and its EBITDA margins will be at a relatively attractive mid-teens level. This guidance has been increased during the most recent earnings call on May 4. Previously, Cummins had guided for low-double-digit revenue growth. During 2020, despite the downturn, Cummins remained profitable - the same was true in previous downturns, such as in 2016 and 2009.

Looking at current analyst estimates, we see that solid growth is expected for both 2021 and beyond:

Data by YCharts

Analysts are forecasting earnings per share growth of 11% for 2022 and 9% for 2023, while the long-term EPS growth consensus of close to 10% is attractive as well. Historically, Cummins' earnings per share growth has stemmed from revenue growth, margin increases, and share repurchases. Through the same formula, the company could be able to deliver an attractive EPS growth pace in the future as well, even though revenues will likely not grow all that much.

Still, uncertainties around electrification remain, and I believe that a weaker revenue and earnings performance -- versus what analysts are currently forecasting -- can't be ruled out. It remains to be seen whether Cummins will be able to continue to grow its profits meaningfully during the mid-2020s and beyond.

Dividend History

Cummins has, compared to many other companies in the (commercial) vehicle industry, a relatively strong dividend track record:

Data by YCharts

There hasn't been a dividend cut in the last 25 years, and over the last 15 years, there were a lot of dividend increases. Those did not occur like clockwork - sometimes the dividend has been kept at a certain level for more than four quarters - but Cummins still raised its dividend by 8% a year over the last five years, and by 18% a year over the last decade. Dividend investors should also consider a couple of other metrics, including the current yield and the sustainability of Cummins' dividends.

Cummins Dividend Yield

Right now, with shares trading for $252, shares offer a yield of 2.1%. That is higher than what one can get from the broad market, but it isn't high compared to the yield one could get from CMI in the past:

Data by YCharts

Cummins' yield has mostly moved in the 2.5%-3.5% range over the last five years, compared to that, shares offer a below-average yield right now. The combination of a 2% yield and a high-single-digit dividend growth rate is not bad at all in a vacuum, but the fact that Cummins' yield is well below the historic average may still indicate that right now is not a great time to enter a position.

Cummins Dividend Safety

Looking at Cummins' dividend sustainability, which is a key concern for long-term-oriented income investors, we see that Cummins easily covers its dividend with both earnings and cash flows. At $5.40 per year, the dividend requires about 38% of this year's expected net profits. Since Cummins has historically generated free cash flows that were at least on par with net profits in most years, the dividend also doesn't require an outsized portion of Cummins' cash flows. Based on 2020's free cash flow, Cummins' cash dividend payout ratio was below 40% as well. When we further consider Cummins' very healthy balance sheet, with available liquidity of $7 billion and $4 billion in cash, then the risk of a dividend cut seems very low. The company didn't cut its dividend in 2020, it didn't cut its dividend during the Great Recession, and it most likely won't cut its dividend in the foreseeable future.

Is CMI A Buy, Sell, Or Hold?

Historically, Cummins has delivered solid business growth, attractive shareholder returns, and its dividend have grown quite a lot over the last two decades as well. Its business is somewhat cyclical, but in 2021 and the foreseeable future the company should benefit from an economic recovery that will likely lead to higher truck sales.

It is not guaranteed that Cummins will manage to emerge as a premier electric engine manufacturer, but the company has able management and ambitious plans for electrification, which also includes battery offerings. Still, uncertainties remain here, and investors should keep an eye on how profitability for the New Power business develops.

Cummins offers an above-average dividend yield relative to the broad market, but its yield is low relative to how Cummins traded historically. This, combined with an earnings multiple of 17, which isn't inexpensive for a company like Cummins, makes me believe that Cummins isn't a strong buy right here. The company offers attractive traits and is a quality pick, and it looks like 2021 will be a strong year for the company, but the best time to buy is when shares are at their cyclical lows, and not when they are close to their all-time high. All in all, one can summarize that Cummins is a very solid company with a healthy near-term outlook and a somewhat uncertain longer-term outlook. Timing isn't great right now, and waiting for a better valuation seems like an opportune choice.

Analyst’s Disclosure: I/we 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.