Cummins Motors Along
Board: Falling Knives
Cummins has been around since 1919, and makes primarily diesel engines. It's the biggest seller of medium and heavy truck engines in North America, Brazil, and India (through joint ventures with Paccar and Tata) and does significant business (through JV with Dongfeng and others). It's the biggest player in (diesel) power generation in Brazil, India and China, which was news to me, even after doing a little research on Siemens and ABB.
It's got four business units: Engines (>50% of sales), Power Generation (16%), Components (filtration, turbo, fuel systems) (18%), and Distribution (16%). Of these, Engines and Power Generation are a little more cyclical, with Power Generation being more a late-cycle business. Components and Distribution are a little less cyclical. So obviously, we should expect some impact from a global slowdown.
Seven customers, mostly truck manufacturers (Paccar, Man, Volvo, Daimler, Ford, Chrysler), account for 30% of sales. Many of these relationships are long-standing (Cummins has supplied engines to Paccar for 67 years). Diesel engines are long-lived, but tractor trailers also do a lot more miles per year than passenger vehicles, so there's attrition: at a certain point vehicles have to be replaced. Folks in the industry expect Class 8 (tractor trailer) sales for 2012 in North America to come in around historical replacement levels. A truck dealer quoted in an industry publication earlier this year points out, however, that carriers have been nursing older vehicles along for the last few years:
“In our customer base they’re buying trucks because they have to. They can’t maintain trucks with 800,000 miles on them and they haven’t bought a lot for several years,” said Yates, president of Truck Centers Inc. He added that there is a struggle to meet demand.
Clearly, recent growth has come from outside North America--as Cummins's expansion in India, South America (30% yoy) and Africa (50% yoy) suggests. Truck fleets in these markets are likely to continue to grow at a good clip for many years. U.S. sales accounted for about 40% of total in 2011 and the rest of the world 60%, but that may well shift over time.
Cummins has an interesting joint venture with Westport to manufacture spark-ignited natural gas engines. Natural gas is a lot cheaper than diesel fuel, and if a network of fueling stations can be expanded, these engines will likely grow in popularity. Cummins is already developing its own spark-fired natural gas engine, which should go into production by 2014.
The DOE Alternative Fuels Data Center has some good resources for mapping nat gas fueling stations:
Cummins ROE is around 35%. Debt-to-capital at the beginning of 2012 stood at about 12%, down from 14% in 2010. At $84/share, the stock is down about 35% from a 12-month high of $128. In 2011, the company repurchased about 6.4 m shares or 3% of shares outstanding, at an average price of about $88/share, and at the same time hiked the dividend (current 1.7% yield, 14% payout ratio). The recent earnings warning that sent shares down about 10% (give or take) is for flat 2012 earnings. This shouldn't have been a shock, given that these risks were flagged in the annual report:
We currently expect the following challenges to our business that may reduce our earnings
potential in 2012:
• In China and India, demand in certain industrial markets could remain low in the first half of
2012, although improvements are expected in the second half of the year.
• Our engine sales in Brazil in 2012 could be negatively impacted by pre-buy activity in the second
half of 2011 ahead of the implementation of Euro V emission regulations, as well as one of our
customers replacing our B6.7 engine with their own proprietary engine.
• Demand in certain European markets could decline in 2012.
• We will increase our investment in new product development.
• Currency volatility could put pressure on earnings in 2012.
Bear in mind that 2011 was a record year. Flat earnings for 2012 would still be pretty decent earnings.
As far as price, a return to this year's exuberant high of $128 any time in the next year or so would give a 50% return, while assigning the company about a 13x P/E, which seems about right to me. Even if Cummins manages to grow at only 5% for the next few years, they should still be doing almost $13 in earnings by 2017. I think growing international demand, and possibly a reconfiguration of the domestic tractor-trailer fleet to take advantage of cheap natural gas, could push earnings closer to $16.
Quick link to 2011 annual report:
Superficial foolish optimism: