Cummins Is A Classic Long-Term Value Creator

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Jul 09, 2014

Cummins (CMI, Financial) designs, manufactures, distributes, and services diesel and natural gas engines, and engine-related component products. The company has been a value creator in the past and will continue to be a value creator in the future. This article discusses some of the key factors that make Cummins an excellent long-term investment.

Long-Term Supply To Solid Customers

Cummins supplies engines and other products to thousands of customers worldwide. However, the company has medium to long-term supply agreements with some strong companies. These agreements ensure that Cummins will have a steady revenue stream.

The company’s largest customer is PACCAR (PCAR, Financial) and the company accounted for 12% of Cummins consolidated sales in 2013. Cummins has a long-term supply agreement with PACCAR for its engines and a strong 69 year relationship is likely to continue.

Cummins also has medium to long-term agreements with Navistar, Volvo and Chrysler, MAN, Ford and Komatsu. On a consolidated basis, these customers (including PACCAR) contributed to 36% of the company’s sale in 2013.

Therefore, a significant portion of the company’s revenue comes from strong long-term agreements and relationship. This ensures that the company’s cash inflow is secure to some extent.

Strong Fundamentals

For 2013, Cummins had revenue of $17.3 billion, which has increased from $10.8 billion in 2009. Cummins has therefore grown at a robust pace in the last five years. One interesting aspect about the growth has been the revenue contribution from US and non-US. The percentage of US sales has remained constant at 48% over the last five years. This trend is likely to change with higher growth coming from China and India.

Another point, which indicates strong fundamentals and operational efficiency, is the gross margin over the last five years. The company’s gross margin has increased from 20% in 2009 to 25% in 2013. The company has therefore done exceedingly well on the cost cutting front.

What I also like in the company’s financials is the kind of operating cash flow generated by the company. The company’s operating cash flow has doubled from $1 billion in 2010 to $2 billion in 2013. The strong growth in operating cash flows has helped the company increase its dividend per share by 157% to $2.25 in 2013 from $0.875 in 2010. These are certainly indications of a company with strong fundamentals and with a focus on shareholder value creation.

Cummins also has a very low debt and this is another factor I like about the company’s overall fundamentals. As of December 2013, the company had a total debt of $1.7 billion and a cash position of $2.7 billion. Therefore, the current cash position is more than sufficient to cover for the company’s debt. All these factors combine to make Cummins a solid company from a fundamental point of view.

Growth From Emerging Markets

Cummins has strong presence in India and China and strong growth is likely from these markets over the next 5-10 years. I believe that Cummins sales contribution from US will decline over the next decade and sales contribution from Asia will increase significantly.

From a geographical distribution point of view, Cummins sales (last twelve months) in Asia Pacific, India and China was 19% of the total sales with US and Canada contributing to 55% of the total sales.

For 2013, the company’s sales (consolidated and unconsolidated) in China was $2.9 billion as compared to $1.6 billion in 2009. Growth in China has therefore been robust. Cummins also has a market leadership position in India with 2013 sales (consolidated and unconsolidated) from the country being $1.2 billion.

Strong Estimates For 2014

After reporting a diluted EPS of $7.91 for 2013, analyst estimates suggest a mean EPS of $8.99 for 2014. This implies an annual EPS growth of 13.7% as compared to 2013, which is robust EPS growth.

Considering the annual EPS of $8.99, the stock is currently trading at a PE of 17.4. I believe these are attractive levels for a stock with strong earnings potential and a good dividend yield of 1.6%.

Analyst estimates also peg 2015 EPS at $11.05 and this would imply a 23% EPS growth as compared to 2014. Therefore, Cummins has some strong growth lined-up for the next 2 years.

Even for the long-term, emerging markets and cost cutting measures will support EPS growth. As the company has a strong cash position, low debt and high operating cash flow, I will not be surprised to see big share buybacks to create shareholder value.

Conclusion

Considering all the factors discussed, Cummins is a great investment for the long-term and a classic buy and hold stock. The company will continue to reward investors through share buyback, robust dividends and stock appreciation.

Cummins has shot up by 39% in the last one year and the stock upside is likely to continue with strong growth likely over the next few years. I strongly believe that investors can consider exposure to this engines giant for the long-term. The company is not likely to disappoint its shareholders.