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Cummins Inc.: Not Particularly Expensive

Gordon Pape

Gordon Pape

17 followers

Contributing editor Glenn Rogers is back this week with a new stock selection in the engine and powertrain industry. Glenn is an entrepreneur, businessman, and active investor who has worked in both Canada and the U.S. He and his family live in Southern California. Here is his report.

U.S. natural gas discoveries and reserves have ballooned over the last two years. You can thank hydraulic fracturing ("fracking") and other technological breakthroughs in drilling for that surge in supply. Together, abundant U.S. and Canadian supplies have created enough of a price differential for natural gas over gasoline and diesel fuels to make natural gas a potentially attractive alternative.

As a result, interest is finally growing in powering large long-haul vehicles like tractor-trailers, which still transport most of the goods and services in North America, with natural gas-powered engines. Vancouver, B.C.-based Westport Innovations Inc. (TSX: WPT) (WPRT), which we recommended last June, has been at the forefront of natural gas engine technology (a complete update follows below). However, this week, we will look at one of Westport's largest partnerships, Cummins Inc. (CMI).

Based in Columbus, Indiana, Cummins Inc. is one of the largest diesel engine manufacturers in the world, operating in 190 countries with over 48,000 employees. The company had sales of over $17 billion (all figures in U.S. dollars) in 2013, with net income of $1.4 billion. It competes with companies like Caterpillar Inc. (CAT) and Deere & Company (DE) and has been doing so successfully since 1919. Cummins also manufactures a number of components for the power generation industry, including engines, controls, alternators, and so on.

But the product line it is developing with Westport is what first got me thinking about the company. Cummins supplies engines for companies like Volvo, Daimler, Ford, Chrysler, and others. The most substantial part of its business is still traditional diesel engines, but as the infrastructure for natural gas stations along the major U.S. freeway systems is built out (more on that later), the company will have a unique opportunity to secure its existing customer base and expand into new ones.

Famed oil and gas investor T. Boone Pickens has been pushing this idea for a number of years, and here's why: There are more than 10 million natural gas vehicles in operation around the world, but only about 130,000 are in the United States. The opportunity to convert not only 18-wheelers but also refuse and recycling trucks along with mass transit buses is significant.

In Los Angeles, just north of where I live, there are 2,800 natural gas buses in operation already. One of the hurdles to mass conversion has been adequate refueling infrastructure. However, that is being addressed by companies like Clean Energy Fuels Corp. (CLNE), which are building a national system of natural gas refueling stations along the major transportation routes in the U.S.

In the past, the knock against natural gas engines was that they were not powerful or efficient enough to power the big rigs that move most of our goods and services. But now the collaboration between Westport and Cummins has been bringing to market engines that can do that job. The new engines are winning converts amongst the key group that uses them, the drivers and the owners of the transportation companies, who see the opportunity to save money with a cleaner alternative to the power plants they currently employ.

Cummins just increased its dividend payout by nearly 25% (for a yield of 2.04%), which will return an additional $114 million to investors annually. The company also added another $1 billion to its share repurchase plan. The board is committed to returning 50% of full-year operating cash flow to its shareholders through this combination of dividends and stock buybacks. That is still only 20% of estimated earnings in 2014, so the company can afford it - and it's been paying dividends since 1948.

The stock is not particularly expensive with a price/earnings ratio of 18.41. True, Goldman Sachs did take the company off its conviction buy list recently, which caused the shares to sell off modestly, but Goldman still ranks Cummins a buy. This is a very solid company with a long history that now has an opportunity to benefit from a generational change in power plants. Given the run-up in the market, a good dividend payer with solid earnings always deserves a look.

Action now: Buy Cummins Inc. (CMI) with a target of US$170. The shares closed on Friday at US$152.74.

About the author:

Gordon Pape
GuruFocus - Stock Picks and Market Insight of Gurus

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Comments

Dr. Paul Price
Dr. Paul Price premium member - 4 months ago

Value Line notes that CMI's 10-year median multiple has been just 12x. That makes its current valuation quite expensive.

Cummins' averaged an 11.1x multiple in 2011, 11.9x in 2012 and 15.3x in 2013.

You title does not accurately describe the relative pricing of shares in this fine firm. CMI is a great example of a good company, but at an inflated asking price.

CMI sold for as low as $123.70 on Feb. 3, 2014. Its 52-week low was $115.30. Why pay up for CMI now? It seems fitting to wait for a better entry point.

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