Expect Cummins to Continue Trending Higher

Solid dividends and potential growth from emerging markets will take the stock higher

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Jun 06, 2016
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There are several stocks that are worth holding in the long-term portfolio through good and bad times. Cummins (CMI, Financial) is one such name. Cummins is worth buying even after the stock has delivered robust returns of 29% year to date.

Cummins is a dividend aristocrat and that is the first reason to buy this evergreen stock. Currently, Cummins offers dividend payout of $3.9 per share that translates into dividend yield of 3.39%. With solid cash flows and relative stability in earnings, Cummins is a dividend stock that is worth holding in every portfolio. While I don’t expect strong increase in the dividend in the foreseeable future, the factors to be discussed will ensure that the company’s dividend growth is strong in the coming years.

Before discussing important growth drivers for Cummins, I must mention here that the company has guided for revenue decline of 5% to 9% for fiscal year 2016, largely because of current economic conditions. Sluggish growth is discounted in the stock, and markets will be looking beyond the current sales recession.

One of the major reasons to be bullish on Cummins for the next three to five years is the geographical diversification and the potential that low revenue-contributing regions hold. Just to put things into perspective, China contributed to 8% of LTM revenue, India contributed 3% and Latin America and Mexico contributed 6%. Further, Africa contributed only 2% to LTM first-quarter revenue. Clearly, these high growth markets still are a small revenue contributor.

In the next five years, revenue from the U.S. and Europe will decline while the revenue contribution from emerging markets will increase. Revenue share from China is significantly higher than India, but in the next five years, India will contribute to an increasing chunk of total revenue. Clearly, my view is that emerging markets will be the revenue, EBITDA and cash flow driver in the coming years, and this will ensure that Cummins stock continues to trend higher along with decent growth in dividends.

From a valuation perspective, Cummins is currently trading at a trailing 12-month PE of 15.0 and at a forward PE (December 2017) of 14.4. I don’t see valuations as a concern considering the stock offers strong dividends. Further, investors are likely to consider exposure to relatively safer bets and Cummins offers that safety with robust cash flows.

Innovation is likely to be another key growth driver for Cummins. On April 7, the company announced that it was awarded a $4.5 million grant from the U.S. Department of Energy to develop a Class 6 commercial plug-in hybrid electric vehicle that can reduce fuel consumption by at least 50% over conventional Class 6 vehicles. If these innovations take off, it can serve as a major growth catalyst.

Cummins will offer shareholders value creation in the coming years through share buybacks besides stock upside and healthy dividends. While the stock has trended higher by 29% for the year to date, I don’t see current PE valuations as expensive and forward valuations remain attractive. Investors can therefore consider exposure to this dividend aristocrat at current levels, and emerging markets will deliver growth and stock upside trigger in the next three to five years.

Disclosure: No positions in the stock.

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