There is a very short list of companies that make it through GuruFocus' Dividend Income Portfolio screener, no doubt because of the numerous and relatively tough criteria.
Cummins Inc (CMI, Financial) was one of the nine companies that made the cut as of July 16. It is the $27-billion company best known for building diesel engines for trucks and equipment. However, it has other lines of business, and describes itself this way:
“Cummins Inc., a global power leader, is a corporation of complementary business segments that design, manufacture, distribute and service a broad portfolio of power solutions...
The company’s products range from diesel, natural gas, electric and hybrid powertrains and powertrain-related components including filtration, aftertreatment, turbochargers, fuel systems, controls systems, air handling systems, automated transmissions, electric power generation systems, batteries, electrified power systems, hydrogen generation and fuel cell products.”
Its biggest customer is a company called PACCAR (PCAR, Financial), which designs and manufactures trucks with Kenworth, Peterbilt and DAF nameplates. It accounted for 15 percent of Cummins’ consolidated net sales in 2018.
Since the demand for automobiles in general, and trucks in particular, fell off after the Covid-19 virus hit, Cummins was affected by the subsequent economic slowdown. North American sales dropped 16% while international sales were off by 17% compared to the first quarter of 2019.
But this 101-year old company was in good shape before the economy slowed and has taken remedial measures to solidify its balance sheet, so unless the industry gets into serious problems, Cummins should survive handily.
In this analysis, we will assume the economic troubles will be a going concern over the next five to 10 years, based on data from the previous decade.
Fundamentals
These are the four fundamentals criteria for the dividend income portfolio stocks:
- Financial strength of at least 6/10
- Profitability rank of at least 7/10
- Predictability rank of at least 2.5 out of 5
- Return on capital (ROC) of at least 10% (10-year median)
Cummins just makes it on financial strength:
As this 10-year chart indicates, the company has stepped up its debt:
While long-term debt has gone up, Cummins can comfortably handle it. The interest coverage ratio is 23.19, meaning it has enough operating income to cover current expenses many times over.
Cummins enjoys a strong profitability rating:
Both the operating and net margins, keys to profitability, have been reasonably steady:
Turning to predictability, Cummins is rated a 4 out of 5, although that rating is under watch. A rating of 4 means the company has been quite consistent in growing its revenues and Ebitda (earnings before interest, taxes, depreciation and amortization) per share over the past 10 years:
The profitability table also shows revenue, Ebitda and EPS (earnings per share) without NRI have all grown by double digits in the past three years.
Finally, in the fundamentals section, the 10-year median ROC (return on capital) must be at least 10%. GuruFocus explains the importance of this metric: “ROC% measures how well a company generates cash flow relative to the capital it has invested in its business. It is also called ROIC%.”
Cummins meets this test. In only one out of the past 10 years has its ROC dipped below 10%; otherwise is has usually been in the 14% to 15% range, with pops to more than 18% and 22%.
Growth
The following are the growth criteria for the dividend income portfolio stocks:
- Five-year revenue growth rate of at least 5%
- Five-year EPS without NRI Growth rate of at least 5%
Judging by what we saw on the Profitability table, Cummins more than met the test over the past three years. To check the five-year growth rates, we examine this chart:
From the chart, we see that a turnaround in revenue and earnings per share without NRI (non-recurring items) took place in the previous five years.
Profitability
The following are the profitability criteria for the dividend income portfolio stocks:
- Operating margin (10-year median) of at least 10%
- Must have been profitable in 10 of the last 10 years
Both the operating margin and the net margin have been relatively stable over the past 10 years, as we saw in the margins chart above.
Again, we see improvements in the past couple of years, particularly in the net margin. The operating margin has been quite consistent at just over 10%.
On the Dividend Income Portfolio screener, we see it has been profitable for all 10 of the preceding 10 years.
Dividends
The following are the dividends criteria for the dividend income portfolio stocks:
- A yield of at least 1.5%
- Five-year yield-on-cost of at least 2.3%
- Dividend payout ratio below 70%
- At least 10 years of dividend increases
Cummins beats the threshold for dividend yield, but how much of the yield is based on the current share price?
The yield has been driven by the share price to some extent. In this case, the share price has recovered from the initial market slump, and that recovery has had the effect of pushing the yield down.
The five-year yield on cost, at 4.8%, also exceeds the requirement of 2.3%. The yield on cost indicates what we might earn, on average, per year, if we bought and held the stock for the next five years, and if management continued to increase dividends at the same rate as it has for the past five years.
The third criterion is a sustainable dividend payout ratio, less than 70% of earnings. At 37%, Cummins is comfortably below the maximum.
Finally, a company must have posted dividend increases for 10 years. As this chart shows, that is true for Cummins:
Gurus
Although guru ownership of a company’s shares is not required for the Dividend Income Portfolio screener, Cummins has 12 of them.
Hotchkis & Wiley held the biggest position at the end of the first quarter. After adding 13% during the quarter, it held 3,132,441 shares, representing 2.12% of Cummins’ shares outstanding and they made up 2.39% of the firm’s portfolio.
First Eagle Investment (Trades, Portfolio) also added Cummins stock during the quarter, increasing its holding by 17.58% to 2,201,444 shares. Bill Nygren (Trades, Portfolio) of the Oakmark Fund reduced his position by 12.38% to end the quarter with 1,472,000 shares.
Valuation
The price-earnings ratio 13.49, which is low compared to its own history and it is at least reasonable when compared with its competitors and peers.
The DCF (discounted cash flow) calculator shows the fair or intrinsic value is $217.22, well above the current share price of $181.71. That means the stock has a 16.35% margin of safety.
Conclusion
Cummins offers investors a set of solid fundamentals at a modest discount from intrinsic value. As such, it is worth considering by investors who want a position in the industrials. Value investors would likely want a larger margin of safety, and the one that emerged briefly in the spring disappeared as the company quickly bounced back from the first stock market decline.
I think ncome investors will likely look elsewhere. Cummins has a strong record of growing its dividends, but it is putting more of its free cash flow into reinvestments.
I do not own shares in any companies named in this article.
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