Investment overview
Cummins Inc. (CMI, Financial), which produces diesel and natural gas engines and engine-related components, has been a value creator for investors on a consistent basis.
Cummins has created value through stock upside, high dividend payouts and share repurchases. Year to date, the stock is 21% higher and the company recently announced its decision to increase quarterly dividends to $1.08 per share (previously $1.02 per share).
The stock will continue to move higher backed by steady growth and increasing dividends. At current dividend payout (annual) levels of $4.32 per share, Cummins is worth holding for dividend investors.
Emerging markets: key growth drivers
From a geographical perspective, the biggest chunk of revenue for Cummins comes from the U.S. and Canada (57% in first-quarter 2017). Europe is the next biggest revenue contributor with 12% in the first quarter.
For the next five to 10 years, however, growth is likely to be driven by Asia Pacific, Latin America and Africa. China currently contributes 9% of sales while India’s contribution is 4%. These two countries will be key revenue drivers in the future.
In the engines segment, Cummins reported 2% sales growth for the quarter as compared to first-quarter 2016. This growth was driven by an 11% increase in international revenues (primarily in China), which was partially offset by a decline in North America. With key reforms undertaken in India, it would not be surprising to see the country become a key growth driver in the next 12 to 24 months.
The components segment reported a 9% increase in sales for first-quarter 2017 as compared to first-quarter 2016. This was primarily driven by a 60% increase in revenue from China, partially offset by a 2% decline in revenue from North America.
The key point from these numbers is revenue from the U.S. and Canada might remain flat or see marginal growth, but revenue from Asia will be a key growth driver. India and China are likely to have a higher share of total revenue in the coming years, ensuring dividends remain robust.
Recovery in oil and gas
The company’s power system segment clocked revenue of $882 million for the first quarter, a 9% increase from the prior-year quarter. The growth in revenue was primarily due to an increase in engine and aftermarket sales in the mining and oil and gas markets.
It is important to note the oil and gas sector has seen gradual recovery, which I expect to sustain in the coming quarters. At the same time, growth has bottomed out in China. I believe this will support the mining sector.
Therefore, the power system segment can be a potential growth driver for Cummins in the near future. And even if oil trades at $55 to $60 per barrel, the oil and gas industry will see strong growth traction. This will likely support revenue growth in this segment.
Attractive valuations
According to analyst estimates, Cummins is currently trading with a 2017 price-earnings (P/E) ratio of 17.6 and fiscal 2018 P/E ratio of 15.7. I believe the company’s valuation is attractive for several reasons.
First, broad market valuations are stretched. For a stock with solid fundamentals, a P/E ratio of 15.7 for 2018 is attractive.
Second, Cummins offers a current dividend payout of $4.32 per share. Considering robust dividends and continued share repurchases, the company’s valuation is attractive for fresh exposure at current levels.
Third, Cummins has seen decent growth in several segments in the first quarter. This growth has been backed by increased sales in emerging markets coupled with some recovery in the oil and gas and mining industries. If this trend sustains, the company deserves higher valuations.
Concluding thoughts
As broad market valuations look stretched, it makes sense to consider exposure to stocks with solid fundamentals and still look attractive from a valuation perspective.
Cummins has an attractive dividend payout, so even if the stock remains sideways, investors are rewarded through dividends and share repurchases. Regardless, I believe the stock has upside potential in the next 12 to 24 months.
Disclosure: No positions in the stock discussed.
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