Cummins Inc. (NYSE: CMI) designs, manufactures, and distributes diesel engines, electric power generation systems, and engine-related products, such as filtration and emissions solutions. Late last Month, Cummins reported its 2Q12 results and the reported EPS of $2.40 was better than the consensus estimates ($2.27) by a fair margin. Despite a 4.5% YoY decline in sales, I am pleased with Cummins’s gross margin of 27.2%. I believe gross margin improvement is a result of productivity improvements and cost reductions in plants, improved pricing, lower warranty and material cost, along with a more favorable product mix. Further, I believe that Cummins will continue to benefit from its geographic diversification and leadership position in a number of end markets. I am optimistic about its long term growth and expect high single digit growth in 2013, driven by a resumption of growth in emerging markets and power generation.
New Regulations Should Enhance Sales
Cummins is the lone integrated provider of diesel engines with a fully-integrated components offering. Government’s increased focus on energy efficiency makes Cummins’ position even stronger. Further, I believe Cummins is well positioned to benefit from tougher standards on heavy-duty trucks in the near future, with its use of SCR technology and its unique subsystems capabilities. I think there is an opportunity for Cummins to raise prices at the OE level as the more sophisticated engine technology is required for integration of the needed efficiency improvements under new regulations.
Navistar deal: A Win for Cummins
Earlier this month, Navistar International Corporation (NYSE: NAV) announced that it will begin using Cummins’ after treatment with their new ICT engine in order to help meet emissions standards for EPA 2010 and upcoming 2014-2017. Also, Navistar will begin offering Cummins’ 15 liter engine along with Cummins’ after-treatment. This presents all new business for Cummins in 2013 and beyond. Navistar trucks equipped with Cummins’ 15‐liter engines will be introduced in January 2013.
I view this agreement as a huge win for Cummins and a step forward for Navistar. I suspect customers will prefer Cummins’ 15 liter engine over the Navistar solution based on the performance of Cummins’ engine and the fact that it already meets EPA standards. I believe there is potential for a secular shift back from the 13 liter to the 15 liter and perhaps some market share opportunity from Paccar and Freightliner to Navistar. Despite some cannibalization from other customers like Paccar Inc. (NASDAQ: PCAR) and Volvo trucks, I believe sales of these engines will provide huge upside to Cummins’s overall revenue.
Cummins’ Footprint in Emerging Markets
I believe Cummins’ geographic positioning is the best in the group enabling it to capture growth opportunities from both cyclical and secular trends in emerging markets (with over 30% of sales coming from emerging markets and low relative exposure to Western Europe). During just the past five years, Cummins has increased its exposure to China, Brazil and India to 20% of total revenue on a 92% increase in net sales. During the same period, net revenues in China increased by 141%. In Brazil, net revenues have grown by 98%. In India, the company grew revenues by 39%. I believe Cummins’s outlook for 2012 seems appropriately conservative, as it no longer appears to anticipate significant end market recovery in the near-term.
Huge Potential for Power Segment
Cummins’ power generation sub-segment is best positioned for the longer-term growth opportunities afforded by inadequate electricity infrastructure in many emerging economies. For example, I believe company is well positioned for a potential increase in standby power generation work in India. Cummins has very high market share in that particular market and while Indian power generation is only about 5% of company revenue, I think there is some opportunity for incremental growth in this end market given recent Indian power issues.
Caterpillar Inc. (NYSE: CAT) has recently announced its impressive July dealer statistics with strong results in Asia Pacific and North America. Caterpillar’s July results have shown the signs of life in emerging markets for heavy industries and I expect that the same impressive trend will be seen in the results of Cummins. Cummins is a diversified global company with strong balance sheet. I like Cummins’s competitive position in the trucking equipment industry and believe Cummins’s position to be the best to capture business in an economic recovery. Thus, I recommend it a buy.
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