Cummins Inc. (NYSE:CMI) is a global diesel engine manufacturer. The Company designs, manufactures, distributes and services diesel and natural gas engines and engine-related component products, including filtration, after treatment, turbochargers, fuel systems, controls systems, air handling systems and electric power generation systems.
It has four operating segments: Engine, Distribution, Components and Power Generation. The Company sells its products to original equipment manufacturers (OEMs), distributors and other customers. It serves its customers through a network of around 600 Company-owned and independent distributor locations and around 7,200 dealer locations in more than 190 countries.
In addition, engines and engine components are manufactured by the Company’s joint ventures or independent licensees at its manufacturing plants in the United States, China, India, South Korea, Mexico and Sweden. Its subsidiaries include Cummins India Ltd. and Wuxi Cummins Turbo Technologies Co. Ltd.
As we look at the Large Cap 1000 Screener this week, we can see Cummins has an Acquirer’s Multiple of 8.09 putting it in the top 30 Large Caps.
As you can see from the chart below, Cummins share price has dropped over 33% in the past 12 months, and it’s now trading at around $98, which is great news for contrarian investors!
Source: Google Finance.
Let’s take a closer look at Cummins in the Large Cap Screener.
Cummins currently has a market cap of $17.43 Billion, which is just a fraction higher than its enterprise value of $17.36 Billion.
As of September 2015, the company has cash and cash equivalents of $1.688 Billion and its total debt was just $1.622 Billion, leaving it with positive cash to debt of $66 Million.
Its operating earnings, which are taken from the top of the income statement, are $2.147 Billion.
Therefore, when the divide the enterprise value of $17.36 Billion by the operating earnings of $2.147 Billion we get our Acquirer’s Multiple of 8.09, and an inverse 12.4% earnings yield.
What’s been happening recently at Cummins?
On October 27, Cummins announced it would reduce its worldwide professional work force by up to 2,000 employees in response to lower demand for its products in the United States and key markets around the world. The employee reductions will come from all parts of the company. The company will incur a pre-tax fourth quarter charge in the range of $70 million to $90 million for the headcount reductions. In addition to these reductions, it expects to close or restructure several manufacturing facilities over time which could increase the fourth quarter charge and may result in additional charges in the future.
What’s the outlook for Cummins?
In the near term, Cummins expects demand in the North American medium-duty truck market to remain stable. It also expects North American light-duty demand to remain stable.
The new ISG engine, which began production in the second quarter of 2014 as part of the Beijing Foton Cummins Engine Co., Ltd. joint venture, is expected to continue to gain market share in China in its first full year of production, and demand in India is expected to improve in some end markets as their economy continues to improve.
- Industry production in the North American heavy-duty truck markets is expected to decline
- Power generation markets are expected to remain weak
- Weak economic conditions in Brazil will continue to negatively impact demand across its businesses
- End markets in China to remain weak
- Demand in certain European markets could remain weak due to continued political and economic uncertainty
- Foreign currency volatility could continue to put pressure on its revenues and earnings
- It expects market demand to remain weak in the oil and gas markets as the result of low crude oil prices
- Domestic and international mining markets could continue to deteriorate if commodity prices continue to weaken
So where’s the good news?
Cummins has created a cost advantage moat over its competitors.
Engine maker Cummins currently has around 40% of the North American market.
History tells us that engine design is an extremely difficult business, and its been made even more challenging by having to meet the U.S. Environmental Protection Agency’s emission reduction targets. But so far, Cummins has delivered. These same challenges however, have forced some of Cummins major competitors out of the market.
We saw what happened to Caterpillar Inc (NYSE:CAT), who lost significant market share in the North American heavy-duty engines space. We also saw similar events with Navistar who attempted to build a heavy-duty engine business.
It seems obvious to me that engine manufacturers would need to spend considerable time and money to erode the moat that Cummins has created. The company’s ongoing commitment to R&D has made it the clear winner in meeting emission reduction targets, resulted in significant increases in its market share.
Moreover, as emissions and fuel efficiency targets have become higher, Cummins ability to design both turbocharger and after-treatment engine systems in the same organization also lends itself to greater competitive advantage. The company currently has greater than 70% market share in heavy-duty and medium-duty turbochargers.
As long as Cummins maintains its R&D investment in emissions control technology, this will lead to favorable revenue growth as more countries mandate tougher emissions standards. While North America remains Cummins largest market, faster growing emerging markets account for almost one-third of the company’s revenues.
While global economic weakness has hurt Cummins, the company does appear to be great at innovation, cutting costs and allocating capital. When you combine this with the company’s resilient competitive advantage, Cummins will be able to withstand the short term downturn.
Don’t take my word for it!
According to commentary at Gurufocus, we’re not the only ones that like Cummins right now. The website states that, “Bill Nygren’s most noteworthy third-quarter transaction was his acquisition of a 1,900,000-share stake in Cummins Inc. (NYSE:CMI), a Columbus, Ind.-based heavy equipment company, for an average price of $123.51 per share. The deal had a 1.31% impact on Nygren’s portfolio”.
At Cummins current share price of around $100, this would seem like a much greater discount than what Mr Nygren paid at $123.51.
Now let’s take a look at the numbers:
Acquirer’s Multiple – 8.09
Magic Formula Earnings Yield – 12.4%
P/E – 10.69
P/B – 2.29
P/S – 0.92
ROE – 21%
In terms of valuation, Cummins looks cheap!
How safe is the business?
Cheap is one thing, what we want is a cheap safe investment! So we use some other metrics to determine the stability of the company.
Its Altman Z-Score–a measure of the likelihood that a company will end up in bankruptcy within 2 years–of 4.34 indicates that it is far from financially distressed (greater than 2.6 is considered safe).
Its Piotroski F-Score is 6 out of a possible 9, which is about average for a stable company.
Its Beneish M-Score of -2.57 means it’s not an earnings manipulator (anything greater than -2.22 is good news). From a statistical perspective, it’s not close to financial distress (in fact it’s financially strong), and there’s no indication of earnings manipulation.
So, there you have it. For this investor, Cummins Inc is clearly a great stock to add to your portfolio right now.
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