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Equity Research / CMI | Page 6

Cummins Inc.

/ (CMI-NYSE)
Equity Research / CMI | Page 6
Current Recommendation / NEUTRAL
Prior Recommendation / Underperform
Date of Last Change / 04/03/2014
Current Price (04/02/14) / $149.34
Target Price / $157.00

SUMMARY

We are upgrading our recommendation on Cummins to Neutral based on higher revenues and earnings before interest and taxes (EBIT) margin guidance for 2014 as well as its innovative products. However, weakness in operating markets and high competition are downsides. Cummins posted earnings per share of $1.94 in the fourth quarter of 2013, lagging the Zacks Consensus Estimate of $1.98. Revenues rose 6.9% year over year to $4.6 billion, surpassing the Zacks Consensus Estimate of $4.3 billion. For 2014, Cummins expects revenues to increase 4% to 8% and EBIT margin to be in the 12.75–13.25% range in 2014. Cummins also anticipates that earnings will increase at a faster pace than revenues.
Equity Research / CMI | Page 6

SUMMARY DATA

52-Week High / $149.34
52-Week Low / $103.66
One-Year Return (%) / 34.37
Beta / 1.81
Average Daily Volume (sh) / 1,240,142
Shares Outstanding (mil) / 185
Market Capitalization ($mil) / $27,628
Short Interest Ratio (days) / 2.29
Institutional Ownership (%) / 88
Insider Ownership (%) / 0
Annual Cash Dividend / $2.50
Dividend Yield (%) / 1.67
5-Yr. Historical Growth Rates
Sales (%) / 12.1
Earnings Per Share (%) / 34.9
Dividend (%) / 36.3
P/E using TTM EPS / 19.9
P/E using 2014 Estimate / 16.9
P/E using 2015 Estimate / 14.0
Zacks Rank *: Short Term
1 – 3 months outlook / 3 - Hold
* Definition / Disclosure on last page
Risk Level * / Below Avg.,
Type of Stock / Large-Growth
Industry / Engines-Int Cmb
Zacks Industry Rank * / 105 out of 267

OVERVIEW

Cummins Inc. is a leading worldwide designer, manufacturer and distributor of diesel and natural gas engines, electric power generation systems, and engine-related components, fuel systems, controls and air handling systems. Headquartered in Columbus, IN, the company serves more than 190 countries through its network of 600 company-owned as well as independent distributor facilities and more than 6,800 dealer locations.

Cummins sells its products to original equipment manufacturers (OEMs), distributors and other customers worldwide. The company’s customer base comprises leading manufacturers, namely, Chrysler LLC, Daimler AG, Volvo AB, PACCARInc., Navistar International Corporation, CNH Global N.V., Komatsu, Scania AB, Ford Motor Company and Volkswagen.

Cummins has four operating segments: Engine, Power Generation, Components and Distribution.

· The Engine segment: The segment contributed 47.8% of net sales in 2013. Under this segment, the company produces engines and parts for sale to customers in on-highway and industrial markets. The engines are used in trucks of all sizes, buses and recreational vehicles, as well as various industrial applications including construction, mining, agriculture, marine, oil and gas, rail and military. The principal customers of the heavy and medium-duty truck engines include truck manufacturers such as PACCAR, International Truck and Engine Corporation (Navistar International Corporation), Volvo Trucks North America, Daimler Trucks North America (formerly FreightlinerLLC), Ford and Volkswagen AG. Cummins also sells industrial engines to manufacturers of construction, agricultural and marine equipment, including Case New Holland, Komatsu, Hitachi, Ingersoll Rand, Brunswick and Terex. The principal customers of the light-duty on-highway engines are Chrysler and manufacturers of Recreational Vehicles or RVs (vehicles equipped with living space and amenities found in a home). The company’s competitors for the segment in North America are CaterpillarIncorporated, Detroit Diesel Corporation, Volvo Powertrain and International Truck and Engine Corporation (Engine Division). Other engine manufacturers in international markets include Mercedes Benz, Volvo, Renault Vehicles Industrials, Scania, Weichai PowerCompany, Nissan Diesel MotorCompany, Yanmar and Deutz.

· The Power Generation segment: This segment represented 12.5% of net sales in 2013. Cummins is an integrated provider of power systems. The segment sells engines, generator sets, alternators and rents power equipment for both standby and prime power uses. Cummins’ power generation products are marketed under four brands – Cummins Power Generation, Cummins Generator Technologies and Cummins G-Drive for the commercial products and projects, and Cummins Onan for the consumer products. Both include diesel, natural gas, gasoline and alternative-fuel electrical generator sets for all market segments including; commercial, telecommunications, data centers, office buildings, hospitals, factories, municipalities, utilities, universities, recreational vehicles (RVs), boats and homes. The company is a world leader in auxiliary generator sets for RVs, commercial vehicles and recreational marine applications. Cummins’ customer base for power generation products is highly diversified, with varying customer groups based on power needs. India, the Middle East, the U.K. and Western Europe are four of the company’s largest geographic markets outside North America. This segment competes with a variety of engine manufacturers and generator set assemblers across the world. CaterpillarIncorporated, Tognum and Mitsubishi remain the company’s primary competitors, but Cummins also competes with FG Wilson (Caterpillar group), Kohler, SDMO (Kohler group), Generac and numerous regional generator set assemblers.

· The Components segment: This segment formed 18.2% of net sales in 2013. The segment has four businesses, namely, Cummins Filtration, Cummins Turbo Technologies, Cummins Fuel Systems and Cummins Emission Solutions. The company manufactures filtration and exhausts systems for on- and off-highway heavy-duty equipment and supplies filtration products for industrial and passenger car applications. Under the filtration business, the company supplies filtration, exhaust, coolant and chemical products including air, coolant, fuel and hydraulic filters, antifreeze and coolant additives, catalysts, particulate filters and controllers. The products are sold in five continents. The company also makes products for the automotive specialty filtration market and the industrial filtration market through the Kuss subsidiary. Turbo technologies designs, manufactures and markets turbochargers for commercial and light-duty diesel applications from manufacturing facilities in five continents, and sales and distribution worldwide.

· The Distribution segment: The segment generated 21.5% of net sales in 2013. It includes wholly owned and partially owned distributorships engaged in wholesaling engines, generator sets and service parts, as well as servicing and repairing the company’s products and maintaining relationships with various OEMs throughout the world. The segment consists of 18 company-owned and 18 joint venture distributors that distribute the entire range of Cummins’ products and services to end users at approximately 300 locations in over 70 countries and territories. Cummins’ company-owned distributors are located in key markets, including India, China, Japan, Australia, Europe, the Middle East, South Africa, Brazil, North America and Russia. The company’s distributors collectively serve a highly diverse customer base with more than 50% of revenues coming from wholesaling of new power equipment (engines and power generation equipment) and the remaining portion consisting of parts and service repairs. In 2008, Cummins purchased the majority of the interest in three previously independent North American distributors and an equity interest in another North American distributor to increase the company’s ownership interests in key distribution channels.

Cummins also has joint ventures and partnerships with large automakers in the emerging markets including Tata Motors in India, Dongfeng and Foton in China and Kamaz in Russia.

REASONS TO BUY

Ø Cummins is positioned to benefit from its innovative products. In Sep 2013, the company launched the G Series platform, a global heavy-duty engine platform that is expected to meet the global market demands and emission standards both on- and off-highway. In Oct 2013, it announced the launch of a new a 5-liter V8 diesel engine, ISV5.0, which will offer enhanced fuel efficiency and performance and help reduce emission in power pickup-and-delivery vehicles, other light- and medium-duty trucks, school buses. Cummins’ ISV5.0 engine offers better performance, at lower total cost of ownership, to customers in North America. In Nov 2013, Cummins’ Power Generation segment introduced a range of QuietConnect and PowerConnect generator sets that run on natural gas or liquid propane. These sets, suitable for residential and light commercial operations, are in line with the current emissions standards and offer fuel efficiency. They are also easy to install and noise free. In Jan 2014, Cummins started producing 6-cylinder engines certified to meet the U.S. Environmental Protection Agency (EPA) Tier 4 Final regulations effective from Jan 1, 2014, equivalent standards in Canada and Stage IV in Europe.

Ø Cummins expects to achieve revenues of $25–$31 billion by 2018. The company also projects an EBIT range of 16–18% by 2018. For 2014, Cummins expects revenues to increase 4% to 8% due to the impact of acquisitions, higher market share in the North American medium duty truck and bus markets, higher demand in the North American heavy duty truck market and increased content in European truck markets related to Euro 6 emission regulations. The company also expects its 2014 EBIT margin to be in the 12.75–13.25% range. Cummins also anticipates that earnings will increase at a faster pace than revenues.

Ø Cummins has the potential to benefit from higher use of its engine by a number of OEMs, including Nissan and Navistar. Cummins’ 5.0L V8 Turbo Diesel engine will be featuring in Nissan’s next-generation full-size Titan pickup truck. Further, Scania will be using Cummins’ ISB engine in bus applications in Europe.

REASONS TO SELL

Ø Weakness in the operating markets is marring results of the company. Cummins is witnessing a challenging situation in India, Australia, Mexico and Europe, which led to a 4% decline in international revenues in 2013. Revenues from India declined 20% in 2013 due to weak demand and depreciation of Rupee against the U.S. Dollar. Revenues from Europe fell 3% due to a decline in Power Generation revenues. Revenues from India are expected to remain flat in 2014. Demand from Europe-based Power Generation customers is also expected to remain weak in 2014, while the Euro zone revenue is expected to remain flat. Engine shipments are expected to decline between 10% and 20% in 2014.

Ø Cummins operates under a highly competitive environment. Moreover, new technologies, including those developed for gasoline, will provide further competition for the company.

Ø Cummins’ adjusted earnings dropped 11.9% year over year to $7.52 per share in 2013. Lower global demand for power generation equipment and high horsepower engines and weak industry orders for North American heavy duty trucks led to a fall in the EBIT margin to 12.5% in 2013 from 13.6% in 2012. EBIT margin in the Power Generation business fell 2 percentage points to 7.2% due to weak demand. Revenues for full-year 2013 decreased marginally to $17.30 billion from $17.33 billion in 2012.