Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report:4Q17 & FY17 Earnings Update
Previous Edition:4Q17 Earnings Flash Update, Feb 6, 2018
Brokers’ Recommendations:Neutral: 70% (14firms); Positive: 25%(5);Negative:5%(1) Prev. Ed.:12; 4; 4
Brokers’ Target Price: $184.8 (↑ $6.7 from last edition; 15 firms) Brokers’ Avg. Expected Return: 18.9%
Portfolio Manager Executive Summary
Cummins Inc. (Cummins or the company) is a leading worldwide designer, manufacturer and distributor of diesel and natural gas engines, electric power generation systemsand engine-related components, fuel systems, controls and air handling systems.The company’s customer base comprises leading vehicle manufacturers, including Chrysler LLC, Daimler AG, Volvo AB, PACCAR Inc., Navistar International Corporation, CNH Global N.V., Komatsu, Scania AB, Ford Motor Company and Volkswagen.
Of the 20 firms in the Digest group covering the stock, 14 provided neutral ratings, fiverendered positive andone assigned negative ratings.15firms among these provided target prices.
Neutral or equivalent outlook (70%; 14/20firms): These firms are concerned about the company’s dependence on NAFTA Class 8 truck demand, as well as non-NAFTA on-highway end market demand.The company has increased the fiscal guidance due to increased demand in markets, which are highlydependenton oil and gas price fluctuations. However, the firms expect Cummins to benefit from the new truck emission standards as this will lead to increased demand for more fuel-efficient, emissions-compliant engines.The other tailwinds include expansion in India and increasing penetration in China. The company will also gain from its focus on cost reduction and completion of acquisitions in the North American distribution business.The company is actively pursuing significant restructuring actions, resulting in strong margin performance.
Positive or equivalent outlook (25%; 5/20firms): The bullish firms believe that because of Cummins international presence, it is poised to benefit from the global economic growth, specifically in the emerging markets. The firms also believe that distributor acquisitions and increase in off-highway demand will also help the companyoutperform. Further, improvement in NAFTA truck demand will also boost the company’s performance. These firms also recognize the strength of Cummins’ distribution network,which should help boost sales. They further believe that the performance of the company’s Engine business will be driven by the rising demand for medium- and heavy-duty trucks. Also, strict global emission regulations shoulddrive the sales of filtration and engine components and lead to higher demand for efficient, emission-friendly engines. Moreover, lower tax rates due to US Tax Cut and Job Act, along with reduced interset expense anticipation, is likely to benefit its financials.
Negative or equivalent outlook (5%; 1/20 firms): The bearish firms are of the opinion that the company will be affected by persistent weakness in NAFTA truck orders. The company may also be affected bylack of recovery in the off-highway market.The financial impact of acquisitions seems to be very small, at least in FY18.Profitability is anticipated to be down owing to volume and inflation headwinds.
Mar 23, 2018
Overview
Cummins Inc. is a leading global designer, manufacturer and distributor of diesel and natural gas engines, electric power generation systems plus engine-related components, fuel systems, controls and air handling systems. Headquartered in Columbus, IN, the company serves customers through a network of 600 company-owned and independent distributor facilities and over 7,400 dealer locations across190 countries and territories.
Cummins has the following four operating segments:
The Engine segment(contributed 34% in the total sales of FY17) produces and markets a wide range ofdiesel and natural gas powered engines. Its customers consist ofheavy, medium-duty trucks, light-duty automotive and off-highway markets. The engines are used in trucks, buses, recreational vehicles and various industrial applications such as construction, mining, agriculture, marine, oil and gas, rail and military.
The Power Systemssegment(16%) consists of three product lines namely Power generation, Industrial and Generator technologies. This segment engages in designing, manufacturing and selling of power generators, high-horsepower engines and alternator products for external generator set assemblers.
The Componentssegment(23%) has four businesses: Filtration, Turbo Technologies, Electronics and Fuel Systems, Automated transmissionsand Emission Solutions.This segment offers products that complement its Engine and Power Systems segments. Few of its products include filtration productsfor industrial vehicle applications and on- and off-highway heavy-duty and medium-duty equipment.
The Distributionsegment (27%) includes wholly and partially-owned distributorships engaged in wholesaling engines, generator sets and service parts, along with servicing and repairing the company’s products and maintaining relationships with original equipment manufacturers (OEMs) globally. The company’s distributors serve a diverse customer base with 38% of revenues generated from the selling of new engines, power generation equipment and the remaining from parts and service repairs.
The analysts identified the following factors for evaluating the investment merits of Cummins:
Key Positive Arguments / Key Negative Arguments- New Emission Standards: The company is expected to benefit from new emission standards, fuel economy improvement and favorable trends for the Power Generation business.
- New Products:Results of the company should be favorably impacted by new product launches, including light-duty engines in the United States and China plus engines that meet the onand off-highway emission standards in the United States and Europe over the next few years.
- Share Repurchases: Cummins pursues an aggressive share repurchase policy thatshould lead to growth in earnings per share.
- Strong Competition: Cummins faces a strong competition from big companies such as Caterpillar and Navistar.
- Macroeconomic Environment: Theunfavorable macroeconomic environment in Brazil is taking a toll on Cummins.
Further information on the company is available at
Note: Segment sales do not add up to 100% due to inter-segment sales and profit in inventory eliminations and unallocated corporate expenses.
Note: The company’s fiscal year ends on Dec 31.
Mar 23, 2018
Long-Term Growth
Per the firms, stringent emission standards and increased demand for power generation products will facilitate the company’s growth in the next few years.
The firms think that Cummins has an effectivepricing strategy and follows tight cost-control measures. As a result, it is capable of successfully mitigating the impact of higher commodity costs, incremental labor and higher incentive costs in the long run.
In terms of sustainability, the company has been performing quite well by achieving its targets. It reached its 2016 goal to lower water use by 13 million gallons from the 2015 level. For the same period, the company was able to raise health and safety training hours by 20%. After reaching its previous targets successfully, the company has now set up new goals for 2020 in those areas.
Cummins is positioned to benefit from several trends, such as new emission standards, fuel economy improvement (i.e., light-duty diesel penetration) and favorable trends in its Power Generation business (i.e., increased demand for electricity against either aging or insufficient grid capacity). New emission regulations, in particular, create opportunities for the company, such as the ability to raise prices, market share gains (as some competitors cannot implement the new regulations) and increased engine content. The Power Generation segment is expected to be profitable in the long run owing to the rising demand for energy. In addition, the company’s expansion strategy in the international markets will be supported by its owned distribution centers around the world.
The firms believe that the company will benefit from strong demand for high-horsepower engines over the long term.These engines are expected to capture greater share in the off-highway markets. Additionally, the continuous development of new technologies will positively impact the company’s results.Cummins is positioned to benefit from its innovative products.In addition, the company has the potential to benefit from the higher use of its engines by a number of OEMs.
Mar 23, 2018
Target Price/Valuation
Provided below is a summary of target price/valuation, compiled by Zacks Digest:
Rating DistributionPositive / 25%↑
Neutral / 70%↑
Negative / 5%↓
Avg. Target Price / $184.8↑
Digest High / $215↑
Digest Low / $159↑
Upside from Current / 18.9%↑
No. of Analysts with Target Price/Total / 15/20↑
Risks to the target price include a stalled recovery in the truck, power generation, or industrial markets; exposure to many cyclical and mature end markets; an unexpected, severe or prolonged slowdown in global infrastructure spending, global mining, oil and gas production; inability of the company to pass along raw material price increases to customers; interruptions in the manufacturing supply chain (i.e., labor, quality, raw material supply, etc.) and the inability to successfully integrate an acquisition.
Mar 23, 2018
Recent Events
On Feb 13, 2018, Cummins’ board members approved a quarterly dividend of $1.08 per share. The cash dividend was paid on Mar 8, 2018, to shareholdersof record as of Feb 23, 2018.
On Feb 6, 2018, Cummins announced 4Q17 earnings results. Highlights are as follows:
- Operating income was $595 million compared with $507 million in 4Q16.
- Earnings per share (EPS) were $3.03compared with$2.25 in 4Q16.
Revenues
Cummins’ revenues rallied 22% year over year to $5.48 billion in 4Q17 from $4.5 billion in 4Q16.The figure also beat the Zacks Consensus Estimate of $5.2 billion.The year-over-year rise was owing to increased demand for trucks, construction and mining equipment. Also, sales inboth North America and international markets rose 22%.
Segment Details
Revenues in the Engine segment rose 16% to $2.3 billion,owing to 14% growth in on-highway revenues and 27%in off-highway revenues, resulting from the escalated demand in global truck and construction market.
Revenues from the PowerSystemsbusiness jumped 18% to $1.1 billion on the back ofgrowing demand from mining and oil and gas markets.
Revenuesfrom the Component segment surged 32% to $1.6 billion, mainly on35% revenue growth in North America and China.
Revenues from the Distribution segment gained16% to $1.9 billion.The increase was driven by 21% rise in North America’s revenues and 7% increase in international markets.
Full-Year 2017
Consolidated revenues rose to $20.43 billion, up from $17.5 billion in the prior year.
Outlook
For FY18, Cummins expects revenues to rise by 4-8% compared with the prior guidance of 14-15% increase in revenues.
According to the bullish firms,global growth will lead to future spending on infrastructure, which should driveengine sales.With an aging truck fleet in the U.S., demand for the replacement of parts has been increasing. Further, the firms believe that a rise in overall truck demand will drive considerable growth at Cummins’ Engine segment.
According to a few firms, results will be favorably impactedbyCummins’ superiortechnology which promises quality, reliability and performance.In addition,increasing demand for clean, fuel-efficient and high-performing diesel and natural gas engines, owing to the stringent environmental regulations for on-highway and off-highway commercial vehicles, will boost results. Product introductions and distributor acquisitions will also help drive results. The other tailwinds include expansion in India and increasing penetration in China.
However, some of the firms are also apprehensive about the power generation and Industrial Engine markets as well as the emerging markets where demand remains soft.
Margins
Cummins’ gross profit increasedto $1.37 billion in 4Q17 from $1.1 billion in 4Q16.Cost of salesincreasedto $4.1 billion from $3.4 billion in 4Q16.
Selling, general and administrative expensesgrewto $633 million from $519 million in 4Q16.
Research, development and engineering expensesclimbed to $207million from $158million in 4Q16.
Operating incomesurged to $595million from $507million a year ago. Earnings before interest and taxes (EBIT) rose to $596 million from $508million a year ago.
Segment Details
Engine Segment:The segment’s EBIT improved to $244 million (9.8% of sales) from $194 million (9.9% of sales) a year ago.
Power System:The segment’s EBIT increased to $95 million (8.6% of sales)in 4Q17 from $68 million (7.3% of sales) in 4Q16.
Components:The segment’s EBITwas $168 million (10.8% of sales) compared with the 4Q16 figure of $140 million (11.9% of sales).
Distribution:The segment’sEBIT decreased to $97 million (5 % of sales) from $122 million (7.3% of sales) a year ago.
Full-Year 2017
Cummins gross profit increased to $5.1 billion in FY17 from $4.5 billion in FY16. Cost of sales increasedto $15.3 billion from $13.1 billion in FY16.
Selling, general and administrative expenses grew to $2.4 billion from $2 billion in FY16.
Research, development and engineering expenses climbed to $752million from $636 million in FY16.
Operating income surged to $2.4 Billion from $1.9 Billion in FY16. Earnings before interest and taxes (EBIT) rose to $2.4 Billion from $1.9Billion a year ago.
Outlook
The company projectsEBIT guidance for FY17 in the range of 5.8-16.2%, an increase from the previous projection of 11.8-12.2%.
The firms expect margins to improve on higher volumes and the company’s cost-cutting initiatives.However, the cautious firms are concerned about increased investments in the research and development area of engines for the fulfillment of emission standards anddemand for higher fuel efficiency.
Earnings per Share
Cummins’ adjusted earnings per sharewere $3.03in 4Q17, beating the Zacks Consensus Estimate of $2.65. The company’s bottom line was $2.25 in 4Q16.
Full-Year 2017
Cummins reported adjusted earnings of $5.97 per share in 2017, down from $8.23 earned in FY16.
Outlook
Some firms expect earnings to declinedue to weakness in the company’s end-markets and competitive pricing.Further, the cautious firms are concerned about uncertainty in emerging markets.Some firms believe that weakness in the construction, mining and power generation markets will act as headwinds to the company’s overall growth.
Mar 23, 2018
Analyst / Gargi Dam KanunjnaCopy Editor / Sreya Mukherjee
Content Ed. / Sanjoy De
Lead Analyst / Sanjoy De
QCA / Anindya Barman
No. of brokers reported/Total brokers / 15/20
Reason for Update / 4Q17 & FY17 Earnings Update
Zacks Investment ResearchPage 1