Cummins Still Firing on All Cylinders
Keith is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Last week Wells Fargo downgraded Cummins (NYSE: CMI) from an “outperform” rating to “market perform”. Cummins was downgraded based on Wells Fargo’s view that expected NAFTA truck industry production cuts will hurt earnings in the near term and that there were no signs of overall market improvement.
Cummins has been a favorite stock of mine in the past, so I was curious to take another look at the company in light of the downgrade. While the Wells Fargo opinion might be true for the immediate future, I think Cummins is still a great pick for investors. Here are four reasons why.
1. Solid Customer Relationships
Great companies are able to build long term relationships with customers that allow both sides to win. Cummins has accomplished this feat especially well with PACCAR (NASDAQ: PCAR). PACCAR sells trucks under the Kenworth, Peterbilt and DAF brands.
How close is the relationship between PACCAR and Cummins? Pretty tight. Cummins has provided engines to PACCAR for nearly 70 years. PACCAR is Cummins’ single biggest customer and accounted for 12% of sales in 2011, up from 7% in 2010. No other customer is in double digits.
Cummins also has long term agreements with Ford, MAN, and the North American truck divisions of Volvo and Daimler. The company has forged very close business relationships with some of its larger customers. Scania is in two fuel systems joint ventures with Cummins. Cummins also has distribution and manufacturing joint ventures with Komatsu.
Even with some truck companies becoming more vertically integrated and using their own engines, Cummins increased its North American market share in 2011 to over 39%, according to WardsAuto.com. Cummins continues to benefit from the decision by rival Caterpillar (NYSE: CAT) to exit from the truck engine market. The two companies still compete in other markets.
2. Strong Financials
A by-product of keeping customers in its fold is Cummins’ strong financial performance over recent years. Revenues, net income, shareholder equity and operating cash flow are all rising.
Cummins’ return on equity over the past 12 months is a strong 35.58%. The company showed continued strength in its most recent quarter, with revenues growing by nearly 16% compared to the previous year and earnings up nearly 33%.
Cummins has around $1.8 billion in cash and short-term investments. From an investor’s perspective, it has made good use of its cash in the past. Cummins completed a $500 million share buyback in 2011 Q1. A further $1 billion share buyback was authorized in the same quarter, of which over $500 million was completed in 2011. Cummins also increased its dividend by 52% in the latter part of 2011. The forward dividend yield currently stands at 1.7%.
My favorite reason for liking Cummins is its attractive valuation. Its trailing P/E of 9.33 and forward P/E of 8.01 are both at the bottom of the stock’s typical P/E range.
The consensus of analysts is that growth will slow over the next several years to an annual rate of just below 13%. However, even with these slower growth projections the PEG for Cummins is 0.71. This reflects a good potential for upward movement in share prices.
Cummins should see 2012 earnings well over $10 per share. Using a not-too-ambitious P/E multiple of 12 with that EPS would result in a price target of at least $120. Cummins is currently trading at a discount of over 25% to this target.
4. Potential Near-Term Catalysts
I won’t argue with the Wells Fargo opinion about potential slowing in the North American truck market and concerns about the world economy. However, I do think there are some near-term catalysts that could help Cummins.
First, China announced an interest rate cut of 25 basis points last week. This should benefit companies like Cummins who have significant business in China and adjacent Asian markets. I hesitate to state unequivocally that the Chinese rate cut will definitely help Cummins in the short term. There is a possibility that the cut is a precursor to future announcements of worse-than-expected economic news from China. In the longer run, the rate cut is good news.
Second, one of Cummins’ competitors continues to flounder. Navistar (NYSE: NAV) recently announced horrible earnings results. Particularly encouraging for Cummins is that Navistar is struggling with reliability and performance of the engines that it is making on its own. Navistar purchased engines from Cummins in the past, a notable exception to Cummins’ strong track record of customer retention.
Navistar has yet to receive certification from the EPA, although the EPA is allowing Navistar to sell its engines and pay fines for not being certified. A recent Motley Fool commentary sheds even more light on Navistar’s management woes. The situation with Navistar is ugly, but it has Cummins sitting pretty.
Even if the Wells Fargo take on the near term is right, Cummins still appears to be a good opportunity for investors. The company has solid long-term agreements in place with several large customers. Its financial metrics are strong. Best of all, Cummins is valued at a bargain right now. And there are potential short-term catalysts for upward stock movement.
Rather than depend on speculation about what might or might not happen in the next few months, though, I say focus on a company’s long term prospects. Cummins has the technology, management team and track record to power forward. All the signs point to Cummins still firing on all cylinders.
Keith Speights (www.keithspeights.com) has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Cummins and PACCAR Inc. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.