The Way to Profit From Infrastructure Spending

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Between the steadily improving U.S. economy and increased demand from emerging markets, there should be a rise in infrastructure and construction spending in the years ahead. There are several ways to play this trend, such as materials companies, homebuilders, construction retailers, etc., but my favorite way is through heavy machinery manufacturers such as Cummins (NYSE: CMI). With the company set to report its second quarter earnings on Tuesday, July 30, now is a great time to take a look at Cummins to see what we should pay attention to during the earnings call. We’ll also look at a couple of alternatives to keep an open mind about others in the sector.

A bit about Cummins

Cummins makes and services diesel and natural gas engines as well as power generation systems. The company produces diesel engines for such companies as Chrysler (the Ram Trucks diesel option), Volvo, Navistar, Komatsu, and Ford, just to name a few. 

Cummins makes the majority (53%) of its revenue from engine sales for applications including trucks, buses, RVs, agricultural and construction vehicles, marine, and railroads. The company produces engines of a huge range of sizes and capabilities, with horsepower ratings from 31 to 3500. The rest of Cummins’ business is derived from power generation products (12% of sales), components (16%), and its distribution network (19%). 

The numbers and what to watch for

Despite a few ups and downs, Cummins is pretty flat for the year in terms of share price. Shares trade for 14.7 times this year’s expected earnings of $7.90 per share, and the company’s profits are projected to grow nicely over the next few years.

<img alt="" src="http://g.fool.com/editorial/images/60667/cmi-6-month_large.png" />

So, where is this growth going to be coming from? Well, first of all, Cummins is seen as the leader in truck engine technology, which should give the company an advantage in emerging markets. More than half of Cummins’ sales currently come from outside of the U.S., and the company should continue to have success as countries such as China and Brazil increase their infrastructure investments over the next few years. During the earnings call, any discussion of infrastructure spending or emerging market trends will be the key points going forward, even more important than whatever the current earnings figures turn out to be.

If all goes well, analysts are very optimistic on Cummins and the consensus calls for earnings to grow to $9.55 per share next year and $11.24 in 2015. This translates to year-over-year earnings growth of 21% and 18%, respectively, and makes the current P/E look downright cheap. Add into the equation that Cummins has an excellent balance sheet with net cash (cash minus debt) of almost $1 billion, and it is hard to make a case that shares are not attractively priced right now.

Competitors

There are very few “direct” competitors to Cummins, but there are a few that are similar in nature. Caterpillar (NYSE: CAT), for example, was more of a threat to Cummins in the past, but exited the on-highway truck engine market in 2009. The company has since ventured back into the truck market a bit, but makes the majority of its money from off-highway applications, and is in fact the world’s largest maker of earthmoving equipment. Caterpillar has underperformed so far in 2013, primarily due to weakness in demand for the company’s mining products, but is starting to look like a good value again.

Caterpillar 6-month chart:

<img alt="" src="http://g.fool.com/editorial/images/60667/cat-6-month_large.png" />

Yet another alternative is Deere & Co. (NYSE: DE), the world’s largest producer of farm equipment. On paper, Deere is actually the cheapest of the three at just under 10 times this year’s expected earnings. While the forecast for farm equipment demand is pretty strong, investors should keep in mind that they have the added risk of being dependent on a much narrower range of product applications than the other two companies. The company also carries slightly higher debt levels than the others, which isn’t terribly significant but worth taking into account when valuing the company.

Final Thoughts

Any of the three companies mentioned would make an excellent play on the increase in global infrastructure that is projected to take place over the next decade and beyond. I prefer Cummins due to its perception as the technology leader, but I would wait until after earnings before jumping in. Who knows, any weakness in this year’s numbers, while pretty insignificant to the big picture could create an even better entry point.

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Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Cummins. The Motley Fool owns shares of Cummins. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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