This Steep Sell-Off Creates a Great Buying Opportunity
Neha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If a company cuts back its earnings guidance, I’d usually be ready with my yellow caution tape. But this time, knowing how fundamentally solid this company is, I couldn’t help but take out my research glasses to see if things really are that bad.
Given that I am more interested in long-term prospects than day-to-day meanderings, the sell-off in Cummins (NYSE: CMI) actually seems like a great long-term opportunity to me. No, it isn’t just the 25% increase in dividends I am talking about. There’s a lot more…
Cummins’ business is closely tied to the health of the American trucking industry as it derives more than half of its engine segment sales from the North American market. While things appeared bright with rising freight rates, tonnage and demand for replacement, a sequential decline in truck tonnage over the past two months proved to be a dampener. Nevertheless, tonnage continues to grow on a year-over-year basis. Besides, low fuel price is keeping the retail sales market, which accounts for a good chunk of total truck tonnage, busy. And if we consider the American Trucking Association’s latest forecasts, the trucking industry is headed for golden days in the years to come.
All this tells me how the slowdown seems more of a cyclical phenomenon than a deep-rooted issue. Further, I feel what’s slowing down now (read: emerging markets) will prove to be the driving factor in the future.
Bonds that work
Frost & Sullivan’s latest report forecasts heavy-duty truck production from global platforms to double in the next 5-6 years. If you ask me, I think Cummins is hitting it right by increasing investments in the international markets, which accounted for nearly 60% of its total sales last year. Expansions and contribution from tie-ins took it this far. Having some of the best-known names in the industry as partners definitely helps. One such example is the 50:50 joint venture with India’s leading automaker, Tata Motors (NYSE: TTM). Revenue from this venture has consistently played a crucial role in pushing up Cummins' joint venture income. This, along with other big tie-ins in China and elsewhere, has prompted Cummins to target $17 billion of sales from joint ventures by 2015 -- double of what it achieved last year.
Your pain=my gain
Cummins’ forte also lies in its exemplary planning and execution. An example is the way it has pulled off the uphill task of making its engines compliant with the 2010 emission standards. While peer Navistar International (NYSE: NAV) is bearing the brunt of heavy warranty and repair claims, which are also taking a toll on its bottom line, Cummins' warranty costs hit a 15-year low in 2011.
In fact, Navistar’s pains should easily turn into Cummins’ gains now. With customers losing faith in Navistar’s products, Cummins can strive at a bigger market share. Ironically, Navistar recently agreed to power its new trucks with engines made by Cummins in collaboration with Westport Innovations (NASDAQ: WPRT). With Navistar’s dreams of getting its engines EPA approved hitting the wall, it might turn to Cummins’ engines while trying to pull its act together.
Cummins-Westport engines are anyway emerging as hot favorites in the industry. PACCAR (NASDAQ: PCAR), which is also Cummins’ largest and oldest customer, recently displayed its top brand truck models fitted with the new Cummins-Westport heavy-duty ISX12 G engines, which will go into full production next year. With the natural gas conversion heating up, I see the Cummins-Westport venture as one of the biggest opportunities in the near future.
No scope for complaints
If you thought managerial competency or global presence are Cummins’ only strengths, there’s more. Picture this: a total debt-to-equity ratio of 10.7%, an interest coverage ratio of a whopping 68 times, positive unlevered free cash flow, and cash equivalents of $1.3 billion (as of April 1). That’s Cummins for you.
Such solid financials, and great shareholder returns—where’s the scope for any complaint? Cummins has consistently achieved a return on equity of more than 25% in the past eight quarters. It definitely deserves a pat on the back for achieving this with such low leverage.
A consistent dividend payer, Cummins has increased dividends by more than 125% since 2009. In fact, there’s enough scope to raise payout further (which currently is well below 20%) considering the excellent margin of safety it enjoys. Not to forget the shares repurchases it makes from time-to-time.
Final Foolish thoughts
If Cummins says its 2012 performance will replicate last year’s, it only proves its capability to ride out macro challenges. That’s because 2011 was a record year for Cummins on both top and bottom lines; so achieving the same level despite the headwinds this year is commendable.
Cummins bounced back strongly from the downturn in 2009, and can do it again. Any dip makes it worth adding to your portfolio. If you think differently, share your views in the Comments section below.
Neha Chamaria has no positions in the stocks mentioned above. The Motley Fool owns shares of Westport Innovations. Motley Fool newsletter services recommend Cummins, PACCAR Inc, and Westport Innovations. 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.