Why This Stock Could be One of the Best Upturn Bets

By Neha Chamaria - September 17, 2012 | Tickers: CMI, NAV, PCAR, TTM, WPRT | 0 Comments

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Some say it’s worth it, some say it’s not. With Cummins (NYSE: CMI) trading well over $100 now, bulls and bears seem equally charged. Is the engine maker worth more? Yes, for prudent investment decisions shouldn’t be influenced by temporary hiccups, especially when the stock in question is a cyclical one.

Exceptional growth
Cummins has performed exceptionally well in the past few years. From 2009 to 2011, its revenue nearly doubled to $18 billion, and operating profits more than trebled. The way the company bounced back after the financial crisis proves its underlying strength and resilience.

CMI Revenue TTM data by YCharts

If Cummins’ operational performance looks impressive, its financials are too-good-to-be-ignored. Picture this: a total debt-to-equity ratio of 13%, an interest coverage ratio of a whopping 71 times, free cash flow of nearly $1 billion, and cash equivalents of $1.4 billion (last quarter). How many companies do you know that can boast of such darn good financials? For such low debts, a return on equity of 34% acts like icing on the cake.

One reason why critics don’t give Cummins an all-good score is its low dividend payout of 16%, which I think is unwarranted. The company’s superb margins and heavy cash flows suggest one thing -- there is plenty of room for Cummins to increase dividends in the future. It recently hiked dividends by 25%, which not only doubled its yields to 2% in few months but also brought it more or less in line with peers. Caterpillar and Deere each pay a 2.3% yield, while PACCAR (NASDAQ: PCAR) pays 1.9% yield. Since 2009, Cummins has increased dividends by 150%.   

Crossing boundaries
Cummins has demonstrated excellent commitment to research and development, and innovation over the years. Its capital spending last year was 70% more than 2010 levels as it launched new products and upgraded existing ones to meet emission standards. The engine maker proved itself when its warranty costs hit a 15-year low in 2011, ironically at around the same time when peer Navistar’s (NYSE: NAV) warranty and repair costs hit the roof. This expertise will sure come handy for Cummins as emission norms get tighter in other countries.

Cummins has projected 30% higher capital expenditure this year, with as much as 50% going towards the overseas market. This company is probably one of the best examples of how global expansion can turn fortunes. Over the years, Cummins has particularly achieved a strong foothold in India and China – the two markets also touted to be the top truck markets in the world. Together, the two accounted for 43% of Cummins’ total revenue last year. Consolidated sales in India grew by around 60% from 2009 to 2011, while that in China grew by nearly 90% during the same period. Strong tie-ins and overseas co-operation have been keys.

Cummins’ 50:50 joint venture with India’s leading automaker Tata Motors (NYSE: TTM) that manufactures engines for the latter’s trucks as well as for industrial applications is increasingly playing a bigger role in contributing to Cummins’s joint venture income. With Tata Motors dominating the market with over 60% share and sale of trucks in India projected to double by the end of the decade, Cummins should only grow bigger. 2012 marks 50 years of Cummins operations in India.

In China too, the company has joined hands with some of the biggest names in the truck and engine markets. After writing success stories in these markets, Cummins is now expanding into Russia, Africa, Turkey, and Indonesia. With the BRIC markets accounting for nearly 75% of truck sales globally, Cummins’ plans seem bang on target.

The best of the lot
But probably the tie-in that stands out and ups the ante for Cummins is its long-standing partnership with Westport Innovations (NASDAQ: WPRT), the company with the unique natural-gas engine technology. While Cummins doesn't provide a breakdown of earnings from this partnership, Wesport's financials show how the alliance is contributing more than 50% to its top line and is also its most profitable segment.

Shipments from the Cummins-Westport partnership are increasing with growing demand for their engines. Cummins’ largest and oldest customer, PACCAR, will fit its next-generation trucks with Cummins-Westport heavy-duty ISX12 G engines that will go into full production next year.  Navistar (NYSE: NAV) recently got added to the list when it announced plans to go for Cummins-Westport engines as well.

In fact Navistar is actually one reason why you should buy Cummins. After the embarrassing mess-up the former got into with its engine-certification dreams, it has no option but to adopt Cummins’ engines while it gets its act together. Which means Cummins can not only win over Navistar’s customers, but have the company itself as its customer now! If that’s not a double treat, what is?

So, what now?
That Cummins is a fundamentally solid company is clear, but the million-dollar question now is if it’s a buy at current prices. The stock has generated highest returns among peers, and is still well off its 52-week high. More importantly, at around 10, Cummins’ P/E ratio is hovering near its low point of last five years.

CMI Total Return Price data by YCharts

CMI PE Ratio data by YCharts

The bottom line
Cummins will be a big beneficiary as natural gas conversion gathers steam, more so as it is even developing its own 15-liter now. Business cyclicality has its downs, but Cummins’ long-term story remains intact. When critical markets bounce back, this company will definitely be a runway hit. If you can withstand short-term volatility, Cummins won’t fail you.

There’s another reason to like Cummins. Our experts have chosen it as one of four stocks that could jump after the presidential election because of its advances in low-emissions technology that make it a winner in any new clean-energy policy. To find out what the other three stocks are and what the political parties like about them, click right here to access out new special free report: "These Stocks Could Skyrocket After the 2012 Presidential Election."

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