Under the Microscope: Cummins Incorporated
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Cummins Incorporated (NYSE: CMI) was founded in 1919, as Cummins Engine Company, by Clessie Cummins. The company struggled until 1929 when Clessie Cummins took William Glanton Irwin, a local banker and investor, for a ride in America's first diesel-powered automobile. Irwin displayed great enthusiasm for the new engine and provided a much-needed cash infusion to the company. In the years after the cash infusion, Cummins went on to set a number of speed and endurance records using its diesel-powered engines.
In the 1950s, the United States embarked on a most ambitious goal of constructing a highway system connecting the east and west coasts. Cummins, by that point a leader in diesel-powered engines, was there to help. Its engines were used, not only in the large fleet of construction trucks building the highways, but also in those vehicles traveling along the new highway system. As the company grew in both popularity and reliability, it looked to expand outside the United States, opening its first foreign manufacturing facility in Shotts, Scotland, in 1956. Just 15 years later, the company had expanded to 2,500 dealers in 98 countries. Today, the company operates in more than 197 countries and maintains a large portfolio of diversified products.
For a full background on the company, including many cool videos of their products, click here.
Cummins maintains a vast portfolio of diversified products, ranging from various engine and power generation components, to fuel systems, generators, filtration devices, and, of course, their diesel engines. The company's products are found not only in pick-up trucks and 18-wheelers, but in emergency vehicles, mining haul trucks, and maritime vessels.
To reduce the cyclical and capital intensive nature of its product lines, Cummins created a world-wide distribution service consisting of 17 company-owned distributors and 10 joint ventures, which are engaged in 90 countries. The company uses this distribution service to sell business solutions, maintenance contracts, engineering services, as well as customized integrated products. For a full list of the company's product lines, click here.
Current Chairman and CEO, Tom Linebarger, joined the company in 1994, working in various capacities which included Program Manager, Vice President, Chief Financial Officer, President, and Chief Operating Officer. Linebarger attained the position of Chairman and CEO in January of 2012. With two decades of experience and commitment to the company, I believe Linebarger was a great choice to fill this critical position. A complete list of Mr. Linebarger's accomplishments and positions can be seen here.
Marya Rose currently holds the position of Chief Administration Officer, having received the position in August of 2011. Rose joined Cummins in 1997, serving in the positions of Corporate Counsel, Director of Public Relations, and Corporate Secretary. A complete list of Mr. Rose's accomplishments can be seen here.
Pat Ward is the current Vice President and Chief Financial Officer, having received the position in May of 2008. Ward joined the company in 1987, working in various capacities to include Plant Accounting Manager, Group Accounting Manager, and Executive Director - Engine Business Controller. A complete list of Mr. Ward's accomplishments and positions can be viewed here.
The individuals who comprise the company's current management team each have 15 years or more working for the company and operating in various capacities. I often find that companies which promote senior leadership from the inside tend to have strong management teams and are able to execute the business properly.
Cummins faces competition from a number of worthy companies, to include Caterpillar (NYSE: CAT), United Technologies (NYSE: UTX), and Navistar International (NYSE: NAV) to name a few. Caterpillar, the largest of the three mentioned competitors, reported record-breaking 2011 sales and revenues of $60.138 billion, a 41 percent increase from the year prior. Caterpillar also raised their 2012 sales and revenues outlook to $68-$72 billion. United Technologies, on the other hand, has seen increases in sales and earnings, but not on the scale of Caterpillar, posting only a 7 percent increase in fiscal year 2011. Navistar International, with a market capitilization of $3.28 billion, is the smallest of the mentioned competitors. Navistar has had some issues in the past few years, having to restate earnings due to some internal practices. They have greatly benefited from the wars in Iraq and Afghanistan, providing MRAP vehicles to the United States military. With the draw-down of combat operations in both war zones, Navistar may find it difficult to replace that income source.
Despite numerous competitors, the company is able to expand its product lines and distribution services through product innovation, an expanding patent library, and further expansion. It is also worth mentioning that Cummins is the market share leader in terms of emission solutions to on-highway truck manufacturers for the medium and heavy-duty, Euro IV/V and EPA 2007 markets.
The balance sheet has always been of particular importance to me in investing. I have always found that companies that maintain solid balance sheets can continue to operate for years and years, even if economic or industry specific difficulties arise. When I look at the balance sheet, there are really three things that I am looking for: is there debt (if there is, how much?), what is the cash position, and are there any other significant assets. So, let's take a look.
For the period ending December 31, 2011, the company had $658 million in long-term debt, down from $709 million the year prior. I always like to see the long-term debt number as low as possible (zero being my favorite), and if there is debt, I prefer to see the number decline year over year. Now that we know the amount of debt, we need to know if it is a sustainable level.
The company has a cash and equivalents position of $1.484 billion, up from $1.023 billion the year prior. In contrast to the debt position, this is a number I like to see go up, and for the most part, I like to see a large cash position. Because the company has $658 million in debt and a cash position nearly double that, I am comfortable with the debt level.
The final thing I am looking for is whether there are any other significant assets. The company has just over $2 billion in plant and equipment and $566 million in goodwill/intangibles. I do not believe either of these to be significant other assets, so I will just keep them in the back of my mind when doing a valuation exercise.
Earnings are always important since we, as investors, want our companies to make lots of cash and which can then be passed on to us. Companies which have negative earnings can be great investments, but the process for choosing the right ones is much more complicated. So, for the most part, I prefer that a company has positive earnings, and preferably increasing earnings. When looking at earnings, I like to first use EBIT, just in case there were some crazy tax advantages. For the year ending December 31, 2011, Cummins earned $2.71 billion, up from $1.617 billion the year prior. Two positives for me here: positive earnings, and increasing earnings.
The next thing I look at here is the number of shares outstanding. As a shareholder, I want as big a piece of earnings as I can get. When share count is increasing, my piece is getting smaller. When share count is decreasing, my claim to earnings is getting bigger. Naturally, I prefer the latter. For the same reporting period, diluted shares outstanding were 193.6 million, down from 197.1 million. I can check this off as another positive, and move on to the next step.
Cash flow can be calculated in a number of different ways, but this is how I do it: net cash provided by operating activities (CPOA) minus capital expenditures. I do not subtract out dividends because I like to look at valuations as if I were to buy the company as a whole. If I were to buy the entire company, I would not be paying out dividends. This may be a flawed way to look at the problem, but it is my approach.
For the reporting period ending December 31, 2011, Cummins reported $2.073 billion in CPOA, up from $1.006 billion the year prior. They also spent $622 million in capital expenditures, compared to $364 million in 2010. Using my method of calculating free cash flow, the company produced $1.451 billion in free cash flow in fiscal year 2011, up from $642 million in fiscal year 2010. Positive and increasing cash flow is another positive mark in my book.
Recent Reports & Outlook
The company reported 4Q 2011 and end of year earnings on 02 February 2012. You can view the earnings report here, and the conference call transcript here. The company also provided its outlook for fiscal year 2012, saying it expects to see 10% revenue growth for the year, as well as EBIT margins increasing to 14.5%-15%.
Management also stated that they believe the company is on track to achieve its long term goal of $30 billion in sales, with EBIT margins of 18%, by 2015.
Shares of Cummins Inc. closed Friday, 03 February, at $120.09 per share. With diluted shares outstanding at 193.6 million, the company is currently valued at $23.249 billion. There are a number of ways to approach valuation and various ratios that can be used. I prefer to use a mixture of various ratios depending on the company I am looking at. My favorite method of valuation is the price to free cash flow ratio (P/FCF). I like this method because it shows me how many years it would take for me to recoup my investment, if I were to buy the entire company, keeping any cash left over after capital expenditures.
Having calculated free cash flow for the company to be $1.451 billion for fiscal year 2011, that gives us a P/FCF of 16. Normally, I stick to investing in companies that offer a price to free cash flow ratio of 10 or below. This is not a hard and fast rule for me, but it will usually keep me looking at companies that are out of favor with the market.
Cummins Incorporated is a very interesting company that offers a large variety of products in many global markets. Its advances in distribution services have diversified its traditionally cyclical product lines, and have created synergies amongst its core products. The current management team consists of a number of well-seasoned company and industry veterans who are leading the company down a profitable path. With the company creating new and innovative products, expanding further into untapped markets, and being on track to achieve its 2015 goal of $30 billion in sales, I believe the company will be a great performer in the coming years. It is for this reason that I am giving Cummins Inc. a green thumbs up on my CAPS page.
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