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Cummins India (CUMM.BO, Neutral): Attractive exposure to industrial growth; priced in
Source of opportunity
We initiate coverage on Cummins India with a Neutral rating and P/E based 12-m TP of Rs 807 implying 8%
potential upside.
Cummins is well positioned to benefit from continuing power back-up demand (generator business) and
capex recovery (engines for equipment used in transportation, construction and infrastructure activities).
Key growth drivers
– Continuing power shortages driving demand for backup power: Our GS Equity Utilities analyst
expects power deficits to continue until FY13. This gap in supply vs. demand and the need to have backup
power is the key driver for Cummins’ generator business, in our view.
– Recovery in export demand: After a 63% decline in export revenues in FY10, we see this as an
important opportunity for Cummins India in FY11 and FY12 as it emerges as the key sourcing hub for
Cummins Inc, its parent company. We expect exports to grow at a CAGR of 74% over FY10-12E.
– Capacity expansion at the Phaltan mega-site: With most of the company’s plants currently running at
70%-80% utilization, this expansion increases the company’s ability to supply both the domestic and
export markets. The company expects to commission four facilities – including a parts distribution
center and reconditioning factory at the mega-site in FY11.
Margins for the company have improved by 530 bp since FY08, driven by capacity expansion and efficiency
improvement initiatives. While the Street seems to be building further expansion in margins, we expect
margins to stay flat from here primarily as we see import content increasing (was one of the lowest in
FY2010) and due to increasing commodity prices.
The company’s strong cash generation ability ensures that it is well funded for expansion initiatives. We
forecast capex of Rs5 bn over FY11E-13E as the company ramps up capacity at Phaltan.
Valuation
Cummins currently trades at a 12m forward P/E of 20.5X – at a 28% premium to its 5-year average 12m
forward P/E of 16X. These premium valuations already price in the next six quarters’ earnings, in our view.
Our 12m TP of Rs807 is based on 20X FY12E – 1 standard deviation above the 5-year median 12-month
forward P/E. We expect a 34% EPS CAGR over FY10-12, higher than the FY05-10 EPS CAGR of 26%.
Key risks
Upside:1) Stronger-than-expected pick-up in industrial growth requiring further power usage, 2) Further
improvement in margins Downside: 1) The exports segment performing below expectations, 2) Lower than
expected demand for power back-up products in India.
Well positioned to benefit from continuing power deficits and recovery in industrial capex
The power generator business is Cummins India’s biggest segment. We expect this segment to benefit from continuing power
supply deficits in India and the growing demand for back-up power. The engines business caters to various infrastructure and
industrial construction segments and we expect this segment to register a 25% CAGR over FY10-12. A significant improvement in
exports revenue – as Cummins India emerges as a key resource hub for Cummins Inc. – is a key growth driver for the company, in
our view.
Our key differentiation from consensus, which leads us to our Neutral rating on the stock, is our view that margins should
stabilize at current levels vs. consensus expectations of further improvement in margins. The improvement in margins thus far
has primarily been due to lower imports and hence, lower raw material costs. However, going forward, we expect the exports
business to show significant growth and the direction of import content in raw materials to reverse.
Engines Segment – Offers attractive exposure across key areas of capex investments
Our Global ECS team expects industrial activity to trend higher over 2011. With attractive exposure to most areas of industrial
activity through its industrial engines business, we foresee the pick-up in industrial activity as a key growth driver for Cummins India.
In addition, the high horse power engine segment is an important component of exports from India to the parent company
Cummins Inc. Thus, we foresee a strong opportunity for the engines segment both in the domestic and export markets.
Valuations – Strong growth prospects already factored into current price
Though the growth prospects for the company are strong, current valuations – at a 28% premium to 5-year median on 12-month
forward P/E basis – we believe this is already priced, hence, our Neutral rating on the stock.
Company overview
Cummins India Limited (CIL), a 51% subsidiary of Cummins Inc, is India’s leading manufacturer of diesel engines with a range from
205 hp to 2,365 hp and value packages serving the Power Generation, Industrial and Automotive Markets. CIL also caters to the
growing market for gas and dual fuel engines.
Cummins Power Generation Business is the market leader in the Diesel and Gas power systems with over 25,000 MW of installed
captive power across various industry sectors like telecom, construction, IT/ITES, realty, hospitality, textiles, auto & auto ancillaries,
food processing, govt., pharma, gas and manufacturing.
Cummins Industrial Business is the market leader in Diesel and Gas engines in the range of 65 hp to 2,700 hp. These engines
power a variety of mobile and stationary equipment used in various applications like Construction, Mining, Compressor, Fire &
Industrial Pumps, Rail, Marine, Oilfield and Defense.
Cummins Automotive Business caters to the growing automotive segment in India. It supplies B series Euro III, ISBe Electronic,
Stoichometric as well as lean burn Natural Gas, C and L series engines for On-highway applications.
Cummins Sales and Service India provides products, packages, services, and solutions for uptime of Cummins equipment
engaged in the business of sale of engines, and providing after-sales services to engines and generators manufactured by Cummins.
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