Emkay: Cummins India Confident Approach, Upgrade to BUY; Target Rs 800

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Cummins India

Confident Approach, Upgrade to BUY

BUY

CMP: Rs 649                                       Target Price: Rs 800

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n     In Q3FY11, Cummins India (CIL) reports 6% yoy decline in APAT to Rs1.4 bn – Below EMKAY expectation of Rs1.6 bn

n     Increases annual capex commitment from Rs1 bn to Rs5 bn for next 3 years – CIL will invest in existing facilities, tech centre, uplift facilities alongside Megasite capex

n     Guides for 21% revenue growth in FY12E with stable margins –also retains 45% revenue growth for FY11E – CIL remains relatively confident on business operations

n     Recent price correction (down 20% in 3 months) has translated into attractive valuations – Upgrade CIL from ‘HOLD’ to “BUY’ with revised target price of Rs800/Share

Net profits decline 6% yoy to Rs1.4 bn - remains below estimates

After robust H1FY11 performance (net profit grew 74% yoy), Cummins India (CIL)

reported 6% yoy decline in Q3FY11 APAT to Rs1.4 bn –below EMKAY expectation of

Rs1.6 bn. The decline in APAT was led by, lower then expected revenues (Rs9.9 bn

versus EMKAY expectation of Rs10.4 bn) and higher then expected decline in Ebidta

margins (-480 bps versus EMKAY expectation of 390 bps). The Ebidta margins in

Q3FY11 were 18.1%, down 480 bps yoy led by higher input costs and other

expenditure. Revenues were impacted by (1) shutdown at Kothrud facility and (2) slow

ramp-up in material supplies.

Exports up 150% yoy, Domestic sales decline 6% yoy

§ Exports continued strong growth trajectory and remain on expected lines. Exports

grew 150% yoy and 4% qoq to Rs2.9 bn. Its contribution to revenues increased from

12% in Q2FY10 to 30% in Q3FY11.

§ Infact, domestic business reported decline in Q3FY11 - down 4% yoy and 15% qoq

to Rs6.7 bn. It was largely hit by base effects and lower deliveries in the quarter. The

Power Cogen and Industrial engines were impacted, but Automotive and Spares

business registered growth.

Megasite progress on track - Reconditioning and Rebuild commence

operations, but small generators plant postponed to CY12E

Few updates on Megasite expansion at Phaltan – (1) reconditioning and rebuild units

commences operations in Q3FY11 – expect ramp-up in ensuing quarters and (2) phase-

1 of Tata Cummins JV for CV engines commences operations. But, small generators

facility (less then 200 KVA) planned for export has been delayed by one year –

commence operations in 2HCY12 versus Q4FY11 earlier. No firm reason given for

delay in commencement of this critical expansion.

Quite surprisingly, CIL increases annual capex commitment from Rs1 bn to

Rs5 bn for next 3 years

CIL has increased its annual capex commitment from Rs1 bn to Rs5 bn for next 3 years.

The proposed capex at Megasite has been increased from Rs7.5 bn to Rs9-10 bn over next

3 years. CIL share in proposed capex has risen from Rs3.5 bn to Rs4-4.5 bn. Alongside

Megasite capex; CIL will also spend on (1) Kothrud site – to augment High HP capacity for

Power Cogen (2) new Power Cogen facility- location unknown (3) technology centre and (4)

uplift centre for Mid HP engines. CIL should access the annual cashflow and liquid

investments for the proposed capex. We would factor these investments at latter stage,

upon getting better clarity.

CIL guides for 21% revenue growth in FY12E with stable margins –also

retains 45% revenue growth for FY11E

CIL shared continued growth momentum for FY12E à revenue growth at 20% with stable

operating margins - driven by both domestic and export business. Domestic business would

see contribution from rebuilds and reconditioning units alongside supply from Tata

Cummins JV in Auto engines. Domestic market for Power Cogen engines should grow at

15-18% annually. Export business will benefit from firm commitment of Cummins Inc to

source small generators less then 200 KVA and high HP engines from India facility. For the

near term, Cummins expects to grow at 10% qoq for Q4FY11E and 45% for FY11E- citing

current business environment and YTD 2011 performance.

Upgrade from HOLD to BUY, Revised price target of Rs800/Share

We have fine-tuned earnings - revise FY11E and FY12E earnings by -4% (Rs30.6/Share)

and -2% (Rs36.6/Share). Increase in annual capex commitment certainly reflects the

confidence of Cummins Inc in India operations. Also, CIL remains relatively confident on

business operations and its ability to generate 20% growth in ensuing years, led by

domestic engines business, export business and service business. We remain confident on

growth opportunity and CIL execution capabilities. Recent price correction (down 20% in 3

months) has translated into attractive valuations – we upgrade CIL from ‘HOLD’ to “BUY’

with revised target price of Rs800/Share.