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Cummins India’s 3QFY11 results were sharply below expectations on revenue miss
due to peaking production capacity, maintenance shutdown and slowing demand,
in our view. However, the company’s retention of 20% sales growth guidance, the
upcoming facility at Phaltan and export recovery are positives. We cut estimates
11-15% on domestic growth slowdown and lower base in FY11F, while entry into a
more moderate growth phase and higher capex curtailing ROE justify a mid-cycle
valuation for the stock. We remain NEUTRAL with new PT of Rs670.
Catalysts
Stronger pick-up in exports and domestic segments are upside triggers, while
slower domestic segment and higher RM costs are negative catalysts for the stock.
Anchor themes
We believe India’s industrial sector promises the unfolding of a huge opportunity
over the coming years. We see potential opportunities in niche segments.
Slowing growth?
3Q FY11 results sharply below expectations
Cummins India’s 3Q FY11 results surprised negatively on revenue
growth as it plunged 10.2% q-q led by both domestic (down 12% q-q)
and export (down 4% q-q) segments. Management attributed this to a
maintenance shutdown during the quarter, impacting production for
~8-10 days. Adjusting for these implies the revenue run-rate was still
flat q-q — this could imply either a production peak or demand
flattening. We believe it could be a mix of both as management also
indicated that rate of growth has slowed during the quarter, especially
in the domestic business.
Growth guidance unchanged but now on a lower base
The company has retained its 20% revenue growth guidance for FY12,
although this comes over a lower revenue base now in FY11 after
3Q’s disappointment. While management refrained from a segmental
breakdown for FY12F, we believe there are upside risks to these
numbers as the US parent itself has guided for 20%+ growth at the
US consolidated level, which could imply greater export opportunities
from India. Management has also guided for flat margins over FY11
despite raw material cost pressure due to cost reduction initiatives.
Cut estimates 11-15%, PT to Rs670; maintain NEUTRAL
On expectations of slower growth in the domestic segment and a
lower base in FY11F, we are cutting earnings estimates by 11-15%
over FY11-13F. As the company enters a relatively moderate growth
phase from high growth earlier and ROE expectations too decline on
higher capex, we believe mid-cycle multiples are justified for the stock.
Accordingly, we are revising our PT to Rs670 which is 16x (from 18x)
FY13F EPS (from Sep 12F). Despite a fundamentally positive bias,
we remain NEUTRAL on the stock given limited upside and
recommend waiting for a better entry point.
3Q FY11 results sharply below expectations
ABOVE OR BELOW ESTIMATES
Cummins India’s 3Q FY11 results were below estimates, with adjusted EPS at
Rs6.57 vs. Nomura estimates at Rs8.97.
Revenue miss was the key reason for the surprise as revenue declined 10.2% q-q
although it was up 17.6% y-y vs Nomura estimate of 45.8% y-y growth.
The results include a tax provision write-back of Rs88mn, adjusting for which EPS
is 27% below Nomura estimates.
WHAT DOES THE RESULT MEAN?
On high expectations by both Nomura and the Street, the weak top-line growth is a
negative. The revenue decline was led by a lesser number of working days during
the quarter, as per management, due to a maintenance shutdown (8-10 days). A
loss of 10-11% of working days led to an exactly similar decline in revenue q-q,
implying that either demand was also flat q-q or production capacities peaked. We
believe that a mix of both factors was in play as management confirmed that rate of
growth might be slowing in the domestic segment, while considerable capex has
been outlined for the next three years.
The company’s guidance for 8-10% q-q sales growth in 4Q FY11 means that FY11
revenue growth will be below consensus expectations, and even though the
company retains 20% growth guidance for FY12F, it will be on a lower base.
Accordingly, we find revenue growth downgrades to the extent of 8-12% likely
unavoidable, across the Street, for FY11-13F.
RM cost/sales ratio rose 150bps q-q, which was lower than our expectation of
210bps and is thus a positive. Other cost items including staff cost and other
expenses were also lower q-q on absolute terms. To us, this implies that in the
absence of a maintenance-shutdown-led revenue decline, the company would have
delivered better-than-expected results on better margins; this paints a positive picture
for next year’s margins, we expect. Management also guided that despite RM cost
pressures, the company is likely to maintain margins at the FY11F level next year
due to cost-reduction initiatives.
EARNINGS CHANGE
We are cutting estimates 11-15% on the revenue miss in 3Q and lower growth
guided for 4Q FY11. We build in a higher-than-guidance (20%) sales growth of
26% for FY12 as we believe the company could surprise positively on better export
recovery.
While management has guided that margins will be maintained at FY11F levels, we
estimate a decline of 30bps led by higher RM cost, although operating leverage
could help revive margins by FY13F.
Rising capex also has a negative impact on depreciation and interest income, thus
impacting our overall earnings estimates.
LIKELY STOCK REACTION
The stock has already reacted negatively to the below-expectations results;
however, we expect further downside near term on account of muted growth
guidance and rising capex, which implies lower-than-earlier estimated ROEs and
thus a multiple compression along with earnings downgrade.
Long term though we remain confident of Cummins India’s ability to generate free
cash flow through an ungeared balance sheet and market leadership in an underpenetrated
industry.
Valuation: revising PT to Rs670; retain NEUTRAL rating
We value Cummins India at 16x (from 18x earlier) FY13F (from Sep-12F earlier) EPS
to arrive at our 12 month PT of Rs670/share. Our PT change is mainly due to
11-15% downward revision in earnings estimate for FY11F, FY12F and FY13F
Rollover of PT from Sep-12F EPS to Mar-13F EPS
Reduction in target multiple from 18x to 16x as we roll over and align to mid-cycle
multiples from a peak multiple earlier.
We believe the reduction in target multiple to mid-cycle valuations is justified as
Cummins India enters a more moderate growth phase from our earlier forecast
high growth phase. Also, the company is stepping up its capex substantially from
Rs1bn pa to Rs4-5bn pa for the next three years, which implies that our ROE
estimates (for FY12-13) will fall from 41-42% to ~36%, thus justifying the multiple
compression.
Why we would not recommend a SELL on the stock?
Impressive balance sheet and return profile.
Cummins India is a clear leader in its segment with little competition (except in the
price sensitive lower horse-power engines segment).
Back-up power gensets penetration is still very low in India and can continue to
provide a stable growth in the long run.
Limited plays in the capital goods sector in the current environment means that
quality names such as Cummins will attract a premium valuation.
Lastly, but importantly, there is a possibility that the parent company (Cummins Inc)
might want to buy back shares à la ABB [ABB IN].
Downside risks
Slowdown in domestic demand and rising commodity prices pose a downside risk
to our estimates.
Appreciation of the rupee could dampen the growth outlook as the competitive
advantage of cheap Indian products will be reduced to an extent.
Increasing diesel prices pose a risk to the demand for back-up power.
Competition from Chinese players — apart from some domestic competition,
Cummins India also competes with Chinese manufacturers. However, the nature of
the industry prohibits a large market share for vendors without a solid service
support network in the country. As such, we believe KKC will remain the dominant
player in its category.
Upside risks
Export recovery could surprise on the upside.
Potential buyback offer from the parent company for India-listed shares could be a
positive trigger.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Action
Cummins India’s 3QFY11 results were sharply below expectations on revenue miss
due to peaking production capacity, maintenance shutdown and slowing demand,
in our view. However, the company’s retention of 20% sales growth guidance, the
upcoming facility at Phaltan and export recovery are positives. We cut estimates
11-15% on domestic growth slowdown and lower base in FY11F, while entry into a
more moderate growth phase and higher capex curtailing ROE justify a mid-cycle
valuation for the stock. We remain NEUTRAL with new PT of Rs670.
Catalysts
Stronger pick-up in exports and domestic segments are upside triggers, while
slower domestic segment and higher RM costs are negative catalysts for the stock.
Anchor themes
We believe India’s industrial sector promises the unfolding of a huge opportunity
over the coming years. We see potential opportunities in niche segments.
Slowing growth?
3Q FY11 results sharply below expectations
Cummins India’s 3Q FY11 results surprised negatively on revenue
growth as it plunged 10.2% q-q led by both domestic (down 12% q-q)
and export (down 4% q-q) segments. Management attributed this to a
maintenance shutdown during the quarter, impacting production for
~8-10 days. Adjusting for these implies the revenue run-rate was still
flat q-q — this could imply either a production peak or demand
flattening. We believe it could be a mix of both as management also
indicated that rate of growth has slowed during the quarter, especially
in the domestic business.
Growth guidance unchanged but now on a lower base
The company has retained its 20% revenue growth guidance for FY12,
although this comes over a lower revenue base now in FY11 after
3Q’s disappointment. While management refrained from a segmental
breakdown for FY12F, we believe there are upside risks to these
numbers as the US parent itself has guided for 20%+ growth at the
US consolidated level, which could imply greater export opportunities
from India. Management has also guided for flat margins over FY11
despite raw material cost pressure due to cost reduction initiatives.
Cut estimates 11-15%, PT to Rs670; maintain NEUTRAL
On expectations of slower growth in the domestic segment and a
lower base in FY11F, we are cutting earnings estimates by 11-15%
over FY11-13F. As the company enters a relatively moderate growth
phase from high growth earlier and ROE expectations too decline on
higher capex, we believe mid-cycle multiples are justified for the stock.
Accordingly, we are revising our PT to Rs670 which is 16x (from 18x)
FY13F EPS (from Sep 12F). Despite a fundamentally positive bias,
we remain NEUTRAL on the stock given limited upside and
recommend waiting for a better entry point.
3Q FY11 results sharply below expectations
ABOVE OR BELOW ESTIMATES
Cummins India’s 3Q FY11 results were below estimates, with adjusted EPS at
Rs6.57 vs. Nomura estimates at Rs8.97.
Revenue miss was the key reason for the surprise as revenue declined 10.2% q-q
although it was up 17.6% y-y vs Nomura estimate of 45.8% y-y growth.
The results include a tax provision write-back of Rs88mn, adjusting for which EPS
is 27% below Nomura estimates.
WHAT DOES THE RESULT MEAN?
On high expectations by both Nomura and the Street, the weak top-line growth is a
negative. The revenue decline was led by a lesser number of working days during
the quarter, as per management, due to a maintenance shutdown (8-10 days). A
loss of 10-11% of working days led to an exactly similar decline in revenue q-q,
implying that either demand was also flat q-q or production capacities peaked. We
believe that a mix of both factors was in play as management confirmed that rate of
growth might be slowing in the domestic segment, while considerable capex has
been outlined for the next three years.
The company’s guidance for 8-10% q-q sales growth in 4Q FY11 means that FY11
revenue growth will be below consensus expectations, and even though the
company retains 20% growth guidance for FY12F, it will be on a lower base.
Accordingly, we find revenue growth downgrades to the extent of 8-12% likely
unavoidable, across the Street, for FY11-13F.
RM cost/sales ratio rose 150bps q-q, which was lower than our expectation of
210bps and is thus a positive. Other cost items including staff cost and other
expenses were also lower q-q on absolute terms. To us, this implies that in the
absence of a maintenance-shutdown-led revenue decline, the company would have
delivered better-than-expected results on better margins; this paints a positive picture
for next year’s margins, we expect. Management also guided that despite RM cost
pressures, the company is likely to maintain margins at the FY11F level next year
due to cost-reduction initiatives.
EARNINGS CHANGE
We are cutting estimates 11-15% on the revenue miss in 3Q and lower growth
guided for 4Q FY11. We build in a higher-than-guidance (20%) sales growth of
26% for FY12 as we believe the company could surprise positively on better export
recovery.
While management has guided that margins will be maintained at FY11F levels, we
estimate a decline of 30bps led by higher RM cost, although operating leverage
could help revive margins by FY13F.
Rising capex also has a negative impact on depreciation and interest income, thus
impacting our overall earnings estimates.
LIKELY STOCK REACTION
The stock has already reacted negatively to the below-expectations results;
however, we expect further downside near term on account of muted growth
guidance and rising capex, which implies lower-than-earlier estimated ROEs and
thus a multiple compression along with earnings downgrade.
Long term though we remain confident of Cummins India’s ability to generate free
cash flow through an ungeared balance sheet and market leadership in an underpenetrated
industry.
Valuation: revising PT to Rs670; retain NEUTRAL rating
We value Cummins India at 16x (from 18x earlier) FY13F (from Sep-12F earlier) EPS
to arrive at our 12 month PT of Rs670/share. Our PT change is mainly due to
11-15% downward revision in earnings estimate for FY11F, FY12F and FY13F
Rollover of PT from Sep-12F EPS to Mar-13F EPS
Reduction in target multiple from 18x to 16x as we roll over and align to mid-cycle
multiples from a peak multiple earlier.
We believe the reduction in target multiple to mid-cycle valuations is justified as
Cummins India enters a more moderate growth phase from our earlier forecast
high growth phase. Also, the company is stepping up its capex substantially from
Rs1bn pa to Rs4-5bn pa for the next three years, which implies that our ROE
estimates (for FY12-13) will fall from 41-42% to ~36%, thus justifying the multiple
compression.
Why we would not recommend a SELL on the stock?
Impressive balance sheet and return profile.
Cummins India is a clear leader in its segment with little competition (except in the
price sensitive lower horse-power engines segment).
Back-up power gensets penetration is still very low in India and can continue to
provide a stable growth in the long run.
Limited plays in the capital goods sector in the current environment means that
quality names such as Cummins will attract a premium valuation.
Lastly, but importantly, there is a possibility that the parent company (Cummins Inc)
might want to buy back shares à la ABB [ABB IN].
Downside risks
Slowdown in domestic demand and rising commodity prices pose a downside risk
to our estimates.
Appreciation of the rupee could dampen the growth outlook as the competitive
advantage of cheap Indian products will be reduced to an extent.
Increasing diesel prices pose a risk to the demand for back-up power.
Competition from Chinese players — apart from some domestic competition,
Cummins India also competes with Chinese manufacturers. However, the nature of
the industry prohibits a large market share for vendors without a solid service
support network in the country. As such, we believe KKC will remain the dominant
player in its category.
Upside risks
Export recovery could surprise on the upside.
Potential buyback offer from the parent company for India-listed shares could be a
positive trigger.
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