Cummins India: TP: INR432:Motilal Oswal Securities

Profitability supported by cost optimization measures
High capex to dilute returns, 60 L engine is INR2.6b opportunity in 5 years
 Profitability supported by cost optimization – a widening moat
 Expect meaningful increase in capex at INR6.5b each in FY13/FY14 v/s INR2.1b in FY12
 60-liter engine has revenue potential of INR2.6b over 5 years, construction commences
at Phaltan SEZ
 Liquidity crunch and slowing global economy likely to impact growth in 1HFY13
 Valuation and view: KKC currently trades at 9% premium to its LPA P/E whereas the
capital goods sector is at a 9% discount to its LPA P/E. Such rich valuations leave little
room for disappointments. Maintain Neutral.

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Profitability supported by cost optimization – a widening moat
In FY12, Cummins India (KKC) curtailed its EBITDA margin decline at 200bp to
16.9%, despite slowing sales (up 3% YoY) and rising input costs. Raw material
(RM) costs rose only 3% YoY despite 16% YoY rise in pig iron prices, which forms
over 50% of RM cost. This commendable achievement is a result of increased
indigenization and cost optimization measures:
(i) RM imports have declined significantly from 29-30% of revenues in FY07-08
to 20% in FY12. Also, within RM, component imports have declined to 69% of
RM consumed (from 77% in FY08) and share of semi-finished components
have increased to 19% from 5% in FY08.
(ii) Cost optimization measures like ACE III (Accelerated Cost Efficiency) are
expected to generate savings of INR2.3b till 2014 by reducing the total cost of
ownership of direct materials by 20%. TRIMs (Total Reduction in Indirect
Materials & Services) targets to reduce the direct cost of ownership in indirect
materials by 10% over 3 years.
Expect a meaningful increase in capex
In its recent analyst meet, KKC stated that capex in FY13/14 is expected at ~INR6.5b
each, which is meaningful given FY12 gross fixed assets at INR9.7b. Capex in FY12
increased to INR2.1b, and stood at 28% of the opening gross fixed asset. A large
part of the incremental capex (~65%) pertains to the India Technical centre and
India Office Campus, which will also be shared with group companies and thus
KKC will earn lease income (IOC to commence in April 2014). This will likely
dilute return ratios (FY12 ROE at 28%) and remains an area of concern. Capital
commitments stood at INR4.3b in FY12, up from INR550m in FY11; thus, expect a
steep increase in FY13 capex.
60-liter engine has revenue potential of INR2.6b over 5 years
KKC’s FY12 Annual Report states that the 60-liter engine will be an INR2.6b
opportunity over 5 years. This is meaningful given that KKC's domestic engine
sales in FY12 is ~INR12.6b. Construction for high horsepower QSK60/23 engines
in India commenced in FY12 at Phaltan megasite. We believe that going forward,
there exists possibilities that some of the new products will be manufactured /
exported by Cummins Inc, while KKC retains the marketing rights in India.