CMI - Cummins Gives You Growth Dividend Growth And Value

2023-12-20 08:05:00 ET

Summary

• Cummins is a global leader in power solutions, with a strong reputation and wide-reaching scale.
• It demonstrates strong profitability, has given a higher total return than its peers, and is expanding into new engine types.
• The company has a solid balance sheet, a history of returning capital to shareholders, and sits below its normal valuation, making it an attractive long-term investment opportunity.

It’s been a while since I last visited Cummins ( CMI ) stock here back in July with a ‘Buy’ rating, noting its positive long-term outlook driven by electrolization and truck fleet modernization trends around the globe. Unfortunately, my timing may have been a bit off, as that was near a near-term peak for CMI in terms of price.

The stock has recently clawed back some of its losses as fears around ‘higher for longer’ interest rates have abated, but the stock still remains 6% below where it was since my last piece. Understandably, CMI isn’t a high yielding name, but it can be a great pick for total return investors who prize growth with a kick of dividends on the side.

In this piece, I provide an update and discuss why now may be a great opportunity to pick up CMI while the market seemingly has yet to fully appreciate this long-term wealth compounder, so let’s get started!

Why CMI?

Cummins is a global leader in power solutions, with products ranging from diesel, natural gas, electric and hybrid powertrains for commercial trucks, off-highway equipment, railroad locomotives, and prime power generators. CMI’s leadership position and scale, combined with a growing market, has contributed to strong shareholder gains over the past 10 years.

This is reflected by CMI’s 128% total return over the past decade, which surpasses the 85% of peer Toyota Industries Corporation ( TYIDY ) and the 6% total return of Daimler Truck Holding AG ( DTRUY ), on a same-period comparable basis since DTRUY became public in 2021, as shown below.

CMI’s advantage stems from its reputation and wide-reaching scale and customer base, making it the top supplier of truck engines and components globally. This reputation is underpinned by its extremely durable engines, which keeps customers coming back for both new models and the parts and services aftermarket. Importantly for its customers, CMI’s engines enhance the value of their trucks leading to a competitive advantage for the company.

Having strong brand equity and scale results in above-average margins for CMI, as reflected by its ‘ A ’ grade for profitability. CMI generates an 8.4% net income margin, sitting ahead of the 6.1% median for the Industrials sector, and carries a leading 29% return on equity, sitting ahead of the 12% sector median due in part to share buybacks over its history.

Moreover, tight supply chains in recent years have resulted in increased demand from transportation companies. This has resulted in 68% sales growth and 64% EBITDA growth for CMI’ trailing 12 reported months compared to 2020, and both metrics have consistently grown every year over this timeframe, as shown below.

Management is also guiding for 19.5% and 15.3% Sales and EBITDA growth, respectively, for the current full year. As shown below, this is driven by Heavy and Medium Duty Truck markets in North America, China, and India, offset by a decline in Brazil.

Meanwhile, CMI also saw near-term growth, with sales growing by 15% YoY during the third quarter, driven by robust 16% and 13% growth in North America and International segments, respectively. This was driven by strong demand across most global markets and the addition of Meritor, which CMI acquired in November of last year. This acquisition bolstered CMI’s New Power division by adding direct drive and transmission-based remote mount electric motors, software, and other critical elements in electric powertrains.

Looking ahead, CMI could benefit from new product introductions that could help companies to meet climate standards and lower emissions. This includes CMI’s collaboration with Knight-Swift Transportation (KNX), which successfully tested CMI’s new X15 engine in California. This engine uses renewable natura gas to reduce nitrous oxides and greenhouse gas without compromising performance, and is expected to launch in 2024 as the first natural gas engine designed specifically for heavy duty highway truck applications.

Risks to CMI include the cyclical nature of the surface shipments industry, as it’s vulnerable to economic downturns. This includes a potential slowdown in China as the country grapples with a tepid economy and weaker overall activity due in part to a 10% decline in construction volume there. Moreover, CMI has seen a decline in aftermarket activity due to the market swinging from inventory shortages last year to too-high inventory this year. As such, inventory destocking to do CMI customers’ rightsizing of their fleets could be another near-term headwind.

Importantly, CMI carries a strong balance sheet for the current interest rate environment with an A+ credit rating from S&P, and a debt-to-capital ratio of 39% as of the end of Q3 (down from 46% in the prior year period). This was driven in part by $500 million reduction in long-term debt over the past 12 reported months, and CMI has plenty of capacity to continue debt paydown and/or invest in growth initiatives with $2.8 billion in cash and short-term investments on the balance sheet.

CMI could also utilize its capital to further its share buybacks as a tax efficient manner of returning capital to shareholders. As shown below, CMI has reduced its share count by nearly a quarter (24%) over the past 10 years.

Plus, dividends provide another total return kicker for investors. At present, CMI yields 2.7% and the dividend is well-covered by a low 32% payout ratio. The dividend also comes with an 8% 5-year CAGR and CMI is on its way to becoming a dividend aristocrat with 18 consecutive years of dividend growth under its belt.

Lastly, while CMI isn’t cheap at the current price of $244 with a forward PE of 12.3, it’s far from being expensive and sits below its normal PE of 15.4, which I believe is a fair valuation for a moat-worthy but cyclical company. CMI has a 5-year EPS CAGR of 8.9% and analysts expect current full year EPS growth of 22%. While EPS is expected to decline by 2.7% next year due in part to the aforementioned headwinds, analysts expect EPS to resume growth at 11.4% in 2025. As such, I see value in CMI at the current price, even if doesn't return to its normal valuation anytime soon.

Investor Takeaway

Overall, Cummins is a leading player in the truck engine and components industry with strong brand equity, scale and a durable product portfolio. Its recent acquisition of Meritor has also strengthened its position in the electric powertrain market, positioning it well for future growth opportunities. Despite near-term headwinds from cyclical and inventory-related issues, CMI has a solid balance sheet, a history of returning capital to shareholders through dividends and share buybacks, and sits below its normal valuation, making it an attractive long-term investment opportunity. As such, investors looking for exposure in the industrials sector should consider adding CMI to their portfolio. I reiterate my 'Buy' rating on CMI stock.

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