CMI - Cummins Offers Stability And Growth In A Still Necessary Industry

2023-05-18 06:33:30 ET

Summary

• Cummins has been able to increase revenues an impressive amount despite supply chain issues and a continued challenging global economy.
• The market outlook remains positive as some emerging markets could help fuel plenty of growth for CMI in my opinion.
• The company raised its guidance for 2023, and I think the current valuation makes for a strong buy case.

Investment Summary

Cummins ( CMI ) is a prominent provider of advanced power and engine-related technologies on a global scale. They specialize in the design, manufacturing, distribution, and servicing of engines, power generation products, and filtration systems. With a wide range of innovative products, Cummins has established itself as a leading player in the industry.

A crucial factor behind the success of Cummins is its expansive global presence, spanning over 190 countries. With a strong presence across many nations, the company has netted themselves a market share of around 8 - 9% which leaves a lot of room for more growth in my opinion. This seems to be reflected by the last earnings report as well, which had the management raise the 2023 guidance. The current valuation is below the sector average and offers a very nice dividend. I think natural gas and diesel are things we won't see disappear for many decades which still leaves opportunity for CMI and I will be rating them a buy.

Market Outlook

One of the main drivers behind the growth the company had in the first quarter of 2023 was the components segment seeing an increase in demand. Primarily fueled by an acquisition of Meritor which helped raise sales by 79% YoY as demand was strong in some important markets. One of them is India, where the company has seen a steady revenue increase over the last several years. CMI has been present here for a long time and I think this strong presence will help them benefit more than competitors perhaps.

Looking at the natural gas market as a whole, which CMI helps serve with their various products as prices have seen a drastic decline but it hasn't hindered the growth of CMI.

Looking at the North American market though for CMI, they saw a major revenue increase here in the components segment by 87% YoY. I think the momentum will continue as the natural gas market in North America is expected to continue seeing the growth of around 5% CAGR between 2022 - 2027 in a report by mordorintelligence .

Risks

One of the risks I see with CMI is that they might get hit by a slowdown in the global economy, which is already happening but also expected to rebound. I think this could result in some inconsistent quarterly results, but the management seems to remain certain in their outlook, Jennifer Rumsey the CEO said the following in the last report , " We will continue monitoring global economic indicators closely to ensure we are prepared should economic momentum slow". A slowdown could result in margins getting compressed which means the valuation of the stock price needs to be adjusted downwards to reflect the decrease.

I think the aggressive capital deployment the company is doing could eventually backfire as too much is spent on that instead of keeping a healthy balance sheet with a manageable long-term debt. However, right now that seems improbable as the company has both a strong cash position and decent cash flows generated over the last 12 months. An increase in the free cash flow margin however should be a priority for the company in my opinion.

Financials

Looking at the balance sheet for the company I think they are in a strong position to not need to divert from giving back to shareholders with dividends and buybacks. The company might have seen a decrease in the cash position QoQ, but the almost $2 billion in cash is still enough to make a significant impact on the long-term debt of around $4.4 billion. Something I value quite highly when it comes to assessing the financial state of a company. I means they are in a healthy and flexible state to maneuver around challenges.

Comparing the current assets to the current liabilities the company still outweighs it with a healthy 1.28 ratio. Looking at the long-term debt it is decreasing on a QoQ basis as the company made it clear they want to reduce this number to create a better long-term position for CMI. I think this is great to see as prioritizing this in the face of an eventual slowdown will only make them come out on top. To further emphasize the debt not being an issue CMI has a net debt/EBITDA ratio of just 1.44 right now. Anything below 3 I think is great and it makes me more confident that shareholder-friendly actions will continue.

Valuation & Wrap Up

Looking at the valuation of CMI it sits at a forward p/e of around 11 right now and it's decreasing as the company projects growth to continue. Looking at a company like Caterpillar ( CAT ) I think CMI still offers the better opportunity as they are around a third of the market cap of CAT and that leaves a lot of room for growth still. The forward p/e is also lower and CMI has a higher dividend yield too. Where CAT wins is the margins as they are a bigger and more well-established company, but I think that over time the margins for CMI will only increase as they continue to hopefully take more market share.

Paying 10x forward earnings for a company growing revues between 15 - 20% is great in my mind and also getting a dividend just adds to the investment case. I will be rating CMI a buy and any continued dip in the price should just be viewed as another opportunity to add more.

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