2023-05-08 09:51:21 ET
Summary
- Cummins is a global company that provides power solutions, with a growing focus on green energy and sustainability.
- It has been working towards transforming its business to align with the increasing demand for sustainable power solutions.
- By leveraging both acquisitions and internal innovations to shift its business mix towards green energy, it reduces its dependence on fossil fuels.
- With an EV/EBITDA multiple in line with historical averages, the company is at best fully valued and doesn't offer enough margin of safety for investors.
- I recommend waiting for a pullback in order to find a better entry point to protect against downside risk.
Company Overview
Cummins Inc. ( CMI ) manufactures and sells engines, powertrains, and related components worldwide. It sells a wide range of diesel and natural gas engines, as well as hybrid and electric powertrains for a variety of applications including trucks, buses, generators, construction equipment, and marine vessels. The company also offers related products and services such as filtration systems, fuel systems, emission solutions, and electrical power generation systems. Cummins operates in more than 190 countries and has approximately 58,000 employees worldwide.
By segment, engines make up about 30% of its business, components make up 30%, distribution makes up 25%, and power systems make up 14%. It also generates 1% of its sales from Accelera, which is a new brand launched in March for the New Power business segment. Accelera is an energy technology company with a diverse portfolio of zero-emissions solutions includes battery systems, fuel cells, ePowertrain systems and electrolyzers.
Revenue Breakdown (Investor Presentation)
Cummins has been around for over a century and first started making diesel engines in 1919 . While the company did not invent the diesel engine, it built off of what Rudolf Diesel had done in 1892 and created its own Model F engine. Since its invention, the diesel engine has been used to power several key technologies. Diesel engines offered many advantages including the ability to travel faster than gasoline engines, requiring less maintenance than other engines, and having a longer lifespan compared to alternatives. Over the next fifty years, diesel engines quickly made their way into powering several vehicles like delivery trucks, trains, buses, boats, construction machinery, military vehicles, and more.
With the effects of diesel engines becoming scrutinized by scientists and climate change becoming more studied, Cummins was faced with a risk to its core business as it creates engines that require fossil fuels to generate power. By shifting its business mix towards green energy through both acquisitions and internal innovations, the company has been in the process of transforming its business to reduce its reliance on fossil fuels and align with the growing demand for more sustainable power solutions. By transitioning to a more sustainable energy portfolio, I believe the company is better equipped to meet changing market demands.
Investment Thesis
One of the big opportunities for Cummins is transitioning to decarbonization as the world moves away from fossil fuels. The company plans to manage its base business by expanding its presence in core segments, growing in aftermarket sales, and continuing to generate strong free cash flow. For its new power businesses, the company has been replicating its powertrain position by making key investments through acquisitions and by developing new technologies to support a zero-emissions future. In my view, this should allow the company to expand into strategic adjacencies (as it has already done through a few joint ventures) and sustain growth well into the future.
With the launch of Cummins' new power business unit, Accelera, the company is getting involved in hydrogen. With a plan to supply a 90-megawatt PEM electrolyzer system for Varennes Carbon Recycling plant in Quebec, this will be the largest PEM installation in North America and a key step in transitioning the company into the green hydrogen economy. While the new segment is currently operating at a loss, it has gained traction with customers through higher volumes. While there are higher fixed costs on the battery electric side, the company expects to have positive gross margins as they ramp up and aim to be EBITDA neutral by 2027.
I believe the potential for the new power segment will be huge going forward. While Cummins' base business is expected to grow to $33-35 billion in revenue by the end of the decade, the company expects that it should generate $6-$13 billion in revenue for the new power segment. While this new segment won't be EBITDA breakeven until 2027, I'm optimistic about the company's long-term growth prospects in the new power segment. By 2030, the company expects total revenues of $41-46 billion, which implies that its total business will be about 36-53% bigger than what it is now.
Another key growth factor for Cummins is the recovery it is seeing across all markets, both domestic and international. For its most recent quarter , revenues were $8.5 billion, up 32% compared to the same quarter last year. The company also reported record EBITDA at $1.4 billion or 16.1% compared to $755 million or 11.8% a year ago. While some of the revenue and EBITDA growth can be attributed to its acquisition of Meritor in February, industry production of heavy-duty trucks in the first quarter was up 17% to 76,000 units with heavy-duty unit sales up 27% to 29,000 from 2022 levels, showing that volumes are picking up as well.
In my view, the Meritor acquisition is a noteworthy purchase. At a purchase price of $3.7 billion, the company adds $4.3 billion in revenue to its topline and $366 million of EBITDA to its bottom line. As a global leader of drivetrain, mobility, braking, aftermarket and electric powertrain solutions for commercial vehicle and industrial markets, the acquisition is immediately accretive and presents opportunities to develop economically viable zero carbon solutions for commercial and industrial applications. By adding complementary products that are independent of powertrain technology, the company is able to leverage its global footprint and realize significant synergies from efficiencies in SG&A, supply chain, and facilities optimization.
Finally, the company is also expecting good growth going forward with guidance for revenues from China increasing 16% in 2023 (vs. previous guide of 7%). The company also expects a 15% to 25% improvement in heavy and medium-duty truck demand and a 10% to 20% improvement in demand for the light-duty truck market, coming off the low market levels in 2022. With total company revenue for the year expected to be 15% to 20% compared to prior guidance of up 12% to 17%, the company seems optimistic that demand is improving and I believe that we've likely seen the lows in 2022. With China reopening, copper prices rising, and economic indicators improving, I believe this upwards revision to guidance is appropriate.
Financials
In its most recent quarter, Cummins returned $222 million to shareholders via dividends which has been in line with its long-term goal to payout about half of operating cash flows. With record sales and EBITDA, the company is in a good position to maintain its current dividend. However, watching how the macroeconomic environment plays out, particularly on the demand side with global growth, will be a key factor to watch going forward.
Over the last 35 years, Cummins has grown revenues and EBITDA at a 6.3% and 8.9% CAGR, respectively. Considering that the company is a relatively mature industrial and capital goods company, this growth rate seems decent as it is above the long-term GDP growth rate over this time of 2.5%. When we consider that the company should grow revenues at a 4.4-6.3% CAGR based on its 2030 revenue projection range, it seems like the company's growth rate should come down slightly.
Author, based on data from S&P Capital IQ
On the balance sheet front, Cummins has about $2.4 billion of cash on its balance sheet with $7.7 billion of long-term debt, where $3.3 of its long-term debt due within 12 months. The company's Debt/Equity ratio is 0.77 and its Net Debt/EBITDA is 1.4x, so the company's solvency ratios look okay. With a strong balance sheet, I believe the company is in a strong position to invest in new growth initiatives, pursue strategic acquisitions, and return value to shareholders through share repurchases or dividend payments. Moreover, Cummins' strong credit profile and ability to access capital on favorable terms provide it with flexibility to pursue growth opportunities and adapt to changing market conditions.
Valuation
Based on 10 analysts offering 12 month price targets for Cummins, the average price target is $239.72, with a high estimate of $290.00 and a low estimate of $137.50. From the average price target of $239.72, this implies about 8.3% upside, however the average is slightly skewed by the low estimate which is well below all other estimates (all above $200 per share). With analysts expecting upside of 8.3%, this suggests that the company's share price is generally viewed as fairly valued by analysts, with limited near-term potential for significant stock price appreciation.
At 8.7x EV/EBITDA and 12.7x P/E, the company is trading at a slight discount to its 10-year historical average and is at the midpoint of its 10-year range, between 5.2x and 13.1x EV/EBITDA. For a company expected to grow at a slower rate going forward, I believe the current multiple suggests that the company is at best fairly valued and doesn't offer enough margin of safety if things go wrong. Hence, I would wait for a pullback in the share price before buying shares.
Conclusion
In summary, Cummins is a global company that provides power solutions, with a growing focus on green energy and sustainability. By shifting its business mix towards green energy through both acquisitions and internal innovations, the company is transitioning the business away from fossil fuels to sustainable energy solutions. By transitioning to a sustainable power portfolio with its strong balance sheet that affords the company several options for investment and balanced capital allocation, the company should be in a better position to meet the changing market demands of its customers. However with analysts only projecting modest upside and the EV/EBITDA multiple in line with historical averages, the company is at best fully valued and doesn't offer enough margin of safety for investors. As a result, I recommend waiting for a pullback in order to find a better entry point in an effort to protect against downside risk.
For further details see:
Cummins: Buy This Stock On The Next Pullback