1. Great result not clear in income statement

Great result not clear in income statement

Street’s fears being unfounded, Cummins is the top pick in mid-cap industrials sector

By: | Published: August 15, 2016 6:24 AM

Cummins India’s (KKC) Q1FY17 result was spectacular as net cash jumped to R7 bn (up 75% q-o-q) from R4 bn, a R3 bn cash accretion for net income of R1.8 bn (down 14% y-o-y). Segment-wise, off highway sales (industrial + distribution) rose 16% y-o-y to R4.3 bn, offsetting most of the slowdown in exports and domestic power gen business. We are also enthused by the CEO’s promise during the AGM that no manufacturing unit of KKC has/will be transferred to Cummins Inc. Thus, Street’s fear on KKC becoming Cummins Inc.’s marketing arm, akin to Bayer Corp, is unfounded and provides an excellent opportunity to buy the stock. Maintain ‘BUY’, rendering it our top pick in the mid-cap industrials sector.

AGM: Key takeaways

Management reiterated its focus on new products for the India market; recent one being QSK50 (fully developed in India) with potential annual revenue of R0.5 bn from railways apart from L mechanical engines (power gen portfolio). It also indicated that with capacity expansion in place, KKC is well equipped to tap the recovery cycle over the medium term. Capex is likely to peak out by FY17 at
R4-4.5bn, post which it will come off to R1.5-2.0 bn per annum. Management has set a target of high/low teens growth in domestic/exports market over FY16-20, implying doubling of revenue over the said period. KKC is setting up its largest global technical centre in Kothrud by FY17 to focus on new product development; benefits will accrue over the long term.

Cash flows unscathed from exports/domestic slowdown

Unlike industrial peers, KKC’s cash generation was higher than net income, leading us to believe that management’s demand revival commentary is based on confidence in customers’ ability to pay for purchases. For us, cash monitoring remains a critical parameter for differentiation in assessing our top pick. We concede that near-term revenue growth may be muted, but cyclicality in earnings is likely to be low and return on equity expansion is highly likely.

Outlook and valuations

Considering Q1 FY17 numbers (utilisation <60%), we believe KKC’s forecasted EPS is a cyclically low number and accordingly estimate exit multiple at 30x (vs 26x). Our 12 M exit target multiple is also lower than comparable multiples of other MNC peers despite KKC also enjoying similar OPLEV. Key risk is sharp global meltdown resulting in valuation compression. Maintain ‘BUY/SO’ with revised target price of R1,075 (earlier R960).


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