Cummins India (Cumm) is a strong play on the transformation in India?s power supply profile, which is shifting from large utility sets toward small diesel generator (DG) sets (33% of installed capacity), as end users face increasing blackouts.
CUMM is perhaps the largest beneficiary of demand upsurge in DG sets, engine demand in road construction and tightening emission norms. Our buy rating is premised on: 1) inflection in demand (industry volume likely to double in three years); 2) strong EPS and cash flow CAGR (FY12E-14E) of 27% and 41% respectively, 3) ROE of 28-34%. India?s power deficit is expected to double from 8% to closer to 15% in the next five years as utility players push forward capacity roll-out programmes, leaving end users gasping for alternatives. Over the next three years, we expect DG sets to take more share from utilities; adding to this the demand from road construction and tighter emission standards results in a structural shift for engine demand at a pace far higher than that at the start of the decade.
Our estimates assume CUMM will retain market share. Our estimates (11% above consensus) suggest a CAGR of 27% in EPS and 41% in cash flow from operations for FY12E-14E. ROEs are likely to expand by c600bps to 34% over FY12-14E. With current utilisation at 60%, operating leverage upside potential is high.
We value CUMM at R600 based on an exit P/E of 23x FY13E. We find this reasonable, from the long-term trading bands of CUMM and those of BHEL, a model that has hitherto benefitted from a power deficit in India. CUMM?s cost leadership and strong marketing network could help sustain the pricing power in the medium term. High RoE, strong EPS growth and low leverage are all a rarity in the sector and could help drive minority returns. Increasing competition from MNC peers and a lower off-take from the parent company can act as risks to our call.
? Deutsche Bank
