We expect Cummins India to be able to deliver growth at c.16.4% CAGR (against flat YoY growth in FY18E) between FY18-20 given the continued momentum in industrial demand and potential benefits arising from improving economic outlook in exports market (business impact yet to be confirmed by the management).
We expect Cummins India to be able to deliver growth at c.16.4% CAGR (against flat YoY growth in FY18E) between FY18-20 given the continued momentum in industrial demand and potential benefits arising from improving economic outlook in exports market (business impact yet to be confirmed by the management). Continued efforts towards cost rationalization (maintain Gross margins through value engineering efforts) and operating leverage will be able to offset the cost inflation to a large extent. We see margins reverting towards FY15-16 levels (still far from previous peaks levels of over 18%), consistent with management’s view.
Recovery in high end real estate projects and projects like airports, high rise complexes is critical for Power Generation segment. However, our FY18-20 earnings estimates are based on uptick in the Industrial and Distribution segments and operating leverage led margin resurrection. After the recent correction in the stock price (stock fell c.15% since February and over 26% YoY), the valuations have become attractive at 21.9x FY20 earnings.
We believe that the downside could be limited from the current levels and Cummins India can surprise a rather skeptical market on the margin (and subsequently on earnings) front, making a plausible case for re-rating. We value Cummins India at 26x FY20 earnings and move recommendation to ‘BUY’ from ‘ACCUMULATE’ with revised target price of Rs 862 (Rs 897 earlier).
Cummins India stock has underperformed the broader index (over 40% deviation vis-à-vis benchmark index) in the last six quarters. Contraction in valuations is largely explained by diminishing ROE trend over the past few years. ROE has halved from 29% in FY13 (c.18% in FY18E) levels due to 1/ adverse business climate in India and abroad in last two years and 2/ increased equity base driven by productive and unproductive assets including India office campus. We believe that current valuations largely discounts the above mentioned negatives and there could be potential case of re-rating on first sight of earning recovery (street has turned negative on earnings disappointment in past six quarters).