All those warnings about weakness in the fourth quarter are starting to sound like a pattern. At least I’m starting to see investors and analysts leap to work building a pattern.
Be careful, though—the warnings are coming from very different directions, which should make it hard to draw larger conclusions about market sectors and the global economy.
Let’s take the October 25 poster child for fourth-quarter warnings, Cummins (CMI). (Cummins is a member of my Jubak’s Picks portfolio.)
That day, Cummins announced third-quarter earnings of $2.35 a share, beating the Wall Street consensus by 11 cents a share. Revenue fell by 0.3% from the third quarter of 2010 and, at $4.63 billion, came in short of Wall Street projections of $4.62 billion.
But what sent the stock down for the day by more than 5% was the company’s guidance for the fourth quarter. For the full year, Cummins said revenue will be $17.5 billion to $18 billion. That’s down from the company’s former guidance of $18 billion and the Wall Street consensus projection of $18.13 billion.
EBIT (earnings before interest and taxes) margins will fall to 14% to 14.5%, from previous guidance of 14.5%. This works out to full-year earnings per share of $8.40 to $8.95. The Wall Street consensus projects $8.88 a share.
This kind of fine-tuning is worth a decline of 5%?
Absolutely—if it’s a harbinger of a slowdown in Cummins’ business. If the company is pointing to the lower results in the fourth quarter of 2011 as an indication of a continuing or deeper slowdown in 2012, then, yes, the market’s reaction is absolutely appropriate.
Which means, of course, that you’d better take a look at why Cummins reduced its guidance.
Problems with its core North American and European truck business? Nope. Sales of diesel truck engines rose 43% for the quarter from the third quarter of 2010, on strength in the North American and Brazilian markets. Heavy duty truck engine sales grew 89% in the third quarter, and for the year Cummins guided truck revenue growth to an 86% rate.
Problems in China and India? Yep. But very limited problems. Cummins pointed to reduced demand for truck engines as its Dongfeng joint venture, as the plant works through a build up of inventory.
Demand for diesel engines for power generation from China is expected to ease in the fourth quarter. That follows on weaker demand from India in the third quarter.
But serious problems anywhere? Not unless you believe that China’s economy is headed for a hard landing in 2012, when measures from 2011 intended to slow economic growth and inflation overshoot. (Of course, if you believe that, you need to run—not walk—to the nearest market exit, because a big slowdown in Chinese growth—something less than 7%—will take down pretty much everything.)
In looking for an explanation of why Cummins decided to tweak its guidance, I think you also need to consider the effect of turnover in the CEO job. CEO Tim Selso will retire in January, to be replaced by Tom Linebarger, president and COO since 2008 and a 17-year Cummins veteran.
Many new CEOs tend to be extra conservative with their initial guidance, knowing that lowering targets on the old guy’s watch so that the new guy can start off beating expectations is a good career move.
I think the 2012 will be a bit slower in China—and certainly in Europe—than I expected when I calculated a $153 target price for Cummins by March 2012. I’d trim that a bit to $145 by July.
The stock has pretty much recovered from its October 25 drop…and then some. Shares were up almost 8% today as of 2:30 New York time. That pushed the price back over $100 a share, a level that has presented an obstacle to the stock recently.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Cummins as of the end of June. For a full list of the stocks in the fund as of the end of June, see the fund’s portfolio here.
