Update Cummins (CMI)
04/27/2011 4:01 pm EST
To figure out what the stock is worth, you now have to answer just two questions. First, do you think this quarter represents the top of the cycle for this maker of truck engines and backup power systems or is it more like the middle of the cycle with lots of sweet spot still ahead? Second, do you believe the company’s projections?
I think both are easy questions to answer after this quarter.
Cummins is clearly hitting on all cylinders—and will keep firing at that pace until 2014 or so. In other words the company is about in the middle of the cycle and not at the end.
The North American truck market is still working off a huge backlog of delayed sales from the recession. The U.S. truck fleet came out of the recession with an average age of seven years, the highest average in 20 years. It now looks like sales of Class-8 trucks, the big rigs, will continue at a double digit annual rate through 2014. Investors get a little extra margin of safety from Cummins’ huge installed base—the company had about 50% of the U.S. heavy-truck market in the last two years. That means continuing revenue from the company’s distribution and components businesses as it services those sales will even out any bumps in new truck and engine sales. Together those units make up about a third of gross sales.
Outside North America sales are growing at a stunning rate. This quarter, Cummins reported, sales grew by 66% in China, 31% in India, 39% in Brazil, and 40% in Africa and the Middle East. Sales outside the United States now make up 61% of all sales.
And this was a hugely believable quarter—which increases the credence I put in the company’s guidance for the rest of 2011. The company hit all its benchmarks. In earlier guidance Cummins had said that margins on engine sales, for example, would come in at 10% to 11%--this quarter they came in at 12.1%. Cummins’ components margin, to take another example, had been projected at 10% to 11%. It came in at 11.4%. The cost-cutting that the company did during the recession—Morningstar calculates that Cummins reduced fixed costs by $600 million during the recession—has resulted, in my opinion, in permanent improvements in the company’s margins.
If, after digesting all this, you decide to keep the multiple that you’ll pay for Cummins’ $7.75 in 2011 earnings at the same level as when the company was projected to earn $7.24—I’m using the same 19.4 multiple as Standard & Poor’s does—you get a new target price of $150 a share by December 2011.
So as of April 27 I’m raising my target price for Cummins in my Jubak’s Picks portfolio http://jubakpicks.com/ to $150 a share by December from the prior $136.
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 March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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