Cummins (CMI) beats low expectations for the second quarter--but I'd wait until fall to add to positions

08/02/2012 8:30 am EST


Jim Jubak

Founder and Editor,

The headline on the second quarter earnings release from Cummins (CMI) on July 31, read: “Cummins Reports Strong Second Quarter Profits.”

Kind of surprising since revenue for the quarter fell by 4% from the second quarter of 2011 and earnings, excluding the effect of divestitures, declined to $663 million from $707 million in the second quarter of 2011.

But the results were much stronger than expected so let’s give the headline writer a pass. Excluding divestitures the company reported earnings of $2.45 a share. That was up from $2.41 in the second quarter of 2011, but a huge 18 cents a share above what Wall Street expected. (Cummins is a member of my Jubak’s Picks portfolio  )

The stock climbed almost 6% on July 31, before giving back 2.4% yesterday.

Cummins is almost a classic example of a good company operating in a bad economy. The company is executing about as well as anyone could in this very tough global economy. EBIT margins (earnings before interest and taxes) are holding up extremely well with the company projecting 14.25% to 14.75% for all of 2012 compared with 14.2% in 2011 and 12.2% in 2010. The company has cut capital spending modestly to a projected annual range of $750 million to $800 million, a decline of $50 million, but has found the bulk of its cost improvements in improvements to the supply chain (forecast at a 0.2 percentage point improvement in the second half of 2012) and in lower raw materials costs (a forecast 1 percentage point improvement.) Cummins is suffering like all U.S. exporters from the effect of a stronger dollar, which is forecast to take about $500 million off the revenue numbers for the second half of the year.

Cummins isn’t looking for a particularly strong second half. The company had previously guided analysts to look for flat revenue growth for all of 2012. Engine sales are forecast as flat. Component sales are forecast to climbed 5%. And power generation sales are also forecast to be flat. All those forecasts are lower than previous guidance of 10%, 12%, and 5%-10% growth, respectively.

All these projections assume that Cummins is calling growth in the Chinese economy correctly—something the company called unlikely in its conference call. Don’t trust anyone who says they are certain about what is going to happen in China, Cummins advised. For example, China showed 0% growth in electricity consumption in the second quarter, which certainly implies an economy growing much more slowly than the official 7.6% rate.

Cummins has been aggressive recently in cutting its projected revenue growth to 0% from 10% for all of 2012 and that has certainly lowered the risk that the company will disappoint in the second half. Expectations are extremely modest with Wall Street looking for just 2.8% earnings growth in 2012 to $9.17 a share from the $8.92 a share in 2011.

That does mean, however, that although the odds of disappointment are relatively low, investors are buying the shares for a 2013 recovery. In 2013, Wall Street projects, earnings growth will rebound to 10.6%.

I think it’s a little early to buy Cummins now for that growth—I’d hold off on adding to current positions or starting new positions until the fall. If you hold a position now, as Jubak’s Picks does, I don’t think I’d sell based on the relatively low level of risk in the company’s earnings and revenue guidance. The stock currently pays a dividend of 2.14%--more than a 10-year Treasury--after the company raised the quarterly dividend by 25% to 50 cents a share on July 10. The record date for the dividend is August 22.

I am cutting my target price, however, to $120 a share by July 2013 from the previous $130 a share.

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 not 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
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