Cummins Update: Sticking to Game Plan

05/05/2014 4:35 pm EST


Jim Jubak

Founder and Editor,

This fully-intergrated engine maker continues to take costs out of its business, raise margins, and improve revenue, which is why MoneyShow's Jim Jubak consistently gravitates towards it and other companies doing the same.

Execution, execution, execution.

With stocks near all-time highs and the US and global economies chugging along but at growth rates that won’t lift all boats, I find myself increasingly gravitating to companies such as Cummins (CMI). The company sticks to its game plan of investing enough in R&D to stay at the leading edge in the market for engines. At the same time, it continues to take costs out of its business and to raise margins. And lastly, like a handful of leaders in other sectors (Intel (INTC) comes to mind) Cummins recognizes that manufacturing can be a significant competitive advantage. In recent years, Cummins has emerged as one of the few fully-integrated engine makers, a market position that makes it a major supplier to most of its competitors.

These factors let Cummins crank out quarters like the one reported on April 29. First quarter earnings per share increased 23% to $1.83 (or $1.87 a share excluding one-time tax charges). The Wall Street consensus was looking for earnings per share of $1.67. Revenue climbed 12% year over year to $4.41 billion against analyst expectations of $4.18 billion. The company had earlier guided Wall Street to expect revenue growth of 4% to 8% for 2014. In the conference call for this quarter, management increased that guidance for 2014 revenue growth to 6% to 10% for the full year.

The improved revenue picture is a result of stronger than expected demand in North America (sales were up 25% year over year) and in China. The company raised its growth forecast for sales of heavy-duty trucks in China to flat, from previous guidance for a 7% decline in 2014. On the earnings side, increased sales volumes certainly contributed to the beat, but the company also produced a 90 basis point improvement year over year in gross margins to 25.3%. Management left its guidance for EBIT margins (earnings before interest and taxes) at 12.75% to 13.25% for 2014. That would be a slight improvement from the 12.5% EBIT margin in 2013, but the tweak raised questions among analysts during the conference call. With revenue up so strongly, shouldn’t EBIT margins be climbing faster? analysts asked. Cummins management’s answer boiled down to “Maybe so, but it’s better to be conservative.”

Besides the upside that conservative take on margins implies, Cummins is also looking at a gradual recovery in international sales during 2014 and to continued improvement in sales in its power generation unit. In that business, order trends are positive, although sales growth for 2014 looks to be somewhere between up 3% and down 3%, according to company forecasts.

I added Cummins to my Jubak Picks 50 Long-Term Portfolio in May 2013. Since then, it has gained 25.02%. I don’t think you should expect that kind of return over the next year—15% is a reasonable expectation. With the market as a whole looking unlikely to match last year’s 32% return (for the Standard & Poor’s 500 (SPX)), I think that’s a very good relative return for this market. It’s not too shabby in absolute terms either, of course.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund did not own shares of Cummins as of the end of March. In preparation for closing the fund at the end of May, as of the end of March I had moved the fund’s holdings almost totally to cash.

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