Cummins India: A value trap for investors or value buy? Analysts cautious

The Cummins India stock has corrected 34 per cent year-to-date. Its valuation at 22x its FY21 estimated earnings is also the lowest in six years. 

For investors, it could imply two things. One, it could be that with the worst behind in terms of growth and the stock probably bottoming out, Cummins India presents a good proposition in the capital goods space. However, the question is whether one has the visibility to call out the bottom yet, with domestic growth estimated at just 3-5 per cent for FY20. 

Second, exports remain on a weak footing, the recovery of which appears difficult in the next six months amid global uncertainties, including Brexit-related issues. Operating profit margins at 9-10 per cent in the first half were the weakest in many years, and are unlikely to recover before mid-FY21, going by analyst reports. 

The recovery of margins also hinges on the early voluntary retirement scheme announced for employees aged 45 and above, with 10 years or more experience. In other words, cost-cutting measures in the organisation should help improve margins, though the gains are not a result of increase in operational productivity. 

Therefore, valuations aside, Cummins India could well be a value trap for investors, considering how fundamentals stack up. Analysts at Prabhudas Lilladher say they remain cautious on the stock, considering weak financials so far in FY20, a deepening slowdown in the export markets, and delay in domestic recovery. Among listed genset (electricity generator) makers, Cummins India’s dependence on exports is the highest, at over 30 per cent of revenues. While these are near-to-medium term concerns, what may favour the company in two years is its preparedness to adopt new emission norms for diesel generators. 

Likely to be effective from 2022, analysts at IIFL say Cummins India is ahead of the curve to cater to these products. “Given its access to the global portfolio, Cummins India has been ahead of peers with regard to preparedness on compliance with the new emission standards for diesel gensets in 2022. It not only provides opportunities to further consolidate the domestic market share, but also to open up export potential for electronic product lines,” the analysts note. For the stock to hold up and not suffer more correction, improvement in underlying demand and financials is critical.