Cummins India: Strong domestic growth fails to cheer investors

Exports may stay on weak footing despite leadership position

For investors of Cummins India, a subsidiary of US-based Cummins Inc, the unpredictability surrounding overall growth is a key concern. While the engine manufacturer has remained positive on domestic growth, exports — which account for over 30 per cent of its overall revenue — have remained the pain point for many quarters.
 
Exports are crucial for the company, not just in terms of revenue, but also for profitability. While India is not a key market for high-end products, overseas markets such as Europe, West Asia, and Africa are consumers of heavy-duty motor. Therefore, to scale up profitability, higher-margin export volumes are crucial.
 
FY19 was expected to be better than earlier financial years on domestic and overseas para­meters. However, the disappointment over exports was felt more in the March quarter (Q4).
 
While revenues grew 9 per cent year-on-year (YoY) to Rs 1,340 crore, it wasn’t enough. Net profit shrunk by 13 per cent YoY to Rs 141 crore — also the weakest in recent times.
 
Volumes were largely pumped up by low horse power (LHP) engines, nearly tripling YoY on account of strong domestic demand. As a result, the key heavy-duty segment saw 67 per cent decline in volumes, thereby dragging operating margins down 121 basis points (bps) YoY to 12.8 per cent, in Q4.
 
Cummins ended FY19 with 15.3 per cent margins (up 11 bps YoY), but the weak management guidance on exports indicate that FY20 margins could be capped at current levels, or possibly trend down, unless exports spring up a surprise. Therefore, even if the 10-15 per cent domestic growth is positive, revenue growth and profitability will depend on the domestic product mix.
 
Analysts at ICICI Securities expect the domestic market to witness a gradual revival in demand, driven by data centres (where Cummins India holds highest market share), along with infrastructure, railways and manufacturing growth.
 

With a 3-5 per cent price hike undertaken in FY19, strong demand from these pockets could support profitability at current levels.
 
The good news is that despite a challenging environment, Cummins has maintained a leadership position in India with a market share of over 40 per cent.
 
Yet, at 24 times its FY20 estimated earnings, the Street isn’t too positive on the stock given the expected pressure on near-term earnings.
 
Analysts at JM Financial Research have cut their earnings target for FY19-21 by 10 per cent, and operating margin estimates by 50-100 bps, to factor in an unfavourable product mix.