Benign valuations, long-term triggers favour Cummins India stock

Weak exports and sluggish capex cycle suggest that there would be some near-term pain

After dropping 48 per cent since the beginning of the year, the Cummins India stock has recovered. Over the past five trading sessions, the stock has gained about 35 per cent. While the fall was on account of weak capex cycle, brokerages believe the correction is overdone and ignores expected gains from new emission norms and lower costs.

The implementation of the Central Pollution Control Board’s CPCB4+ emission norms (requires electronic engine platforms compared to mechanical ones) from July 2021 will help Cummins India gain market share. The firm not only has access to its parent’s product pipeline, but is also developing products for the local market at its technical centre in Pune. Given the higher cost of creating new products, Indian peers will have to spend more to make products compliant. 

A positive sign for the company is its focus on controlling costs in the backdrop of weak exports. The segment accounts for 30 per cent of revenues. Given falling crude oil prices, demand from oil-dependent economies in West Asia and Russia has been weak. 

 

 

Further, competitive pressures in Africa, too, have led to lower exports. This led to a sharp fall in margins, necessitating reduction in costs, including through voluntary retirement schemes. 

Analysts at JM Financial believe the change in sales mix over the previous decade is a positive with the share of distribution increasing from 16 per cent to 24 per cent and share of industrial segment from 11 per cent to 17 per cent to offset dip in power business. The ratio of genset to aftermarket sales has also reduced in favour of aftermarket, offering steadier revenue profile. 

The reduction in capex intensity and rental income would keep cash generation high. The fall in metal prices should also support margins. All this could result in increasing dividends.

While the fall in share price has made valuations attractive and it has long-term triggers, there are short-term worries on the demand side, both in the domestic and export segments. 

Investors, thus, should await momentum trends once the lockdown ends.