The worst is over

With the company’s performance likely to improve from FY13, analysts turn positive on the stock.

The stock seems to have bottomed out after a substantial correction of 35 per cent in the last year. The scrip, which touched its 52-week low of Rs 322 on December 21, has gained eight per cent ever since, compared to a 1.1 per cent rise in the Sensex and a 6.2 per cent increase in the BSE Capital Goods index.

Despite a fair valuation of 16 times FY13 estimated earnings and the management revising FY12 estimates downwards for the second time, analysts have turned positive on the stock. They believe the worst is over and Cummins will gain on an expected cut in interest rates leading to better performance in FY13.
 

BETTER TIMES AHEAD
in Rs crore	FY11	FY12E	FY13E
Net sales	4,061.0	4,234.9	4,783.2
% chg y-o-y	40.1	4.3	12.9
Operating profit	779.0	654.6	778.4
% chg y-o-y	33.8	-16.0	18.9
Net profit	591.0	540.7	626.0
% chg y-o-y	33.1	-8.5	15.8
EPS (Rs)	21.3	19.5	22.6
% chg y-o-y	33.1	-8.4	15.8
E: Estimates                                      Source: Company, Analyst reports

Medium term pressure
Demand in the domestic market (70 per cent of sales), which merely grew by a per cent in the first half of FY12, is likely to remain muted for the next few quarters, thanks to slowdown in the power generation segment and other industries. Exports (30 per cent of sales), which grew 19 per cent y-o-y in the first half of FY12, also face downwards pressure due to the global slowdown. Accordingly, the management has lowered its domestic sales growth guidance from 10-15 per cent to 5-10 per cent in the September quarter, while maintaining exports growth guidance at 5-10 per cent.

From 17 per cent in the September quarter, the company expects its profit before tax (PAT) margin to contract 100 basis points (bps) due to several reasons. Its revenue mix is turning adverse, as high capacity engines experience a bigger slowdown than low-end ones. Competition is increasing from China and unorganised players, and alternative back-up sources like UPS and inverters. Firm pig iron prices are also a negative for margins.

Better times from FY13
There are expectations the Reserve Bank of India will shift focus from inflation to growth and lower the interest rates this year. If that happens, the overall economic activity is expected to pick up, though with a lag. Also, the group’s expansion at Phaltan will help boost sales. New capacities contributed 10 per cent of sales in the the September quarter.

The company’s parent has identified India as a key outsourcing destination. Cummins India meets roughly 10 per cent of its parent’s global powergen engine sales, which is likely to increase, given the parent’s target of increasing its global revenues of $18 billion by 70 per cent in the next four-five years.

Importantly, after the Bharat Stage III emission norms, which were implemented in April on off-highway wheeled construction equipment, new emission norms from July 2013 for diesel engines used for power generation will be another major opportunity to consolidate its position in the domestic market. Says Dhirendra Tiwari, analyst, Motilal Oswal, “The company is expected to gain significant competitive advantage from this due to its superior product development capabilities. The average realisation of such engines is likely to be significantly higher.”

Adds Bhavin Vithlani, analyst, Enam Securities, “Valuations do not capture potential rebound in volumes and margins on the back of a change in emission norms from FY14.” Margins will also recover with an improvement in the business mix and the company’s cost-cutting initiatives.

Bottomed out
The stock trades at 17 times and looks fairly valued, given the muted outlook and expected margin contraction in the medium term. Analysts advise long-term investors to accumulate the stock. Says Misal Singh, analyst, Religare Institutional Research, “The stock’s correction provides a good opportunity for long-term investors, as strong business fundamentals ensure sustainability of return ratios and growth over a longer horizon.”