Cummins India: Strong recovery in sight

Domestic demand is making up for weak exports; reasonable stock valuation adds sheen

Multinational companies in the engineering sector have always been viewed as a barometer of India's infrastructure growth, whether in power, railways, or urban infrastructure sectors. But, high valuations and low float have limited investor interest in these stocks. This scenario is changing of late. Indian listed arms of Siemens, ABB, and Cummins have all seen a noteworthy moderation in their valuations, with Cummins India leading the pack. Cummins India, which historically traded at over 40x price-earnings (PE), is now at 31x FY17 estimated PE, making it attractive.

Not just that, the earnings (profit) triggers are improving for Cummins India. Weak export revenues in the past two financial years have been worrisome for the company. Domestic demand wasn't showing much promise till the March quarter either. But in June quarter, even as Cummins Inc (its parent) was cautious in its outlook, the Indian arm raised its revenue growth forecast from 8-12 per cent to 10-12 per cent for FY17, largely driven by a pick-up in domestic market.

With this, a few brokerages raised their target prices for Cummins India's stock. There are reasons for this optimism. First, a secular improvement in domestic business across segments in Q1. With this, analysts at ICICI Securities are confident of further upside to Street estimates in the event of capital expenditure (capex) upcycle trend. Despite weak demand in FY16 and competition from global firms, Cummins India kept its leadership in the medium and high horse-power engines. The two products account for 65 per cent of power generation division's revenues.

Key profit support will come from industrials segment. In past two years, when demand for power generation segment was weak, Cummins India increased its focus on the industrials division and this strategy is yielding positive results. Industrials segment now accounts for 12 per cent of revenues and is growing fast. Strong growth by the industrials segment could partly offset for faint exports, weak since FY15. But in Q1FY17, when the management said they are beginning to see flattish trends in exports, it gave analysts confidence that concern on exports are bottoming out. "Even as global markets are expected to remain soft, the extended product range and offering are likely to contain the weakness in export market," says Renu Baid of IIFL.

The worrisome factor for now is the constant downward pressure on operating margins, thanks to aggressive pricing from international firms. While margins are settling at 16 per cent level, it needs to be seen if Cummins India will cede margins to keep leadership. Prabhudas Lilladher says an improvement in plant use (now at 50 per cent) could leave upside surprises on margins.